How to Calculate Prime Costs in Retail and Why They Matter

Two business owners discuss retail prime costs with charts and graphs

We’re just past halfway through 2020 and it’s already been quite the ride. And while we’re all hopeful that we’re through the worst of it, there is still a whole lot up in the air. Many small businesses have a bumpy road ahead as the retail industry is forced to adapt to new rules, regulations, and norms.

With all of that said, the future is still bright! But it is a time to think about ways to trim the fat and clean up some of your costs. Even as things improve and the retail world goes back to operating as it once did, businesses can continue using some of these strategies.

One area to consider are prime costs. So let’s look at what they are and how to calculate prime costs in retail. Hopefully, you’ll come away with a better understanding of this part of your business and learn how to keep costs manageable.

What Is a Prime Cost?

Prime costs are simply the sum of all costs that go into running your business. They include all costs of goods sold (COGS) as well as any indirect costs that are needed to keep your business in operation. Prime costs cover a broad spectrum of what it takes to keep a business afloat.

As the name suggests, these costs are some of the most important for any business to consider, whether it’s in retail, events, restaurants, or otherwise. Monitoring it on its most basic level offers businesses a simple picture of their revenue and profitability. Going more in-depth with it can provide invaluable insight into your ordering, staffing, pricing, and more.

What Are Costs of Goods Sold (COGS)?

Any cost of goods sold refers to money that is directly spent on producing what it sells. Calculating your COGS will determine your gross profit once it’s subtracted from total sales. The common items that are included in these costs are labor, materials, manufacturing, and products.

COGS do not include any costs that indirectly contribute to sales, including insurance, overhead costs, sales, or marketing. For most retail businesses, COGS will account for the vast majority of your prime costs.

How Do You Calculate Prime Costs?

Like most retail formulas, calculating the prime cost of something is amazingly simple. The hardest part will be adding up all costs.

Take all COGS and then add all direct labor costs. Then take all sales from the same period in which you calculated the costs. Simply divide costs by the total sales and multiple the total by 100 to get the total percentage of your prime costs.

When adding your total labor costs, don’t forget to include each of the following:

  • All salaries
  • Hourly rates
  • Contract work
  • Commissions
  • Health Insurance
  • Bonuses
  • Overtime pay
  • Paid leave
  • Payroll taxes
  • Retirement

And in addition to the costs of your products when calculating your COGS don’t forget to include all packaging costs.

What’s an Example of a Prime Cost Calculation?

We’ve done similar illustrations before, but just as a disclaimer, this example will be very simple – likely far more simple than any of your businesses. But hopefully it illustrates a basic example and process of completing a retail prime cost calculation and analysis.

  • Let’s say you own a small liquor and wine shop. You’ve had a record-breaking few months due to the general public’s increased desire to consume large amounts of alcohol. Now you want to decide if it’s worth it to have some team members work overtime or bring on an extra staff member during some busier shifts.
  • Start by defining the time frame of your cost analysis. Typically, a larger time frame offers a more accurate portrait unless you have a seasonal business with large ebbs and flows to sales.
  • Once a time frame is decided upon (let’s say April 1-June 30), look at the value of your beginning inventory, how much inventory you purchased, and the value of your ending inventory. Total COGS came out to $250,000 for the three months. All hourly labor costs came to $96,000, with another $15,000 in insurance, bonuses, etc. for a total of $110,000 in prime costs.
  • Now look up your total sales. Let’s say they were $439,000.
  • Take the total prime costs and divide by the total sales – $360,000/$439,000 = 0.82 or 82%.

A healthy prime cost percentage varies widely by industry. This example would be alarmingly high for most retail industries, but again, it’s just a hypothetical.

How Can Retailers Keep Prime Costs Low?

Tracking your prime costs is critical to maintaining a healthy bottom line. And while it shouldn’t inspire you to be cheap, it should inspire businesses to cut back on waste.

Start by determining what an ideal prime cost would be for your business. As mentioned above, this is not a one-size-fits-all model and varies across different businesses. Having a great starting point and clearly defined goals make the process a whole lot smoother.

Investigate your COGS and find ways that you can lower them. Don’t sacrifice quality but keep an eye out for inventory changes, bulk purchases, new vendors, areas of waste, and increased efficiency in your POS inventory management system.

Try to reduce your labor expenses without cutting staff or hours. Manage your scheduling carefully to be sure that busy times are adequately staffed but that slower times have fewer people on the clock. Overtime is another easy area to cut back. Not only will it more likely burn out your best team members, but it will also drive up your labor costs since you’re paying at least 1.5x the normal rate. And finally, reduce staff turnover. It’s remarkably expensive to hire, and onboard new staff, and high rates of turnover are bad for overall morale, too.

The more I learn to use KORONA POS, and with the help of awesome customer support, the more I believe this POS system could be a very good fit for many types of businesses out there. What I love the most about this software is the 24/7 customer service and reporting function which are very easy to use.

-Kevin L.

To learn more about how your retail POS can help, reach out to us at KORONA. The powerful reporting makes breaking down your inventory and sales data incredibly easy. And with hundreds of custom KPI reports, you’ll have an in-depth picture of your business’s performance. Click below to learn more!

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Written By

Michael Chalberg

Michael has long focused his writing on the world of retail and small businesses. He''s been a part of the KORONA POS team since 2018 and loves helping entrepreneurs find ways to adapt and succeed. In his spare time, you'll likely find him hiking somewhere in the Southwest.