Retail Book Chap06

CHAPTER 6: FINANCIAL STRATEGU INSTRUCTOR NOTES

ANNOTATED OUTLINE •

Financial objectives and goals are an integral component in every aspect of a retailer's strategy. Retailers can use financial tools to measure and evaluate their performance.

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Financial analysis can be used to monitor the retailer’s performance, assess the reasons its performance is above or below expectations, and provide insights into appropriate actions that can be taken if performance falls short of those expectations.

I. Objectives and Goals See PPT 6-3

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The first step in the strategic planning process involves articulating the retailer’s objectives and the scope of activities it plans to undertake.

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Three types of objectives that a retailer might have are: (1) financial, (2) social, and (3) personal.

A. Financial Objectives •

The appropriate financial performance measure is not profits but rather return on investment (ROI).

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A commonly used measure of the return in investment is return on assets (ROA), or the profit return on all assets possessed by the firm.

See PPT 6-4

B. Societal Objectives •

Societal issues are related to broader issues about providing benefits to society – making the world a better place to live, such as providing employment opportunities for people in a particular area, offering people unique merchandise, providing an innovative service or sponsoring events.

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Ask students to provide specific examples of retailers meetings societal objectives (merchandise, services, events, etc.) they have seen in the current marketplace.

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Regardless of the form the objective takes, performance with respect to societal objectives is more difficult to measure than financial objectives.

C. Personal Objectives •

Many retailers, particularly owners of small, independent businesses, have important personal objectives such as selfgratification, status and respect.

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Whereas societal and personal objectives are important to some retailers, financial objectives should be the primary focus of managers of publicly held retailers (retailers whose stocks are listed on and bought through a stock market).

II. The Strategic Profit Model See PPT 6-5 through 6-9

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The strategic profit model, illustrated in Exhibit 6-1, is a method for summarizing the factors that affect a firm’s financial performance as measured by ROA.

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The model decomposes ROA into two components: (1) net profit margin and (2) asset turnover.

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The net profit margin is simply how much profit (after tax) a firm makes divided by its net sales. It reflects the profits generated from each dollar of sales.

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Asset turnover is the retailer’s net sales divided by its assets. It assesses the productivity of a firm’s investment in its assets and indicates how many sales dollars are generated by each dollar of assets.

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These two components of the strategic profit model illustrate that ROA is determined by two sets of activities, profit margin management and asset management, and that a high ROA can be achieved by various combinations of net profit margin and asset turnover.

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In fact, two different retailers with wide

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discrepancies in net profit margin and asset turnover could have exactly the same return on assets.

For an illustration of ROA for two different retailers, see PPT 6-10

A. Profit Margin Management Path •

The information used to analyze a firm’s Profit Path comes from the income statement.

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The income statement summarizes a firm’s financial performance over a period of time.

See PPT 6-11 and 6-12 for an introduction to a comparison of Federated Department Stores and Costco.

1. Net Sales •

The term net sales refers to the total amount of dollars received by a retailer after all refunds have been paid to customers for returned merchandise:

Net Sales = Gross amount of Sales + Promotional Allowances - Customer Returns •

Customer returns represent the value of merchandise customers return because it's damaged, doesn't fit, and so forth.

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Promotional allowances are payments made by vendors to retailers in exchange fro the retailer promoting the vendor’s merchandise.

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Sales are an important measure of performance because they indicate the activity level of the merchandising function.

2. Gross Margin See PPT 6-13 and 6-14 Gross Margin = Net Sales - Cost of Goods Sold. •

Gross margin, also called gross profit, gives a retailer a measure of how much profit it’s making on merchandise without considering the expenses associated with operating the store.

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Gross margin, like other performance measures, is also expressed as a percentage

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Discuss the difference in gross margin percentage between Costco and Federated. Why is the difference to be expected?

of net sales so retailers can compare (1) performances of various types of merchandise and (2) their own performance with other retailers. Gross margin % = Gross margin / Net Sales 3. Operating Expenses •

See PPT 6-15 and 6-16 Operating expenses are costs incurred in the normal course of doing business to generate revenues.

