financial strategy
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McGraw-Hill/IrwinRetailing Management, 6/e
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 6
Financial Strategy
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6-2
Retailing Strategy
Retail Market Strategy Chapter 5
Financial Strategy Chapter 6
Retail Locations Chapters 7,8
Human Resource Management
Chapter 9
Information and Distribution Systems Chapter 10
Customer Relationship Management Chapter 11
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6-3
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
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6-4
Financial Tradeoff Made by Retailers to Increase ROI
Asset Turnover
Net Profit Margin
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6-5
The Strategic Profit Model: An Overview
Profit Margin x Asset turnover = Return on assets
Net profit x Net sales (crossed out) = Net profitNet sales (crossed out) Total assets Total assets
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6-6
Components of the Strategic Profit Model
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The Strategic Profit Model: Profit Management
Net Profit Margin
Sales
Net Profit
Gross Margin
Total Expenses
Sales
Cost of Goods Sold
15%
15
40
100
60
100 25
-
-
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The Strategic Profit Model: Asset Management
Asset Turnover
Total Assets
Sales
Current Assets
Fixed Assets
Inventory
Accounts Receivable
2.5
100
10
5
4
40
30
+ +
+
Other Current Assets
1
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6-9
The Strategic Profit Model: Return on Assets
Net Profit Margin
Sales
Net Profit Gross Mar
Total Exp.
Sales
Cost Goods Sold
15%
15 40
100
60100 25
--
Asset Turnover
Total Assets
Sales
Current Assets
Fixed Assets
Inventory
A/R
2.5
100
10
5
440
30
+ +
+
Other Cur Assets
1
Return onAssets
37.5%Times
Net Profit Net Profit Net Sales
Total Assets = Net Sales
x Total Assets
Net Sales
Total Assets( )
Net Profit
Net Sales( )
Net Profit
Total Assets( )
÷
÷
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6-10Financial Implications of Strategies Used By
a Bakery and Jewelry Store
Net Profit X Asset = Return on Assets Margin Turnover
La Madeline Bakery 1% X 10 times = 10%
Kalame Jewelry 10% X 1 time = 10%
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6-11
Income Statements for Federated Department Stores and Costco
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Profit Management Path for Federated and Costco
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Net Sales
Gross MarginGross Margin
Gross Sales
Less ReturnsLess customer allowances
COGS
Components of Gross Margin
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Gross Margin for Federated and Costco
Gross Margin = Gross Margin %Net Sales
Federated: $ 6,333 = 40.5%$15,630
Costco: $ 6,014 = 12.5%$48,107
Gross Margin = Gross Margin %Net Sales
Federated: $ 6,333 = 40.5%$15,630
Costco: $ 6,014 = 12.5%$48,107
Why does Federated have higher margins than Costco?
Does the higher margins mean the Federated’s is more profitable?
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Operating Expenses
Operating Expenses = Operating Expenses % Net sales
Federated: $4,933 = 31.6% $15,630
Costco: $4,629 = 9.6% $48,107
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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
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Net Profit
Net Profit = Net Profit %Net sales
Federated: $689 = 4.4% $15,630
Costco: $882 = 1.8% $48,107
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Asset Information from Federated’s and Costco’s Balance Sheet
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Asset Management Path for Federated and Costco
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Inventory Turnover
Cost of Goods = Inventory TurnoverAverage inventory
Federated: $9,297 = 3.0 $3,120
Costco: $42,093 = 11.6 $ 3,644
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Inventory Turnover
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Asset Turnover
Net Sales = Asset TurnoverTotal Assets
Federated: $15,630 = 1.1 $14,885
Costco: $48,107 = 3.2 $15,093
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Return on Assets
Net Profit Margin x Asset Turnover = Return on Assets
Federated: 4.41 x 1.05 = 4.63%Costco: 1.83 x 3.29 = 5.84%
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Strategic Profit Model Ratios for Selected Retailers
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Income Statement for Gifts to Go
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Gross Margin Percent
Gross Margin = Gross Margin Percent Net Sales
Stores: $350,000 = 50% $700,000
GiftstoGo.com $220,000 = 50% $440,000
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Operating Expense Percent
Operating Expenses = Operating Expenses % Net Sales
Stores: $250,000 = 35.7% $700,000
GiftstoGo.com: $150,000 34.1% $440,000
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Net Profit Percentage
Net Profit = Net Profit PercentageNet Sales
Stores: $ 59,800 = 8.5% $700,000
GiftstoGo.com: $ 45,500 = 10.3% $440,000
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Balance Sheet Information for Gifts to Go and Proposed Internet Channel
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Inventory Turnover
Cost of Goods = Inventory TurnoverAverage Inventory
Stores: $350,000 = 2.0 $175,000
GiftstoGo.com: $220,000 = 3.1 $ 70,000
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Asset Turnover
Net Sales = Asset TurnoverTotal Assets
Stores: $700,000 = 1.84 $380,000
GiftstoGo.com: $440,000 = 2.09 $211,000
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Return on Assets
Net Profit Margin x Asset Turnover = Return on Assets
Stores: 8.54 x 1.84 = 15.7%Giststgo.com 10.3 x 2.09 = 21.3%
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Profit Management
Asset Management
The Strategic Profit Model
Net Sales
Cost of goods sold
Variable expenses
Fixed expenses
Gross margin
Total expenses
Net profit
Net Sales
Net profit margin
Asset turnover
Return on assets
-
-
+
Inventory
Accounts receivable
Other current assets
Total current assets
Fixed assets
Net sales
Total assets
+
+ +
x
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6-34
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
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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
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Setting Objectives in Large Retail Organizations
Top Down PlanningCorporate Developmental Strategy
Category, Departments and sales associates implement strategy
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Setting Objectives in Large Retail Organizations
Bottom Up PlanningBuyers and Store managers estimate what they can achieve
Corporate
Operation managers must be involved in objective setting process
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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
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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
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Performance Objectives and Measures Used by Retailers
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Examples of Performance Measures Used by Retailers
Level of Output Input Productivity
Organization (Output/Input)
Corporate Net sales Square feet of Return on assets(measures of store spaceentire corporation)
Net profits Number of Asset turnoveremployees
Growth in sales, Inventory Sales per employeeprofits
Advertising Sales per squareexpenditures foot
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Examples of Performance Measures Used by Retailers
Level of Output Input Productivity
Organization (Output/Input)
Merchandise Net sales Inventory level Gross Margin management Return on(measures for a Investment (GMROI)
merchandisecategory) Gross margin Markdowns Inventory turnover
Growth in sales Advertising Advertising as aexpenses percentage of
sales *
Cost of Markdown as amerchandise percentage of
sales*
* These productivity measures are commonly expressed as an input/output.
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6-43Examples of Performance Measures Used by Retailers
Level of Output Input Productivity
Organization (Output/Input)
Store operations Net sales Square feet of Net sales per(measures for a selling areas square footstore or department Gross margin Expenses for Net sales perwithin a store) utilities sales associate
or per selling hour
Growth in sales Number of sales Utility expenses asassociates a percentage of
sales *
* These productivity measures are commonly expressed as an input/output.
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6-44Illustrative Productivity Measures Used by Retailing Organizations
Level of Output Input Productivity
Organization (Output/Input)
Corporate Net profit Owners’ equity Net profit /(chief executive owners’ equity =officer) return on owners’
equity
Merchandising Gross margin Inventory * Gross margin /(merchandise inventory* = manager and GMROIbuyer)
Store operations Net sales Square foot Net sales /(director of stores, square footstore manager)
*Inventory = Average inventory at cost
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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
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6-46
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/companysearch.html