Chapter 6 Financial Strategy Mc GrawHillIrwin Retailing Management

Chapter 6 Financial Strategy Mc. Graw-Hill/Irwin Retailing Management, 6/e Copyright © 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

2 Retailing Strategy Human Resource Management Chapter 9 Retail Locations Chapters 7, 8 Retail Market Strategy Chapter 5 Financial Strategy Chapter 6 Information and Distribution Systems Chapter 10 Customer Relationship Management Chapter 11

3 Retailer Objectives Financial – not necessarily profits, but return on investment (ROI) – primary focus Societal – helping to improve the world around us Personal – self-gratification, status, respect

4 Financial Tradeoff Made by Retailers to Increase ROI Net Profit Margin Asset Turnover

5 The Strategic Profit Model: An Overview Profit Margin x Asset turnover = Return on assets Net profit x Net sales (crossed out) = Net profit Total assets

6 Components of the Strategic Profit Model

7 The Strategic Profit Model: Profit Management Sales Net Profit Margin 15% 15 Gross Margin 100 40 Cost of Goods Sold - Sales Total Expenses 100 25 - 60

The Strategic Profit Model: Asset Management Inventory 5 Sales Asset Turnover 2. 5 100 Total Assets 40 + Current Assets Accounts Receivable 10 4 + + Fixed Assets Other Current Assets 30 1 8

9 The Strategic Profit Model: Return on Assets Sales Net Profit Margin 15% Sales Total Exp. 100 25 ( Net Profit Net Sales ) ÷ Times Sales ) Asset Turnover 100 2. 5 Total Assets ( Net Sales Total Assets Net Profit Total Assets ÷ 40 ) Net Profit = Net Sales 100 - Cost Goods Sold 60 Inventory 37. 5% Net Profit Total Assets 40 - 15 Return on Assets ( Gross Mar Net Sales x Total Assets Current Assets 5 + A/R 10 + Fixed Assets 4 + Other Cur Assets 30 1

Financial Implications of Strategies Used By a Bakery and Jewelry Store 10 La Madeline Bakery Kalame Jewelry Net Profit Margin X Asset = Return on Assets Turnover 1% X 10 times = 10% X 1 time = 10%

11 Income Statements for Federated Department Stores and Costco

Profit Management Path for Federated and Costco 12

13 Components of Gross Margin Gross Sales Less Returns Less customer allowances Gross Margin Net Sales COGS

Gross Margin for Federated and Costco Gross Margin Net Sales = Federated: $ 6, 333 $15, 630 = 40. 5% Costco: = 12. 5% $ 6, 014 $48, 107 Gross Margin % Why does Federated have higher margins than Costco? Does the higher margins mean the Federated’s is more profitable? 14

15 Operating Expenses = Operating Expenses % Net sales Federated: $4, 933 = 31. 6% $15, 630 Costco: $4, 629 = 9. 6% $48, 107

Types of Retail Operating Expenses Selling expenses = Sales staff salaries + Commissions + Benefits General expenses = Rent + Utilities + Miscellaneous expenses Administrative expenses = Salaries of all employees other than salespeople + Operations of buying offices + Other administrative expenses 16

17 Net Profit = Net Profit % Net sales Federated: $689 = 4. 4% $15, 630 Costco: $882 = 1. 8% $48, 107

18 Asset Information from Federated’s and Costco’s Balance Sheet

Asset Management Path for Federated and Costco 19

20 Inventory Turnover Cost of Goods = Average inventory Federated: $9, 297 $3, 120 Costco: Inventory Turnover = 3. 0 $42, 093 = 11. 6 $ 3, 644

21 Inventory Turnover

22 Asset Turnover Net Sales = Asset Turnover Total Assets Federated: $15, 630 = 1. 1 $14, 885 Costco: $48, 107 = 3. 2 $15, 093

23 Return on Assets Net Profit Margin x Asset Turnover = Return on Assets Federated: Costco: 4. 41 1. 83 x x 1. 05 3. 29 = = 4. 63% 5. 84%

Strategic Profit Model Ratios Selected Retailers 24 for

25 Income Statement for Gifts to Go

26 Gross Margin Percent Gross Margin = Gross Margin Percent Net Sales Stores: $350, 000 $700, 000 Giftsto. Go. com $220, 000 $440, 000 = 50%

27 Operating Expense Percent Operating Expenses Net Sales Stores: = Operating Expenses % $250, 000 $700, 000 Giftsto. Go. com: $150, 000 $440, 000 = 35. 7% 34. 1%

28 Net Profit Percentage Net Profit = Net Profit Percentage Net Sales Stores: $ 59, 800 $700, 000 = 8. 5% Giftsto. Go. com: $ 45, 500 $440, 000 = 10. 3%