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The operating expense category includes salaries for sales associates and managers, advertising, utilities, office supplies and rent.

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Another major expense category, interest, is the cost of financing everything from inventory to the purchase of a new store location.

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Like the gross margin, operating expenses are expressed as a percentage of net sales to facilitate comparisons across items and departments within firms.

Discuss the difference in expense to sales ratio between Costco and Federated. Why is the difference to be expected?

Operating expenses / Net sales = Operating expense % D. Net Profit •

Net profit (after taxes) is the gross margin minus operating expenses and taxes:

Discuss the difference in net profit margin percentage between Costco and Federated. Why is the difference to be expected?

Net Profit = Gross Margin – Expenses -- Taxes •

Net profit is a measure of overall performance with respect to the profit margin management path and can also be expressed before taxes.

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Like gross margin, net profit margin is often expressed as a percentage of sales:

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Net profit / Net sales = Net profit %

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A commonly used overall profit measure is the profit percentage before interest and

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Net profit is illustrated in PPT 6-17.

taxes. This measure is used because operating managers have little control over interest and tax expenses, so these expenses do not reflect the performance of operating managers or the retailer’s operating effectiveness. III. Asset Management Path See PPT 6-18 and 6-19

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The information used to analyze a firm’s turnover path primarily comes from the balance sheet.

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The income statement summarizes the financial performance over a period of time, while the balance sheet summarizes a retailer’s financial position at a given point in time, such as the last day of the year.

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The balance sheet shows the following relationship: Assets = Liabilities + Owner’s equity

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Assets are economic resources (such as inventory or store fixtures) owned or controlled by an enterprise as a result of past transactions or events.

A. Current Assets •

By accounting definition, current assets are those that can normally be converted to cash within one year. In retailing:

Current assets = Accounts receivable + Merchandise inventory + Cash + Other current assets •

Accounts Receivable are monies due to the retailer from selling merchandise on credit. This current asset is substantial for some retailers.

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From a marketing perspective, the accounts receivable generated from credit sales may be the result of an important service provided to customers.

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The retailer’s ability to provide credit,

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Ask students why retailers take third party credit cards like Visa. ( Because they don't want to tie up their assets in accounts receivable. They would rather get most of their money quickly to invest in more inventory. Also, they must offer credit since customers expect it.)

particularly at low interest rates, could make the difference between making and losing a sale. •

The money invested in accounts receivable costs the retailer interest expense and keeps the retailer from investing proceeds of the sale elsewhere.

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Merchandise inventory is a retailer’s lifeblood. Exceptions to this generalization are service retailers, who carry little or no inventory.

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Inventory turnover is used to evaluate how effectively managers utilize their investment in inventory:

See PPT 6-20 and 6-21 Average Inventory is always considered at retail because sales are in terms of retail as well. Ask students what a turnover of 1.61 means. (Answer: For every dollar in inventory the firm generates $1.61 in sales.)

Inventory turnover = COGS / Average inventory •

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Think of inventory as a measure of the productivity of inventory--how many sales dollars can be generated from $1 invested in inventory. We can think of inventory turnover as how many times, on average, the inventory cycles through the store during a specific period of time (usually a year).

2. Fixed Assets •

Fixed assets are assets that require more than a year to convert to cash. In retailing,

Fixed assets = Buildings (if store property is owned rather than leased) + Fixtures (such as display racks) + Equipment (such as computers or delivery trucks) + Long-term investments such as real estate or stock in other firms Fixed Assets = Asset Cost - Depreciation. •

Although fixed assets don't turnover as

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Ask students which firm has the highest inventory turnover and why they would expect this to be the case. Whose inventory turnover would be higher: a discount store or a specialty retailer? Why?

quickly as inventory, asset turnover can be used to evaluate and compare how effectively managers use their assets. •

When a retailer decides to invest in a fixed asset, it should determine how many sales dollars can be generated from that asset.

