Rethinking Retail Metrics: Why COGP is a Better Indicator than COGS

4 TODAY JUL-AUG 21

When reviewing a profit and loss statement one of the traditional benchmarking metrics is Cost of Goods Sold (COGS). What exactly is COGS anyway? Also referred to as Cost of Sales cost of goods sold is just what it says it is the cost of all of the inventory sold during a given period.

Paul Erickson a colleague of mine at Management One describes COGS as “the most misleading metric in retail.” He prefers to use Cost of Goods Purchased (COGP) as it more directly relates to cash flow and thus the financial health of the business. COGP is determined by simply subtracting purchases from sales for the same period. Paul’s claim is that using COGS can provide a retailer with a somewhat unhealthy financial perspective since selling very little at full price can result in a very good COGS. Using COGP on the other hand relates purchases directly back to cash flow. The following example illustrates the difference between the two.

Example

Let’s assume that you bought 50 widgets for the current season. After four months you were only able to sell 5 of the widgets but they all sold at full price. Your cost of goods sold would be excellent since the cost of selling the widgets did not require any discounting to generate the sales. Herein lies the problem… you still have 45 widgets that you have already paid for remaining in unsold inventory. The cost of goods purchased in this example would paint a much different picture and it wouldn’t be pretty.

Not to complicate issues but it needs to be stated that varying accounting methods will have a bearing on COGS. FIFO and LIFO are the most widely used methods.

Accepted Accounting Methods

FIFO is the most trusted and easiest to use. Simply stated FIFO or first in first out assumes that items purchased first were also the items sold first. LIFO (last in first out) on the other hand would recognize that items purchased last would be sold first. Whichever method you use know that there will be a difference in profits and therefore income taxes.

The FISH Accounting Method

Though clearly not recognized by generally accepted accounting practices this is where the FISH accounting method comes into play – first in still here. I see this all too often especially in the footwear business. Has this ever happened to you? A style or styles get purchased generally with no regard to the merchandise plan get put on the “wall” amidst the rest of the assortment and end up getting lost. The style doesn’t sell as it should and for reasons unknown to all does not get returned or marked down. The result…COGS – excellent! COGP – horrible! The lifeblood of any retail establishment is cash flow and COGS does not take that into account. To add insult to injury if the item is still in the store at inventory time you get to pay taxes on merchandise that a) shouldn’t have been bought in the first place and b) should have been either stock balanced with the vendor or marked down. This is what is meant by the FISH method of accounting.

Overstocked/Understocked

I know this may sound like a contradiction in terms but I see this situation often. When reviewing data at the total company level it often appears at first glance that a store has way more inventory than needed to do the business forecasted for a given time period. However when you drill down to the class/subclass level what you find is an inventory level void of current fresh seasonal product that is way below levels sufficient enough to produce planned sales. As a result sales suffer and both inventory turnover and GMROI are reduced.

Paying Attention to Inventory

Open-to-buy is also restricted due to the inventory number being inflated with unsaleable merchandise. If this situation is not recognized and dealt with no new merchandise is purchased and sales get even worse.

Overstocked/Understocked Dilemma

You can also encounter the overstocked/understocked dilemma when stores have broken sizes discontinued vendors and dated inventory that has not been identified. I refer to this situation as having “a whole lot of nothing.” A store operating this way can never achieve its true upside potential.

Self-Checking Purchases

One simple way of self-checking is to pay attention to purchases. A retailer typically should receive somewhat more than it sells. If not chances are good that the store is not buying enough new merchandise. If receipts are way over what is to be sold for a given period Cost of Goods Sold vs. Cost of Goods Purchased.

NSRA Staff Profile

Tanja Clark

Membership Director Event Planner and Office Manager

Tanja Clark (pronounced Tan-Ya) was hired as NSRA Membership Director in December 2009. During her 11 years at NSRA she has been promoted and now includes Event Planner and Office Manager in her job title. She loves working with the NSRA team and believes every person adds so much personality to the office.

Before coming to NSRA Tanja worked as an Individual Education Plan Coordinator in the Amphitheater School District in Tucson keeping meetings services and records straight for children with special needs. She has had the opportunity to work in many occupations from being the first 12-year-old Summer Camp Counselor for the Kirkland (WA) Boys & Girls Club to sales and scheduling for white water rafting experiences to drafting of commercial kitchens.

Advocacy and Family

In her off time she is a medical advocate for her high-functioning autistic son and for her younger sister who has multiple sclerosis. “When I’m not working for NSRA they are my other bosses” she says. “I love helping my family live the best lives they can.”

Travel and Exploration

She loves to travel and has been fortunate enough to see some spectacular places and do some amazing activities. “My favorite place is a toss-up between Turkey and Italy. They both have their unique charms and I fell in love when visiting these countries.”

Work and Relationships

Tanja’s favorite part of working at the NSRA is the relationships she has with her co-workers and she has so much fun both in the office and when traveling for the Association. The Leadership Conference is a close second. “I love seeing our retailers any time but at our conference I get to see them build relationships with their peers and with vendors. They always grow personally and as a business as a result. The vendors are a kick they know how to have fun and provide lots of entertainment but underneath it all they really care about the independent shoe retailers.”

Gratitude and Future Plans

Tanja is grateful to be a part of NSRA and to be able to live her dream of planning events as part of her job. “I am able to be craft-oriented once more and watch people enjoy the work done by not only me but all of the NSRA staff. I look forward to many more years with the NSRA its staff and our members.”

• The store is most likely in an overbought situation leading to potential cash flow issues let alone future markdowns.

The solution is clearly to recognize

Mistakes quickly and take action.

Margin is great but it’s no substitute for CASH. Consider this would you rather have:

• A store full of aging inventory decreasing sales slow turnover low markdowns and poor cash flow BUT…a healthy gross margin percentage on the profit and loss statement or
• The potential for higher sales due to tighter inventory levels with fresh new product OTB for fill-ins off-price merchandise and new vendors and faster inventory turnover (cash flow) even though it may mean (but not always) sacrificing a few precious margin points?

COVID-caused issues notwithstanding this shouldn’t be a difficult choice yet we often see examples of shoe stores choosing option A.

Next time you are complimenting yourself on a “healthy” cost of goods sold figure go one step further and simply subtract your purchases from your sales to determine cost of goods purchased. If you are doing it right you can pat yourself on the back with both hands. If not we are always here to help.

Ritchie Sayner is with Advanced Retail Strategies LLC an affiliate of Management One. Sayner’s book Retail Revelations: Strategies for Improving Sales Margins and Turnover (2nd Ed.) is available on Amazon. He can be reached at advancedretailstrategies.com.

Sayner continued from page 4

Ritchie Sayner

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