DC Lecture Six: Managing a Retailer's Finances

MKTG 1058: DISTRIBUTION

CHANNELS

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Distribution Channels MKTG 1058LECTURE SIX

2 6-2

(Dunne Chapter Eight)

Managing a Retailer’s Finances

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Learning Objectives for Chapter 8:Learning Objectives for Chapter 8:

•Describe the importance of a merchandise budget and know how to prepare a six-month merchandise plan.

•Explain the differences among and the uses of these three accounting statements: income statement, balance sheet, and statement of cash flow.

•Explain how the retailer is able to value inventory.

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Note:Note:

This is a very practical and technical chapterBased on accounting concepts (you should have covered this before)Much of the content covers the preparation of the merchandise budget and inventory planningLots of detail- read slowly and work out the exercises at the end of the chapterFormulas shown in Exhibit 8-3 (page 262) is very important

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The Merchandise BudgetThe Merchandise Budget

•Merchandising is the planning and control of the buying and selling of gods and services to help the retailer realize its objectives.

•Merchandise budget is a plan of projected sales for an upcoming season, when and how much merchandise is to be purchased, and what markups and reductions will likely occur.

•Gross margin is the difference between net sales and cost of goods sold.

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Five Major Merchandising Decisions Five Major Merchandising Decisions

1. What will be the anticipated sales for the department, division, or store?

2. How much stock on hand will be needed to achieve this sales plan, given the level of inventory turnover expected?

3. What reductions, if any, from the original retail price must be made in order to dispose of all the merchandise brought into the store?

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4. What additional purchases must be made during the season?

5. What gross margin ( the difference between sales and cost of goods sold) should the department, division, or store contribute to the overall profitability of the company?

Five Major Merchandising Decisions Five Major Merchandising Decisions

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Four Rules in Preparing the Merchandise Budget Four Rules in Preparing the Merchandise Budget

•Always be prepared in advance of the selling season.

•The language of the budget must be easy to understand.

•Must be planned of a relatively short period of time (six months is the norm used by most retailers).

•Flexible enough to permit changes.

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Sample Six-Month Merchandise BudgetSample Six-Month Merchandise Budget

Exhibit 8.1(a)

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Exhibit 8.1(b)

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Exhibit 8.1(c)

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Two-Seasons Department Store, Dept.353, Six-Month Merchandise Budget Two-Seasons Department Store, Dept.353, Six-Month Merchandise Budget

Exhibit 8.2

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Formulas for the Six-Month Merchandise BudgetFormulas for the Six-Month Merchandise Budget Exhibit 8.3

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Working out the key steps

Determining the Merchandise Budget

“ THE EIGHT STEP PROCESS”

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Exhibit 8.2

Lets break up the table into different parts; we focus on February only figures

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Lets focus on February

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STEP ONE:STEP ONE:

(Planned Sales Percentage for the Month )X (Planned Total Sales)

= (Planned Sales for the Month)

Determining Planned Sales for the Month

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(Planned Sales Percentage for the Month )

X (Planned Total Sales)

= (Planned Sales for the Month)

15% X 500,000

= 75,000

How to Figure: Planned Sales for the MonthHow to Figure: Planned Sales for the Month

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STEP TWO:STEP TWO:

(Planned Sales for the Month ) X(Planned BOM Stock-to-Sales Ratio for the

Month) = (Planned BOM Stock for the Month)

Determining Planned BOM Stock for the Month

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X 3

=

75,000

(Planned Sales for the Month )

X (Planned BOM Stock-to-Sales Ratio for the Month)

= (Planned BOM Stock for the Month)

225,000

How to Figure: Planned BOM Stock for the MonthHow to Figure: Planned BOM Stock for the Month

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STEP THREE:STEP THREE:

(Planned Sales for the Month ) X (Planned Retail Reduction Percentage for the

Month) = (Planned Retail Reduction for the Month)

Determining Planned Retail Reductionsfor the Month

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X 10%

=

75,000

7,500

(Planned Sales for the Month )

X (Planned Retail Reduction Percentage for the Month)

= (Planned Retail Reduction for the Month)