3. Asset Turnover •

See PPT 6-22 Asset turnover is an overall performance measure from the asset side of the balance sheet.

Ask students which firm has the highest asset turnover and why they would expect this to be the case.

Asset turnover = Net Sales / Total Assets C. Return On Assets •

See PPT 6-23 and 6-24 Overall performance, as measured by ROA, is determined by considering the effects of both paths by multiplying the net profit margin by asset turnover: Net profit margin x Asset turnover = Return on Assets

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Return on assets is a very important performance measure, because it shows how much money the retailer is making on its investments in assets and how good that return is relative to other investments.

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The strategic profit model assumes two important issues:

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First, retailers and investors need to consider both net profit margin and asset turnover when evaluating the retailer’s financial performance.

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Second, retailers need to consider the implications of strategic decisions on both components of the strategic profit model.

D. Illustration: Kelly Bradford's Evaluation of the GiftstoGo.com Growth Opportunity 1. Profit Margin Management Path

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PPT 6-25 shows the income statement for Gifts to Go and Giftstogo.com

See PPT 6-26

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We expect Giftstogo.com to have about the same gross margin percent as Gifts To Go because it will carry a similar but more extensive assortment.

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Her operating expenses as a percentage of sales will be only slightly lower for Giftstogo.com because she needs to hire a firm to maintain the Web site, process orders, and get orders ready for shipment. Also, Kelly will have to invest in advertising and promotion to create awareness for her new channel and inform people who are unfamiliar with her stores.

See PPT 6-27

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Because the gross margin and operating expenses as a percentage of sales for the two operations are projected to be the same, Giftstogo.com is expected to generate a slightly higher net profit margin percentage.

See PPT 6-28

2. Asset Turnover Management Path •

Like Gifts To Go, Giftstogo.com will have accounts receivable because many customers use credit cards to buy gifts. Since the percentage of credit card sales is higher over the Internet channel than in stores, Kelly expects that accounts receivable for the Internet channel will be higher than for the store channel.

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Giftstogo.com should have a faster projected inventory turnover than Gifts To Go because it will consolidate the inventory at one centralized distribution center that services a large sale volume, as opposed to Gifts To Go that has inventory sitting in several stores with relatively lower sales volume.

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Gifts to Go’s store space is rented. Thus, Kelly’s fixed assets consist of the fixtures, lighting, and other leasehold improvements for her stores, as well as equipment such as POS terminals. Fixed assets for GiftstoGo.com are its Web site and its order processing computer system.

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PPT 6-29 shows the balance sheet for Gifts to Go and Giftstogo.com

See PPT 6-30

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GiftstoGo.com’s projected asset turnover is higher than Gifts to Go’s stores because GiftstoGo.com will have a higher inventory turnover, and its other assets are lower.

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Because estimates for the net profit margin and asset turnover for GiftstoGo.com are higher than those for the stores, GiftstoGo.com has a higher ROA.

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See PPT 6-31

See PPT 6-32

This strategic profit model analysis indicates that GiftstoGo.com is a financially viable growth opportunity. PPT 6-33 illustrates this recap of the Strategic Profit Model.

E. Recap of the Strategic Profit Model •

The strategic profit model is useful to retailers because it combines two decisionmaking areas--margin management, and asset management--so managers can examine interrelationships among them.

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The strategic profit model uses return on assets as the primary criterion for planning and evaluating a firm's financial performance.

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The strategic profit model can also be used to evaluate financial implications of new strategies before they're implemented.

III. Setting Performance Objectives •

Performance objectives should include: (1) the performance sought, including a numerical index against which progress may be measured, (2) a time frame within which the goal is to be achieved, and (3) the resources needed to achieve the objective.

Performance objectives are illustrated in PPT 335

A. Top-Down versus Bottom-Up Process •

Top-down planning means that goals are set at the top of the organization and filter down through the operating levels.

