How Retailers Make Money: The Retail P&L

Introduction

Follow $100 of a shopper's spending through a typical retail P&L. Somewhere between $65 and $75 pays for the goods themselves, delivered to the store, after the discounts the retailer had to give and the stock that was stolen or damaged. Most of what is left pays for the people on the shop floor, the rent, the trucks, the technology and the head office. What remains for the retailer as operating profit is often between $3 and $8. Retailing is a business of thin margins on enormous volume, where a small change in any cost line moves profit by a large proportion.

Walmart shows the arithmetic at scale. In its fiscal year to January 2026, it reported net sales of $706.4 billion, a gross profit rate of 24.2%, operating expenses of 20.9% of net sales and operating income of $29.8 billion, or 4.2% of net sales, according to its Form 10-K. This article works through the retail profit and loss statement (P&L) line by line, then covers the four things that decide where a retailer lands: merchandising, markdowns, shrink and scale.

A retailer does not make what it sells. It earns money by buying goods well, presenting them in the right place at the right time and selling them before they lose value, and every line of the P&L reflects one of those jobs. The cost structure that results is mostly fixed in the short run, which is what makes small changes in sales so powerful.

The ranges vary widely by format. A warehouse club runs on low gross margins and very low costs; a specialty apparel chain runs on high gross margins and high occupancy and labor costs. How those differences play out across formats is covered in the retail format map: how store economics differ.

Traffic, ticket and the sales line

Retail sales break into two parts: how many shoppers buy (transactions or traffic) and how much each spends (average ticket). Ticket in turn breaks into the number of units per transaction and the average price of each unit. The split matters because each part responds to different levers. Traffic responds to location, convenience, price perception and marketing; ticket responds to assortment, merchandising, promotions and inflation.

A retailer reporting 3% sales growth from 4% higher ticket and 1% lower traffic is in a weaker position than one growing 3% from rising traffic. Higher prices can lift ticket for a while, but falling traffic means fewer shoppers are choosing the store, and that usually shows up in sales later. Bankers therefore ask for the split every time a retailer reports growth.

Where the costs sit

Retailers do not all draw the gross margin line in the same place. Many specialty retailers report a "cost of sales, buying and occupancy" line that puts store rent and the cost of the buying team above gross margin, while others, including most big-box chains, report occupancy in operating expenses. Distribution and inbound freight can sit in either place too, which affects any peer comparison. The accounting choices are covered in the Accounting guide's retail accounting.

Other income: the line that is growing

A growing share of retail profit comes from outside the product margin, through high-margin income streams. Warehouse clubs charge membership fees: Costco collected $5.32 billion of them in its fiscal year to August 2025, against net income of $8.10 billion, according to its fiscal 2025 results. Walmart reported $6.75 billion of membership and other income. Retailers also earn a share of credit card economics and sell advertising to the brands on their shelves, income streams covered in retail media, loyalty and card income for retailers. These streams carry far higher margins than selling goods, so even a small share of revenue can be a large share of profit.

The merchant is the retailer's central figure: the buyer who decides what to sell, from which suppliers, at what price and in what quantity. Merchandising decisions set gross margin before a single shopper walks in.

Assortment planning decides the breadth of a category (how many different products, or stock-keeping units) and its depth (how many units of each). A broad assortment wins shoppers who want choice but ties up more inventory and produces more slow sellers; a narrow assortment turns faster and lets the retailer buy each item in bigger volumes at lower cost. Retailers judge each product on its sales and margin per unit of shelf space, and they regularly cut slow sellers to make room for better ones.

Space, planograms and category management

Shelf space is a retailer's scarcest resource, and space productivity is how it is judged. Stores allocate space to categories based on their sales and margin per square foot, then lay out each shelf through planograms, diagrams that set exactly which products sit where and how many facings each gets. Products at eye level and on end-of-aisle displays sell far more than those on the bottom shelf, so placement is negotiated with suppliers and often paid for. Many retailers appoint a leading supplier in each category to advise on assortment and layout, a role covered with the rest of retailer-supplier dynamics in the fundamentals section.