How to Figure: Planned Retail Reductions for the MonthHow to Figure: Planned Retail Reductions for the Month

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STEP FOUR:STEP FOUR:

(Planned BOM Stock for the Following Month )= (Planned EOM Stock for The Current Month)

Determining Planned EOM Stock for the Month

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=300,000 300,000

(Planned BOM Stock for the Following Month )

= (Planned EOM Stock for The Current Month)

How to Figure: Planned BOM Stock for the Following MonthHow to Figure: Planned BOM Stock for the Following Month

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STEP FIVE:STEP FIVE:

(Planned Sales for the Month ) + (Planned Retail Reductions for the Month) + (Planned EOM Stock for the Month) - (Planned BOM

Stock for the Month) = (Planned Purchases at Retail for the Month)

Determining Planned Purchases at Retailfor the Month

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How to Figure: Planned Purchases at Retail for the MonthHow to Figure: Planned Purchases at Retail for the Month

= 157,500

(Planned Sales for the Month ) + (Planned Retail Reductions for the Month)

+ (Planned EOM Stock for the Month) - (Planned BOM Stock for the Month)

= (Planned Purchases at Retail for the Month)

+75,000

300,000

7,500

225,000+ -

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STEP SIX:STEP SIX:

(Planned Purchases at Retail for the Month )X (100% minus Planned Initial Markup

Percentage) = (Planned Purchases at Cost for the Month)

Determining Planned Purchases at Costfor the Month

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How to Figure: Planned Purchases at Cost for the MonthHow to Figure: Planned Purchases at Cost for the Month

=

157,500 X

86,625

(100 - 45%)

(Planned Purchases at Retail for the Month )

X (100% - Planned Initial Markup Percentage)

= (Planned Purchases at Cost for the Month)

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STEP SEVEN:STEP SEVEN:

(Planned Purchases at Retail for the Month ) X (Planned Initial Markup Percentage) = (Planned Initial Markup for the Month)

OR(Planned Purchases at Retail for the Month) -(Planned Purchases at Cost for the Month) =(Planned Initial Markup for the Month)

Determining Planned Initial Markupfor the Month

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How to Figure: Planned Initial Markup for the MonthHow to Figure: Planned Initial Markup for the Month

=

157,500 X 45%

(Planned Purchases at Retail for the Month )X (Planned Initial Markup Percentage)

= (Planned Initial Markup for the Month)

70,875

First Formula

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How to Figure: Planned Initial Markup for the MonthHow to Figure: Planned Initial Markup for the Month

Second Formula

(Planned Purchases at Retail for the Month)- (Planned Purchases at Cost for the Month)

= (Planned Initial Markup for the Month)

157,500 86,625-

= 70,875

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( - )

=

STEP EIGHT:STEP EIGHT:

(Planned Initial Markup for the Month) -(Planned retail Reductions for the Month) = (Planned Gross Margin for the Month)

Determining Planned Gross Marginfor the Month

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How to Figure: Gross Margin for the MonthHow to Figure: Gross Margin for the Month

63,375

7,500-

=

70,875

(Planned Initial Markup for the Month )

- (Planned Retail Reductions for the Month)

= (Planned Gross Margin for the Month)

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Analysis of Case Study (Chapter Eight)

Dolly’s Place

See details in your Outline Lecture Notes- pages 63-65

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Dolly's Place Three-Month Merchandise Budget

Date: January 7, 2009 Season: Spring 2009

Seasonal

Spring February March April Total

1.Planned BOM Stock

2.Planned Sales

3.Planned Retail Reductions

4.Planned EOM Stock

5.Planned Purchases @ Retail

6.Planned Purchases @ Cost

7.Planned Initial Markup

8.Planned Gross Margin

9.Planned BOM Stock/Sales Ratio

3.0x 5.0x 6.0x _________

10.Planned Sales Percentage 33% 40% 27% 100%

11.Planned Retail Reduction 5% 10% 20% 11.05%

Planned Total Sales for the Period $250,000 Planned Total Retail Reduction Percentage For the Period 11.05% Planned Initial Markup Percentage For the Period 45% Planned BOM Stock for May $400,000