29 Balance Sheet Information for Gifts to Go and Proposed Internet Channel

30 Inventory Turnover Cost of Goods = Average Inventory Turnover Stores: $350, 000 $175, 000 = 2. 0 Giftsto. Go. com: $220, 000 $ 70, 000 = 3. 1

31 Asset Turnover Net Sales = Total Assets Stores: Asset Turnover $700, 000 $380, 000 Giftsto. Go. com: $440, 000 $211, 000 = 1. 84 = 2. 09

32 Return on Assets Net Profit Margin x Asset Turnover = Return on Assets Stores: 8. 54 Giststgo. com 10. 3 x x 1. 84 2. 09 = 15. 7% = 21. 3%

33 The Strategic Profit Model Net Sales Cost of goods sold Gross margin Variable expenses + Fixed expenses Total expenses Profit Management Net profit margin Net Sales x Inventory Net sales + Accounts receivable Total current assets + + Other current assets Fixed assets Return on assets Asset turnover Total assets Asset Management

34 Productivity Measures Input Measures – assess the amount of resources or money used by the retailer to achieve outputs such as sales Output measures – asses the results of a retailer’s investment decisions Productivity measure – determines how effectively retailers use their resource – what return they get on their investments

Setting and Measuring Performance Objectives Retailers will be better able to gauge performance if it has specific objectives in mind to compare performance. Should include: • numerical index of performance desired • time frame for performance • necessary resources to achieve objectives 35

36 Setting Objectives in Large Retail Organizations Top Down Planning Corporate Developmental Strategy Category, Departments and sales associates implement strategy

37 Setting Objectives in Large Retail Organizations Corporate Bottom Up Planning Buyers and Store managers estimate what they can achieve Operation managers must be involved in objective setting process

38 Financial Performance of Retailers Outputs - Performance • Sales • Profits • Cash flow • Growth in sales, profits – Same store sales growth Inputs Used by Retailers • Inventory ($) • Real Estate (sq. ft. ) • Employees (#) • Overhead (Corporate Staff and Expenses) • Advertising • Energy Costs • MIS expenses

39 Productivity - Outputs/Input • Corporate Level – ROA = Profits/Assets (ROE = Profit/Equity) – Overhead/Sales • Buyers (Inventory, Pricing, Advertising) – Gross Margin % = Gross Margin/Sales – Inv Turnover = COGS/ Avg. Inventory (cost) • GMROI – Gross Margin/Average Inventory – Advertising/sales • Stores (Real Estate, Employees) – Sales/Square Feet inv. Shrinkage/sales – Sales/Employee

Performance Objectives and Measures Used by Retailers 40

Examples of Performance Measures Used by Retailers Level of Output Input Organization Productivity (Output/Input) Corporate Net sales (measures of entire corporation) Net profits Growth in sales, profits Square feet of store space Return on assets Number of employees Asset turnover Inventory Sales per employee Advertising expenditures Sales per square foot 41

Examples of Performance Measures Used by Retailers Level of Output Input Organization Merchandise management (measures for a merchandise category) Productivity (Output/Input) Net sales Inventory level Gross Margin Return on Investment (GMROI) Gross margin Markdowns Inventory turnover Growth in sales Advertising expenses Advertising as a percentage of sales * Cost of merchandise Markdown as a percentage of sales* * These productivity measures are commonly expressed as an input/output. 42

Examples of Performance Measures Used by Retailers Level of Output Input Organization Store operations (measures for a store or department within a store) Productivity (Output/Input) Net sales Square feet of selling areas Net sales per square foot Gross margin Expenses for utilities Net sales per sales associate or per selling hour Growth in sales Number of sales associates Utility expenses as a percentage of sales * * These productivity measures are commonly expressed as an input/output. 43

Illustrative Productivity Measures Used by Retailing Organizations Level of Output Input Organization Productivity (Output/Input) Corporate (chief executive officer) Net profit Owners’ equity Net profit / owners’ equity = return on owners’ equity Merchandising (merchandise manager and buyer) Gross margin Inventory * Gross margin / inventory* = GMROI Square foot Net sales / square foot Store operations Net sales (director of stores, store manager) *Inventory = Average inventory at cost 44

45 Benchmarks Performance of retailer over time – retailer can compare its recent performance to its performance in the preceding months, quarters or years. Performance of a retailer compared to its competitors

46 Sources of Information • Balance Sheet (Snap Shot at One Time) – Asset Management • Income Statement (Summary Over Time) – Margin Management • Annual Reports/ SEC Filings – http: //www. sec. gov/edgar/searchedgar/comp anysearch. html

Federated’s and Costco’s Financial Performance Over Three Years 47

48 Financial Performance of Federated and Other National Department Store Chains