Open-to-buy: the merchant's budget

Merchants cannot buy whatever they like, and the inventory plan sets the limit. Each department works within a budget that ties purchases to the sales plan.

Open-to-Buy (OTB)

The amount of merchandise, at cost or at retail value, that a buyer can still order for a period without exceeding the inventory plan. It is calculated from planned sales, planned markdowns and planned ending inventory, less beginning inventory and goods already on order.

The calculation forces buying discipline. A buyer who overspends early in a season has no budget left for reorders of hot items, while one who holds back keeps reorder flexibility to chase what is selling.

Vendor funding and payment terms

Retailers negotiate more than the purchase price. Suppliers pay vendor allowances for promotions, new listings and advertising, contribute to markdowns on slow sellers and grant payment terms that let the retailer sell goods before paying for them. A retailer that turns inventory faster than its payment terms gets suppliers to finance part of its working capital. The balance of power behind these terms is covered in retailer power, shelf space and customer concentration.

Private label is the other lever. Store brands usually carry higher gross margins than national brands and give the retailer a reason for shoppers to visit, which is why most large chains keep expanding their own-brand ranges, a topic covered in private label vs national brands.

Pricing strategy: everyday low price or high-low

Retailers choose between two broad pricing philosophies, and the choice shapes the whole P&L.

Most retailers mix the two, using everyday low prices on traffic-driving staples and promotions on seasonal and discretionary goods. Bankers look at the share of sales made on promotion and how it has moved, since a rising promotional share usually means the retailer is buying traffic it can no longer earn on price or assortment.

Every retailer sells some goods for less than planned. Markdowns come in two forms. Promotional markdowns are temporary price cuts designed to bring in traffic; permanent markdowns cut the price of goods that are not selling so they can be cleared. Both reduce gross margin, and the second is a sign the merchant bought too much or the wrong thing.

The risk depends on the product. Basics such as groceries, household goods and replenishment items rarely need deep markdowns because they sell steadily and can be reordered quickly. Fashion and seasonal goods, such as apparel, holiday decorations and outdoor furniture, must be sold within a short window; after it closes, their value falls sharply. A retailer's exposure to markdowns therefore tracks its mix of seasonal and fashion merchandise.

Managing markdown risk

Retailers manage the risk through a sequence of decisions:

Retailers that price the first markdown well clear goods at higher prices than those that wait, and markdown optimization tools now set the timing and depth of discounts store by store. Inventory that cannot be sold at or above cost must be written down, and the ratios bankers use to judge whether inventory is healthy are covered in inventory turns, GMROI and retail working capital.

Why inventory risk drives retail credit

Inventory is usually a retailer's largest current asset, and its value depends on how quickly it sells. That is why asset-based lenders lend against inventory at a discount to its book value, set by appraisals of what it would fetch in a liquidation. When markdowns rise, the liquidation value of the inventory falls, borrowing capacity shrinks and a weak season can become a liquidity problem, a sequence that sits behind many retail distress cases.

The mechanics are simple. A lender might advance 85% to 90% of the appraised net orderly liquidation value of inventory, and that value is itself a fraction of cost that falls when goods age or markdowns deepen. A retailer that ends a season with too much stale inventory finds its borrowing base shrinking just when it needs cash to buy for the next season, which is why bankers watch inventory quality as closely as the P&L when a retailer's results start to slip.

Not every item a retailer buys is sold. Some are lost to external theft or employee theft, some are damaged and some disappear through errors in receiving, pricing or record-keeping.

Shrink

The difference between the inventory a retailer's records say it should have and the inventory it actually counts, expressed as a percentage of sales. Shrink combines external theft, employee theft, damage and administrative or process errors, and is recorded in cost of goods sold.