Step 1: work out the Planned Sales

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Seasonal


1.Planned BOM Stock

2.Planned Sales


4.Planned EOM Stock






3.0x 5.0x 6.0x _________




Step 1: work out the Planned Sales

82500 100000 67500 2500000

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Seasonal


1.Planned BOM Stock

2.Planned Sales


4.Planned EOM Stock






3.0x 5.0x 6.0x _________




Step 2: work out the Planned BOM Stock

82500 100000 67500 2500000

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Seasonal


1.Planned BOM Stock

2.Planned Sales


4.Planned EOM Stock






3.0x 5.0x 6.0x _________




Step 2: work out the Planned BOM Stock

82500 100000 67500 2500000

247500(82500 x 3)

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Seasonal


1.Planned BOM Stock

2.Planned Sales


4.Planned EOM Stock






3.0x 5.0x 6.0x _________




Step 3: work out the Planned Retail Reductions for the Month

82500 100000 67500 2500000

247500(82500 x 3)

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Seasonal


1.Planned BOM Stock

2.Planned Sales


4.Planned EOM Stock






3.0x 5.0x 6.0x _________




Step 3: work out the Planned Retail Reductions for the Month

82500 100000 67500 2500000

247500(82500 x 3)

4125(82500x 0.05)

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Seasonal


1.Planned BOM Stock

2.Planned Sales


4.Planned EOM Stock






3.0x 5.0x 6.0x _________




Step 4: work out the Planned EOM Stock

82500 100000 67500 2500000

247500(82500 x 3)

4125(82500x 0.05)

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Seasonal


1.Planned BOM Stock

2.Planned Sales


4.Planned EOM Stock






3.0x 5.0x 6.0x _________




Step 4: work out the Planned EOM Stock

82500 100000 67500 2500000

247500(82500 x 3)

4125(82500x 0.05)

500000

500000 (10000 x 5.0)

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Seasonal


1.Planned BOM Stock

2.Planned Sales


4.Planned EOM Stock






3.0x 5.0x 6.0x _________




Step 5: work out the Planned Purchases at Retail

82500 100000 67500 2500000

247500(82500 x 3)

4125(82500x 0.05)

500000

500000

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Seasonal


1.Planned BOM Stock

2.Planned Sales


4.Planned EOM Stock






3.0x 5.0x 6.0x _________




Step 5: work out the Planned Purchases at Retail

82500 100000 67500 2500000

247500(82500 x 3)

4125(82500x 0.05)

500000

500000

82500+4125+500000-247500 339125

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Seasonal


1.Planned BOM Stock

2.Planned Sales


4.Planned EOM Stock






3.0x 5.0x 6.0x _________




Step 6: work out the Planned Purchases at Cost

82500 100000 67500 2500000

247500(82500 x 3)

4125(82500x 0.05)

500000

500000

339125

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Seasonal


1.Planned BOM Stock

2.Planned Sales


4.Planned EOM Stock






3.0x 5.0x 6.0x _________




Step 6: work out the Planned Purchases at Cost

82500 100000 67500 2500000

247500(82500 x 3)

4125(82500x 0.05)

500000

500000

339125339125 x (1-0.45)

339125x 0.55=186519

186519

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Seasonal


1.Planned BOM Stock

2.Planned Sales


4.Planned EOM Stock






3.0x 5.0x 6.0x _________




Step 7: work out the Planned Initial Markup

82500 100000 67500 2500000

247500(82500 x 3)

4125(82500x 0.05)

500000

500000

339125

186519

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Seasonal


1.Planned BOM Stock

2.Planned Sales


4.Planned EOM Stock






3.0x 5.0x 6.0x _________




Step 7: work out the Planned Initial Markup

82500 100000 67500 2500000

247500(82500 x 3)

4125(82500x 0.05)

500000

500000

339125

186519339125 x

0.45 152606

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Seasonal


1.Planned BOM Stock

2.Planned Sales


4.Planned EOM Stock






3.0x 5.0x 6.0x _________




Step 8: work out the Planned Gross Margin

82500 100000 67500 2500000

247500(82500 x 3)

