Chapter 6 Financial Strategy

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Financial Strategy CHAPTER 06

McGraw-Hill/Irw  in

Copyri Copy ri ght © 2012 by The McGraw-H il l Companies, Companies, In c. All ri ghts res reserve erved. d.

Objectives and Goals

• 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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Components of the Strategic Profit Model

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The Strategic Profit Model: An Overview

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Profit Margin x

Asset turnover

= Return on assets

Net profit x Net sales (crossed out)

Net sales (crossed out) = Net profit Total assets Total assets

Net Profit Margin: reflects the profits generated from each dollar of sales  Asset Turnover : assesses the productivity of a firm’s investment in its assets

Fiscal Annual Income Statement for Family Dollar and Nordstrom

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**

** ($ millions)

Profit Management Path for Family Dollar Stores and Nordstrom

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Profit Margin Management Path

• Net Sales = Gross Sales + Promotional Allowances - Return • Cost of Good Sold (COGs) • Gross Margin (GM) = Net Sales - COGs

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Profit Margin Management Path

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• Operating Expense • Variable (e.g.. sales commissions) • Fixed (rent, depreciation, staff salaries) • Selling, general, and administrative (SG&A) expenses

Profit Margin Management Path

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• Operating profit margin • Operating profit margin = Gross margin - Operating expenses - Extraordinary (recurring) operating expenses • Net profit margin = Operating profit margin - Taxes Interest - Extraordinary nonrecurring expenses

Profit Margin Management Path

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• Gross margin percentage is gross margin divided by net sales. • Retailers use to compare • the performance of various types of merchandise • their own performance with that of other retailers with higher or lower levels of sales. Gross margin Net sales

= Gross margin %

Profit Margin Management Path

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• SG & A or operating expenses can be expressed as a percentage of net sales to facilitate comparisons across items, stores, and merchandise categories within and between firms. Operating expenses Net sales

= Operating expenses %

Profit Margin Management Path

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• Net operating profit percentage is gross margin minus operating expenses divided by net sales Gross margin - Operating expenses Net sales

= Net operating profit %

Asset Management Path

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• Assets: • Economic Resources (e.g., inventory, buildings, computers, store fixtures) owned or controlled by a firm • Current Asset and Fixed Asset • Current Assets = Cash + Account Receivable + Inventory + Other current assets

Asset Management Path

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• Accounts receivable are primarily the monies owed to the retailer by customers that have bought merchandise on credit. • Fixed Assets = Fixture, Stores (owned) • Asset Turnover = Sales/Total Assets Net sales Total assets

= Asset turnover

• Inventory Turnover = COGS/Avg. Inventory (cost) Cost of goods sold  Average inventory at cost

= Inventory turnover

Asset Information from Family Dollar Stores’ and Nordstrom’s Balance Sheets

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*

* ($ millions)

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Asset Management Path for Family Dollar and Nordstrom

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Inventory Turnover

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• 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)

Strategic Profit Model Ratios for Selected Retailers

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Income Statement Information for Gifts To Go Stores and Proposed Gifts-To-www.Go.com Internet Channel

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Balance Sheet Information for Gifts To Go Stores and Proposed Gifts-To-www.Go.com Internet Channel

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Analysis of Financial Strength

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• Cash-Flow Analysis • Retailers need cash to meet their obligations — i.e., salary, rent, vendors, etc. • Cash flow is calculated by making adjustments to net profit involving adding or subtracting differences in revenue and expenses that occur from one period to the next.

Analysis of Financial Strength

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• Debt-Equity Ratio • The retailer’s short - and long-term debt divided by the value of the owners’ or stockholders’ equity.

• Current Ratio • The is short-term assets divided by short-term liabilities, it evaluates the retailer’s ability to pay its

short-term debt obligations.

Analysis of Financial Strength

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• Quick Ratio • “acid-test ratio” • More stringent test because it removes inventory from the short-term assets. • If a retailer needs cash to pay its short-term liabilities, it cannot rely on inventory to provide an immediate source for cash.

Setting and Measuring Performance Objectives

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• 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

Setting Objectives in Large Retail Organizations

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Top-Down Planning Corporate Developmental Strategy

Category, Departments and sales associates implement strategy

Setting Objectives in Large Retail Organizations

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Corporate

Bottom-Up Planning Buyers and Store managers estimate what they can achieve

Operation managers must be involved in objective setting process

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 (e.g., profits) they get on their investments (e.g., expenses)

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Financial Performance of Retailers

Outputs  – Performance

Inputs Used by Retailers

• Sales

• • • •

• Profits • Cash flow • Growth in sales, profits • Same store sales growth

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Inventory ($) Real Estate (sq. ft.) Employees (#) Overhead (Corporate Staff and Expenses) • Advertising • Energy Costs • MIS expenses

Examples of Performance Measures Used by Retailers

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