Chapter 12 Operations Management Financial Dimensions Dr Pointers

Chapter 12 Operations Management: Financial Dimensions Dr. Pointer’s notes

Chapter Objectives ³ To define operations management ³ To discuss profit planning ³ To describe asset management, including the strategic profit model, other key business ratios, and financial trends in retailing ³ To look at retail budgeting ³ To examine resource allocation 12 -2

Operations Management • Operations Management is the efficient and effective implementation of the policies and tasks necessary to satisfy the firm’s customers, employees, and management and stockholders. • Managers must be knowledgeable of the major financial ratios and statements which can help in planning and evaluating the success of a retail operations. 12 -3

Profit Planning One of the most important statement to understand is the P & L Statement ¯ Profit-and-loss (income) statement – Summary of a retailer’s revenues and expenses over a given period of time, usually a year. – Review of overall and specific revenues and costs for similar periods and profitability 12 -4

Major Components of a Profit-and-Loss Statement • Net Sales • Cost of Goods Sold • Gross Profit (Margin) • Operating Expenses • Taxes • Net Profit After Taxes 12 -5 Net Sales $330, 000 CGS $180, 000 Gross Profit $150, 000 Operating Expenses $ 95, 250 Other Costs $ 20, 000 Total Costs $115, 250 Net Profit before Taxes $ 34, 750 Taxes $ 15, 500 Net Profit after Taxes $ 19, 250

Major Components of P & L Statements • Net Sales – revenues minuses returns, markdowns and employee discounts • Cost of Goods Sold- amount paid for merchandise, less discounts. • Gross profit (margin), the difference between net sales and cost of goods sold. • Operating expenses – the cost of running a retail business • Taxes – payments of federal, state and local government taxes • Net profits after taxes - - profit after all taxes and expenses have been paid 12 -6

Asset Management ¯ The Balance Sheet- itemizes a retailers assets, liabilities and network for specific time – Assets- total amount of item with monetary value Current assets – cash on hand Fixed assets – non liquid assets such as property, building, fixtures, equipment and etc – Liabilities – financial obligations owed by retailer – Net Worth- assets minus liabilities (value of business) – Net Profit Margin- performance measures –ratio Net profit/total revenue – Asset Turnover- performance measure that – Return on Assets- performance measure – Financial Leverage – performance measurer 12 -7

Performance Measures • Asset Turnover = Net sales Total assets Return on Assets = Net profit margin X Asset Turnover Financial Leverage = Total Assets Net Worth 12 -8

Assessment of Ratios • Asset Turnover - Best to have ratio greater than 2 because it shows that assets are being used more efficiently • Return on Assets - Ratios close to 1 are good because it shows that assets are properly being utilized • Financial Leverage Ratio – around 2 or less is better. High ratios indicate much higher debt. Need to compare ratio with industry average for good assessment 12 -9

Figure 12. 1 The Strategic Profit Model Net profit Margin X Asset Turnover Net profit Net Sales total Assets X Financial Leverage = Total Assets = Net Worth Return on Net Worth Net profit Net Worth Return on net worth model can help trouble shoot to determine where the major performance problem is. 12 -10

Other Key Business Ratios ¯ Quick Ratio- cash+ acct receivable/current liabilities ( > 1 is good) ¯ Current Ratio – current assets/current liabilities (>2 is preferred) ¯ Collection Period – accts receivable /net sales X by 365. 40 or above for a store with 30 day credit term is means slow turning receivables. ¯ Accounts Payable to Net Sales- accounts receivable / net sales – ratio above industry average indicates that firm rely on suppliers to finance operations ¯ Overall Gross Profit –net sales /cost of goods , then divided by net sales 12 -11

Financial Trends in Retailing ¯ Slow growth in U. S. economy is adversely affecting retailers ( this causes slow sales, then markdowns, cash flow problems which affects profits) ¯ High number of retail lay offs among workers ¯ Funding sources- 3 major types (next slide) ¯ Mergers, consolidations, - many stronger retailers buying smaller retailers. ¯ Spinoffs- some retailers spinoff divisions that no longer meet profit expectations to generate money to use in core businesses. ¯ Bankruptcies and liquidations- safeguard against mounting debts some firms seek bankruptcy protection –Kmart other just sell assets to pay creditors ¯ Questionable accounting and financial reporting practices 12 -12

Funding Sources ¯ Mortgage refinance (due to low interest rates) ¯ REIT (retail-estate investment trust) to fund construction – Company dedicated to owning and operating income-producing real estate ¯ Initial public offering (IPO)- selling stock to finance expansions. 12 -13

Budgeting ¯ Budgeting outlines a retailer’s planned expenditures for a given time based on expected performance ¯ Costs are linked to satisfying target market, employee, and management goals ¯ Successful retailers operate using budgets because they help achieve objectives. 12 -14

Figure 12. 3 The Retail Budgeting Process -Who develops budget -Budget time frame -How often are budgets planned -What are the cost categories -What level of detail is needed -How flexible will budget be 12 -15 Goals Performance Standards Planned Expenditures Monitoring Results Adjustments Actual Expenditures

Budget Benefits ¯ Expenditures are related to expected performance ¯ Costs can be adjusted as goals are revised ¯ Resources are allocated to the right areas ¯ Spending is coordinated ¯ Planning is structured and integrated ¯ Cost standards are set ¯ Expenditures are monitored during a budget cycle ¯ Planned budgets versus actual budgets can be compared ¯ Costs/performance can be compared with industry averages 12 -16

Preliminary Budgeting Decisions 1) 2) 3) 4) 5) 6) 12 -17 Specify budgeting authority Define time frame Determine budgeting frequency Establish cost categories Set level of detail Prescribe budget flexibility

Cost Categories ¯ Capital expenditures are long term investments in lands, buildings, fixtures and equipments ¯ Fixed costs remain constant for specified period. Variable costs will vary based on performance (cost of goods) ¯ Direct costs- incurred by specific departments, product categories and etc. ¯ Natural account expenses- reported by names of costs, such as salaries, ¯ Functional account expenses – classified on the basis of the purpose of activity for which expenditures are made 12 -18

Ongoing Budgeting Process ¯ Set goals based on customer, employee and management needs ¯ Specify performance standards ( usually related to sales forecast) ¯ Plan expenditures in terms of performance goals: Zero based budgeting – new budget developed from scratch or incremental budgeting where past budget is used as a guide and adjusted ¯ Make actual expenditures ¯ Monitor results ¯ Adjust budget s needed ¯ Cash Flow – relates to the amount and timing of revenues received and expenditures made during a specific time. 12 -19

Resource Allocation • Capital Expenditures • Operating Expenditures – Long-term – Short-term selling investments in and administrative fixed assets costs in running a business Must have a good estimate of capital and operating expenditures. Need to have the funds needed to run the operations. Must be flexible to take advantage of opportunities. Opportunity costs – the possible benefits a retailer forgoes if it invests in one opportunity rather another 12 -20

Enhancing Productivity ¯ Productivity refers to efficiency with which a retail strategy is carried out. ¯ Big question is how can sales and profitability be maintained and costs be decreased. ¯ A firm can improve employee performance, sales per foot of space, and other factors by upgrading training programs, increasing advertising, etc. ¯ It can reduce costs by automating, having suppliers do certain tasks, etc. 12 -21

Questions Look for class assignment with problems. 12 -22