4125(82500x 0.05)

500000

500000

339125

186519

152606

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Seasonal


1.Planned BOM Stock

2.Planned Sales


4.Planned EOM Stock






3.0x 5.0x 6.0x _________




Step 8: work out the Planned Gross Margin

82500 100000 67500 2500000

247500(82500 x 3)

4125(82500x 0.05)

500000

500000

339125

186519

152606152606 - 4125

148481

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Retail Accounting StatementsRetail Accounting Statements

•Income Statement•Balance Sheet•Statement of Cash Flow

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Income StatementIncome Statement

• Income Statement is a financial statement that provides a summary of the sales expenses for a given time period, usually a month, quarter, season, or year.

• Gross Sales are the retailer’s total sales including sales for cash or credit.

• Returns and Allowances are the refunds of the purchase price or downward adjustments in selling prices due to customers returning purchases, or adjustments made in the selling price due to customer dissatisfaction with the product or service performance.

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•Net Sales is the gross sales less returns and allowances.

•Cost of Goods Sold is the cost of merchandise that has been sold during the period.

•Operating Expenses are those expenses that a retailer incurs in running the business other than the cost of the merchandise.

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•Operating Profit is gross margin less operating expenses.

•Other Income or Expenses includes income or expense items that the firm incurs which are not in the course of its normal retail operation.

•Net Profit is operating profit plus or minus other income or expenses.

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Retailers’ Basic Income Statement FormatRetailers’ Basic Income Statement Format

Exhibit 8.5A

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Sample Income StatementSample Income StatementExhibit 8.5B

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These are critical in retailing:These are critical in retailing:

Each of these elements of COGS have implications for retail operations, particularly on merchandise management

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What can the retailer do to improve the GM?What can the retailer do to improve the GM?

It has a lot to do with:Buying and selling the right merchandise (hence

Chapter 9)Setting the right mark-ups and avoiding excessive

mark-downsManaging the inventory

Above all being able to add value through differentiation and customer service

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Retailing operations can influence the GM and OPRetailing operations can influence the GM and OP

Gross Sales

Net Sales

Cost of Goods Sold

Gross Margin

Operating Profit

Operating Expenses

Returns & Allowances

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GMROIInventory Productivity Measures

GMROI = Gross Margin Percent x sales to stock ratio

= gross margin x net salesnet sales avg inventory at cost

= gross marginavg inventory at cost

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ROI and GMROIAsset Productivity Measures

Strategic Corporate Level• Return on Assets = Net Profit

Total Assets

Merchandise Management Level• GROI = Gross Margin

Average Inventory

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Cont

rolli

ng E

xpen

ses Why do

we need to monitor these cost

items in Retailing?

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Balance SheetBalance Sheet

Balance Sheet identifies and quantifies all of the firm’s assets and liabilities at a particular point in time.

Asset is anything of value that is owned by the retail firm.

Current Assets are assets that can be easily converted into cash within a relatively short period of time (usually a year or less).

Accounts and/or Notes Receivable are amounts that customers owe the retailer for goods and services.

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Prepaid Expenses are those items for which the retailer has already paid, but the service has not been completed.

Retail Inventories comprise merchandise that the retailer has in the store or in storage and is available for sale.

Noncurrent Assets are those that cannot be converted to cash in a short period of time (usually 12 months) in the normal course of business.

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Goodwill is an intangible asset, usually based on customer loyalty, that a retailer pays for when buying an existing business.

Total assets equal current assets plus noncurrent assets plus goodwill.

Liability is any legitimate financial claim against the retailer’s assets.

Current Liabilities are short-term debts that are payable within a year.

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Accounts Payable are amounts owed vendors for goods and services.

Long-Term Liabilities are debts that are due in a year or longer.

Total Liabilities equal current liabilities plus long-term liabilities.

Net Worth (owner’s equity) is total assets less total liabilities.

