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How to calculate margins when working with clothing wholesalers

If you’re running a clothing retailer, knowing your margins down to the finest detail is the key to a healthy business. But it’s an area that can seem a lot more complicated than you might first imagine. This article will break down the different types of pricing into simple chunks, so you can better keep on top of your finances.

key terms: wholesale, retail, margins, and markup

It’s important to start by defining what we mean by all the financial terms mentioned in this article, or which you’ll see in the wider world. The are: wholesale price; ex-VAT vs inc-VAT; retail/selling price; gross margin and markup; and net margin. Let’s go through them one by one.

WHOLESALE PRICE
This is the price you pay the wholesaler for the goods. There could be a set price, but often the per-item price decreases as you buy more of the product in a single transaction. Bulk discounts might apply to a very specific product (e.g. size M, white, Fruit of the Loom Ladies Iconic 195 Premium T-Shirt), where the discount applies only to that product. Alternatively, the discount might apply to a wide selection of sizes, colours or styles bought in a single transaction, or over a certain period of time. Different wholesalers have different policies here.

EX-VAT (EXCLUDING VAT)
The pure cost of the item, without value added tax (VAT) is termed “ex-VAT”. This is the price that businesses typically work from, as VAT-registered businesses can reclaim the VAT they pay. So, a £10 ex-VAT item might cost £12 including VAT (as VAT on clothing is 20% at the time of writing), but the real cost to the business is £10, as they can claim back the £2 later. Note that there is no VAT on children’s clothing.

INC-VAT (INCLUDING VAT)
The inc-VAT price is what consumers would pay, but some smaller businesses are not VAT-registered, so that is the price they would pay as well, and they would not be able to claim it back. If your business’s taxable turnover for a 12-month period exceeds £90,000, you must register for VAT. If your turnover is below that amount, you can still voluntarily register to take advantage of the benefits.

RETAIL PRICE
The retail price is the price charged to the end customer. Typically, this is presented as inc-VAT for consumers (basically, where they are forced to pay VAT), but businesses often calculate it as ex-VAT when working out margins.

GROSS MARGIN VS MARKUP
Gross margin and markup are both concerned with the relationship between what you (the business) pays and what the customer pays, but they are expressed in different ways. Gross margin is expressed as a percentage of revenue (how much of each pound of sales is profit after direct costs are subtracted). Revenue is often called “turnover” in the UK, although turnover tends to be used solely for sales, whereas revenue can also cover other forms of income, like bank interest. Markup is expressed as a percentage of cost (how much you’re adding on top). Let’s use an example: a hoodie you buy for £40 and sell for £100. 

The gross margin is:
(Selling price − Cost) ÷ Selling price
= (£100 − £40) ÷ £100 
= 0.6 (60%)

The markup is:
(Selling price − Cost) ÷ Cost
= (£100 − £40) ÷ £40 
= 1.5 (150%)

NET MARGIN
Calculating gross margin is useful because it lets you determine your profits based on the cost of goods sold (COGS), but for most businesses, there are several other costs to take into account. For example, there are wages, rent, utilities, shipping, marketing, loans, taxes, and, if you are customising garments, the costs associated with materials and labour that go into the finished product. Net margin considers all other business costs to give you a more accurate picture of what your profits look like.
The formula is: Net profit ÷ Revenue = Net margin

If we go back to our hoodie, you’ll see a different figure between gross margin and net margin:
Gross profit = £60 (60% gross margin, as calculated above)

But if overheads are £45 per item, your net profit is only £15, which works out to a 15% net margin.
It’s really important that you keep your net margins positive. A common error for people starting retail businesses is ignoring the true costs and focusing on gross margins. It’s a mistake that can catch up with you very quickly.

what is your "true cost"?

As we mentioned above under “Net margin”, the cost of the items you pay the wholesaler is not your only cost, as nice as that would be. It’s easy to work out a gross margin for your retail operation and assume the business is going swimmingly. But there are multiple costs that erode your profits. Delivery and shipping from the wholesaler are key costs. It’s not uncommon for wholesalers to offer free shipping when you spend a certain amount on their products (something that happens in retail, too). You might see that as a saving, and it often is, but be wary. When buying in large quantities, whether to benefit from discounted shipping or lower per-unit prices, you need to make sure you are not over-ordering, as it can lead to additional costs elsewhere. For example, you should consider storage, insurance, and the risk of items going out of fashion and becoming unsellable.
Also, don’t forget that once you’ve paid for the products, you no longer have that cash, so your liquidity takes a hit. That can have implications for loan or overdraft fees, as well as your spending power in other areas of your business. Think very carefully before buying in bulk, however good the deal appears.

If you are offering free delivery to customers, that’s clearly not going to be free for you, as you need to pay the courier. Be careful when offering such a deal, and only deploy it if your margins can cover it while you still keep your target margins. It can be a good marketing strategy and can give you a competitive edge, but do the maths first.
Some wholesalers have minimum order quantities (MOQs), which means there’s a risk that the costs mentioned above become unavoidable. Do not overlook MOQs, as they can be crippling for start-ups if they are set too high by the wholesaler. If your added costs from MOQs are too high, look for another supplier.
 If you’re getting your products from outside the UK, you’ll probably have to pay customs or import duties. It’s your responsibility to make sure these are paid. There are some countries that the UK has trade deals with that reduce or eliminate such costs, so do your homework when seeking an overseas supplier. 

Another often-overlooked cost comes from wastage, misprints (especially for customisation businesses), or returns. It’s almost inevitable that a certain percentage of the products you sell will fall short of quality expectations. You might discover the errors while the product is in your workshop, which means you need to replace the item, or the customer might discover them, triggering a return. Some businesses have a liberal returns policy, which means customers can return products within a certain timeframe, even if there’s nothing wrong with them. It can be good for giving customers peace of mind, so it might be a valuable marketing decision. However, it can also be open to abuse, so consider your terms and conditions carefully.

In short, the clearer the picture you have of what your overheads are, the healthier your business will be, because they open up the door to savings. You can shop around not only for suppliers, but also for couriers, insurers, storage providers and so on. 

target margins: what should you be aiming for?

As we’ve covered above, there are plenty of costs that are unavoidable for you as a retailer. Only when you know these costs should you consider what prices you will charge your customers. Clearly, there is a balance to be struck here. Charge too much, and you’ll struggle to sell your products. But charge too little, and you won’t make enough profit to make all your time and effort worthwhile. For retail brands, it’s normal to aim for a gross margin of 55–70%. That might sound like a high figure, but don’t forget that you need to factor in all your own costs, which will usually mean your own clear profits are closer to the 10–20% range. 

Low margins are not always a problem if you are dealing with high volumes, as the numbers add up to decent profits, and there’s an economy of scale associated with bulk buying and selling. However, for more niche or boutique operations, you need to focus on maximising your margins, as volume will be lower. It can work if you’re marketing yourself as unique, rare or luxury, or if you have a certain “story” to sell. That’s in the realm of marketing, rather than the pure maths of apparel retail.

do the maths!

As you can see, all margins are not created equal, and they are often confused with other metrics when you’re running a retail or customisation business. If you are not already familiar with them, it’s a good idea to learn how to use spreadsheets so you can get a bird’s-eye view of your operation and identify savings.  Most retailers have certain lines that are more profitable than others, and that’s normal. It all comes down to bringing in customers by being competitive, while maximising your profits by keeping an eye on supply and demand across your range.
 
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