Shrink matters because of the thin margins it comes out of. The National Retail Federation's (NRF) 2023 National Retail Security Survey found an average shrink rate of 1.6% of sales in fiscal 2022, up from 1.4% a year earlier, equal to about $112.1 billion of losses, with external and internal theft together accounting for 65% of shrink, according to the NRF's summary of the survey.

The arithmetic is unforgiving. A retailer with $10 billion of sales and a 4% operating margin earns $400 million. If shrink rises by half a percentage point, it loses $50 million, or one-eighth of its operating profit, without selling a single item less. That is why loss prevention became a regular topic on earnings calls when shrink rose.

Responses and their costs

Retailers fight shrink with tools that each carry a cost of their own:

The judgment is about net profit, not shrink alone. A retailer that locks up half a category may cut losses but lose more in sales, so bankers ask how shrink initiatives have affected sales and labor costs as well as the shrink rate.

Why shrink arrives as a surprise

Shrink also arrives as a surprise. Most retailers measure it through physical inventory counts taken once or a few times a year, and accrue an estimate in between. When a count shows shrink running above the estimate, the retailer records the difference at once, which can turn a quarter's gross margin without warning. Bankers ask how often a retailer counts, how its shrink accrual compares with the results of past counts and which categories and stores drive the losses.

The largest retailers enjoy cost advantages that compound over time. Purchasing scale wins lower prices and better terms from suppliers. Density of stores and distribution centers lowers the cost of moving each item. Fixed costs such as technology, data science, marketing and head office are spread over far more sales. And higher-margin income streams, from advertising to memberships, grow fastest at the largest chains because brands want to reach their shoppers.

Scale feeds a flywheel. Lower costs allow lower prices, lower prices bring more traffic, more traffic brings more volume and more volume lowers costs again. Walmart's annual report says it expects advertising and other higher-margin initiatives to drive operating income faster than net sales over time, and its US business grew comparable sales 4.3% in the latest fiscal year, with e-commerce contributing about 4.3 percentage points. The economics of value formats built on this logic are covered in value retail: clubs, dollar stores and off-price.

Distribution networks and the supply chain

Behind every store sits a distribution network: regional distribution centers that receive goods from suppliers, sort them and send mixed loads to stores. A dense network cuts the miles each truck drives, lets stores carry less backroom inventory and makes frequent replenishment possible, which keeps shelves full without excess stock. Cross-docking, in which goods move from inbound to outbound trucks with little or no storage, speeds the flow further for fast-moving items.

The same network now serves online orders, either from dedicated fulfillment centers or from the stores themselves. How retailers share the cost of stores between in-store and online sales, and why picking orders in stores changes the economics, is covered in omnichannel and e-commerce economics for retailers. For bankers, the supply chain is often where scale shows up most clearly in the numbers, through lower freight and distribution costs per dollar of sales.

How smaller retailers compete

Smaller retailers rarely win on price against the giants, so they compete on something scale cannot easily copy:

These advantages are real but fragile. A specialist that loses its edge in assortment or service ends up competing on price with retailers whose costs are lower, which is the path many failed chains followed.

When a coverage banker analyzes a retailer, the P&L becomes a set of questions about each line, and the operating model is built from those answers.

The steps rest on a few key metrics. Sales growth breaks down into comparable sales from existing stores and growth from new ones, as explained in comparable sales: how same-store sales work. Gross margin breaks down into merchandise mix, markdowns, shrink, freight and vendor funding. Costs break down into fixed and variable parts, which decide how much margin expands when sales rise, a dynamic covered in retail margins: gross margin, occupancy and SG&A leverage.

The core diligence questions follow from that breakdown:

For a coverage banker, the retail P&L is a lesson in leverage. Every line is small relative to sales, but together they decide whether a retailer earns a margin of 2% or 8%, and the retailers that win are the ones that keep finding fractions of a percentage point in buying, pricing, loss prevention and scale.