chapter 6

McGraw-Hill/IrwinRetailing Management, 6/e

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 6

Financial Strategy

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

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

6-4

Financial Tradeoff Made by Retailers to Increase ROI

Asset Turnover

Net Profit Margin

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

6-6

Components of the Strategic Profit Model

6-7

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

-

-

6-8The 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

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

2.5100

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 SalesTotal Assets( )

Net Profit Net Sales( )

Net ProfitTotal Assets( )

÷

÷

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%

6-11

Income Statements for Federated Department Stores and Costco

6-12

Profit Management Path for Federated and Costco

6-13

Net Sales

Gross MarginGross Margin

Gross SalesLess Returns

Less customer allowances

COGS

Components of Gross Margin

6-14Gross 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

Why does Federated have higher margins than Costco?

Does the higher margins mean the Federated’s is more profitable?

6-15

Operating Expenses

Operating Expenses = Operating Expenses % Net sales

Federated: $4,933 = 31.6% $15,630

Costco: $4,629 = 9.6% $48,107

6-16

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

6-17

Net Profit

Net Profit = Net Profit %Net sales

Federated: $689 = 4.4% $15,630

Costco: $882 = 1.8% $48,107

6-18

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

6-19

Asset Management Path for Federated and Costco

6-20

Inventory Turnover

Cost of Goods = Inventory TurnoverAverage inventory

Federated: $9,297 = 3.0 $3,120

Costco: $42,093 = 11.6 $ 3,644

6-21

Inventory Turnover

6-22

Asset Turnover

Net Sales = Asset TurnoverTotal Assets

Federated: $15,630 = 1.1 $14,885

Costco: $48,107 = 3.2 $15,093

6-23

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%

6-24

Strategic Profit Model Ratios for Selected Retailers

6-25

Income Statement for Gifts to Go

6-26

Gross Margin Percent

Gross Margin = Gross Margin Percent Net Sales

Stores: $350,000 = 50% $700,000

GiftstoGo.com $220,000 = 50% $440,000

6-27

Operating Expense Percent

Operating Expenses = Operating Expenses % Net Sales

Stores: $250,000 = 35.7% $700,000

GiftstoGo.com: $150,000 34.1% $440,000

6-28

Net Profit Percentage

Net Profit = Net Profit PercentageNet Sales

Stores: $ 59,800 = 8.5% $700,000

GiftstoGo.com: $ 45,500 = 10.3% $440,000

6-29

Balance Sheet Information for Gifts to Go and Proposed Internet Channel

6-30

Inventory Turnover

Cost of Goods = Inventory TurnoverAverage Inventory

Stores: $350,000 = 2.0 $175,000

GiftstoGo.com: $220,000 = 3.1 $ 70,000

6-31

Asset Turnover

Net Sales = Asset TurnoverTotal Assets

Stores: $700,000 = 1.84 $380,000

GiftstoGo.com: $440,000 = 2.09 $211,000

6-32

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%

6-33

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

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

6-35

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

6-36

Setting Objectives in Large Retail Organizations

Top Down PlanningCorporate Developmental Strategy

Category, Departments and sales associates implement strategy

6-37

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

6-38

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

6-39

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

6-40

Performance Objectives and Measures Used by Retailers

6-41

Examples of Performance Measures Used by Retailers

Level of Output Input ProductivityOrganization (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

6-42Examples of Performance Measures Used by Retailers

Level of Output Input ProductivityOrganization (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.

6-43Examples of Performance Measures Used by Retailers

Level of Output Input ProductivityOrganization (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.

6-44Illustrative Productivity Measures Used by Retailing Organizations

Level of Output Input ProductivityOrganization (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

6-45

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

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

6-47

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

6-48

Financial Performance of Federated and Other National Department Store Chains