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Retailers’ Basic Balance Sheet FormatRetailers’ Basic Balance Sheet Format

Exhibit 8.6A

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Graphic Presentation of the Balance SheetGraphic Presentation of the Balance Sheet

Net Worth

Fixed Assets

Current Assets

Current Liabilities

Long Term Liabilities

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Sample Balance SheetSample Balance Sheet

Exhibit 8.6B

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Looking at the Assets side of the BSLooking at the Assets side of the BS

Above all, effective management of the

inventory!

Credit sales to customers

Utilization of building and store facility. Productivity of store area and use of

technology in the store to improve efficiency

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Statement of Cash FlowStatement of Cash Flow

•Statement of cash flowlists in detail the sources and type of all revenue (cash inflows) and the use and type of all expenditures (cash outflows) for a given time period.

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Retailing TruismRetailing Truism

Cash “in” must always exceed cash “out” (if you want to stay in business).

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Sample Cash Flow StatementSample Cash Flow Statement

Exhibit 8.7A

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Typical Cash Inflow & Outflow CategoriesTypical Cash Inflow & Outflow Categories

Exhibit 8.7B

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Comparative Financial Analysis of Retailers- worked examples

■ The following slides show how to analyze the financial statements of two different kinds of retailers and then to draw implications about the nature of their retailing operations

■ Areas of analysis include Profitability analysis Gross margins Inventory turnover Asset turnover

Income Statements for Macy’s and Costco

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Profit Management Path for Macy’s and Costco

So which retailer has done a better job in terms of profitability?

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Margin Management

■ Net Sales = Gross Sales + Promotional Allowances - Return

■ Cost of Good Sold (COGs) ■ Gross Margin (GM) = Net Sales - COGs■ Expense

Variable (e.g.. sales commissions) Fixed (rent, depreciation, staff salaries)

■ Net Profit = Net Sales – COGS - Expenses

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Gross Margin for Macy’s and Costco

Gross Margin = Gross Margin %Net Sales

Macy’s: $ 10,773 = 39.9%$15,630

Costco: $ 7,406 = 12.3%$60,151

Why does Macy’s have higher margins than Costco?

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

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Operating Expenses

Operating Expenses = Operating Expenses %Net Sales

Macy’s: $8,937 = 33.1%$26,970

Costco: $5,781 = 9.6%$60,151

= Selling, general and administrative expenses (SG&A) + depreciation + amortization of assets

Includes costs other than the cost of merchandise

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Types of Retail Operating Expenses

Selling expenses = Sales staff salaries + Commissions +Benefits

General expenses = Rent + Utilities + Miscellaneousexpenses

Administrative expenses = Salaries of all employees other thansalespeople + Operations of buyingoffices + Other administrative expenses

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Net Operating Income

■ Before interest expenses/income, taxes, and extraordinary expenses

■ A commonly used overall profit measure due to the lack of control over taxes, interest, and extraordinary expenses

■ Allows for a comparison of financial performance across companies or divisions within companies

Gross Margin – Operating Expenses = Net Operating Income %Net Sales

Macy’s: $10,773 – 8,937 = 6.81%$26,970

Costco: $7,406 - $5,781 = 2.70%$60,151

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Asset Management

■ Assets: Economic Resources (e.g., inventory, buildings, computers, store

fixtures) owned or controlled by a firm Current Asset and Fixed Asset

■ Current Assets =Inventory + Cash + Account Receivable

■ Fixed Assets = Fixture, Stores (owned)■ Asset Turnover = Sales/Total Assets■ Inventory Turnover = COGS/Avg. Inventory (cost)

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

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Asset Management Path for Macy’s and Costco

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Inventory Turnover

■ A Measure of the Productivity of Inventory: It is used to evaluate how effectively retailers utilize

their investment in inventory■ Shows how many times, on average, inventory

cycles through the store during a specific period of time (usually a year)

Inventory Turnover = COGS/avg inventory (cost)Inventory Turnover = Sales/ avg inventory (retail)

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Importance of stock turnover rate

■ Inventory turnover rate differs by Industry Product categories

■ Most retailers that are having problems achieving adequate profits have a poor Inventory Turnover Rate.

■ Managing the inventory effectively and achieving good turnover rates helps to facilitate better cash flow for the retailer.

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Inventory Turnover Rate of Three Retailers in 2000

1

Wal-Mart Stores, Inc.

2 3 4 5 6 7

1

Target Corporation

K-Mart

7.3 timesper year

Jan Mar Jun Sep Dec

2 3 4 5

6.3timesper year

1 2

3.6 timesper year

3

6

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Inventory Turnover of Apparel Retailers

■ Zara (Spain’s fashion specialty store chain) Three times faster than Saks Fifth

Avenue or Abercrombie & Fitch 1.5 times faster than H & M

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Inventory Turnover

Cost of Goods = Inventory TurnoverAverage inventory

Macy’s: $16,197 = 3.04$5,317

Costco: $52,746 = 11.54$4,569

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Asset Turnover

Net Sales = Asset TurnoverTotal Assets

Macy’s: $26,970 = 0.91$29,550

Costco: $60,151 = 3.44$17,494

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Return on Assets

Net Profit Margin x Asset Turnover = Return on Assets

Macy’s: 3.70% x 0.91 = 3.37%Costco: 1.80% x 3.44 = 6.19%

Return on Assets is a very important performance measure because it shows how

much money the retailer is making on its investment

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Evaluation of Financial Path:Macy’s and Costco

Macy’s Costco

Higher net profit margin Higher asset turnover

■ Retailers (and investors) need to consider both net profit margin and asset turnover when evaluating their

financial performance the implications of strategic decisions on both components of the

strategic fit model• EX: Increasing prices => gross margin, net profit margin

sales, asset turnover

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Inventory ValuationInventory Valuation

1. Accounting Inventory System

2. Inventory Pricing Systems

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Accounting Inventory SystemAccounting Inventory System

•Cost Method is an inventory valuation technique that provides a book valuation of inventory based solely on the retailer’s cost of merchandise including freight.

•Retail Method is an inventory valuation technique that values merchandise at current retail prices, which is then converted to cost based on a formula.

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Steps for Using the Retail Method of Inventory ValuationSteps for Using the Retail Method of Inventory Valuation

•Calculation of the cost complement.•Calculation of reductions from retail value.

•Conversion of the adjusted retail book inventory to cost.

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Advantages of theCost Method of Inventory ValuationAdvantages of theCost Method of Inventory Valuation

• Accounting statements can be drawn up at any time. Inventories need not be take for preparation of these statements.

• Physical inventories using retail prices are less subject to error and can be completed in a shorter amount of time.

• The retail method provides an automatic, conservative valuation ending inventory as well as inventory levels throughout the season.

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Some key computations: Some key computations:

(199,000 + 1000)

398,000 x 0.482

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Inventory Pricing SystemsInventory Pricing Systems

•FIFO stands for first in, first out and values inventory based on the assumption that the oldest merchandise is sold before the more recently purchased merchandise.

•LIFO stands for last in, first out and values inventory based on the assumption that the most recently purchased merchandise is sold first and the oldest merchandise is sold last.

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Computations:Computations:

(net sales= 12 x$900)

(15x$500)

Purchases:(June:8x$525)+ (Nov:4x$550)= $6400

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Differences in Ending Inventory- why?Differences in Ending Inventory- why?

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Ending Inventory under LIFO method:Ending Inventory under LIFO method:

Under LIFO method the ending inventory would the same as it was at the beginning of the year ($7500) since we assume that the 12 packages that were sold were the same as the 12 purchased during the year. Hence the ending inventory comprises the opening stocks (15 units) that are valued at $500 per unit.

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Ending Inventory under FIFO method:Ending Inventory under FIFO method:

Under FIFO method, the ending inventory is computed as follows:Sales is 12 units. We take 12 units from the opening stock of 15 units. Therefore balance is 3 units valued at $500. Add this to purchases during the year. Therefore:(3x$500) + (8x$525) + (4x$550) = $1500 + $4200 + $2,200= $7900

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Question to PonderQuestion to Ponder

•Retailers are given a choice as to whether to use the LIFO or FIFO method. Given such a choice, would it make a difference in the selection of a method if the retailer were privately owned versus being a publicly traded company?

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Business

DC Lecture Six: Managing a Retailer's Finances