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In a retailing organization, top-down planning involves corporate officers developing an overall retail strategy and assessing broad economic, competitive, and

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Describe a situation where management has set a higher sales goal for a particular period but has also cut employee hours and eliminated over-time for that same period. Ask students to explain how they would resolve this difference.

For a comparison of top-down and bottom-up

consumer trends.

planning, refer to PPTs 6-36 and 6-37.

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The overall strategy determines the merchandise variety, assortment, and product availability plus store size, location, and level of customer service.

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This top-down planning is complemented by a bottom-up planning approach. Buyers and store managers are also estimating what they can achieve. Their estimates are transmitted up the organization to the corporate planners.

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Differences between bottom-up and topdown plans must be resolved through a negotiation process involving corporate planners and operating managers.

B. Accountability •

At each level of the retail organization, the business unit and its manager should be held accountable only for revenues and expenses it directly controls.

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Thus, expenses that benefit several levels of the organization (such as the labor and capital expenses incurred in operating a corporate headquarters) shouldn't be arbitrarily assigned to lower levels.

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Performance measures should only be used to pinpoint problem areas. Reasons why performance is above or below the planned levels must be examined.

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Actual performance may be different than the plan due to circumstances beyond the manager's control. For example, there may have been a recession.

C. Performance Measures •

The measures used to evaluate retail operations vary depending on: (1) the level of the organization where the decision is made and, (2) the resources the manager controls.

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For example, the principle resources controlled by store managers are space and money for operating expenses (such as wages for sales associates and utility payments to light and heat the store). Store managers focus on performance measures like sales per square foot and employee costs.

D. Types of Measures •

See PPT 6-34 Retailers' performance measures are broken into three types: output measures, input measures, and productivity measures.

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Input measures assess the amount of resources or money used by the retailer to achieve outputs such as sales and profits.

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Output measures assess the results of retailers' investment decisions. For example, sales revenue results from decisions on how many stores to build, how much inventory to have in the stores, and how much to spend on advertising.

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A productivity measure (the ratio of an output to an input) determines how effectively a retailer uses a resource.

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In general, since productivity measures are a ratio of outputs to inputs, they can be used to compare different business units.

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Productivity measures are a ratio of outputs to inputs. Ask students to demonstrate how productivity measures can be used to compare different business units.

See PPT 6-38, 6-39, and 6-40 for an overview of output measures.

See PPT 6-41

1. Corporate Performance •

At a corporate level, retail executives have three critical resources (inputs) – merchandise inventory, store space, and employees – that they can manage to generate sales and profits (output).

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Effective productivity measures of the utilization of these assets are asset and inventory turnover, sales per square foot of selling space and sales per employee.

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Another commonly used measure of overall performance is same store sales growth, or the growth in store that have been open or more than one year. See PPT 6-42

2. Merchandise Management Measures •

The critical resource (input) controlled by merchandise managers is merchandise inventory.

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Inventory turnover is a productivity measure of the management of inventory; higher inventory turnover means greater inventory management productivity. See PPT 6-43 and 6-44

3. Store Operations Measures •

The critical assets controlled by store managers are the use of the store space and the management of the store’s employees.

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Measures of store operations productivity include sales per square foot of selling space and sales per employee or employee working hour.

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Other performance measures used to assess the performance of store managers are inventory shrinkage and energy costs as a percentage of sales. See PPT 6-45

E. Assessing Performance: The Role of Benchmarks •

The financial measures used to assess performance reflect the retailer’s market

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strategy. •

In other words, the performance of a retailer cannot be accurately assessed by simply looking at isolated measures because they are affected by the retailer’s strategy.

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To get a better assessment of a retailer’s performance, you need to compare it to a benchmark.

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One useful approach for assessing a retailer’s performance is to compare its recent performance with its performance in preceding months, quarters or years.

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A second approach for assessing a retailer’s performance is to compare it with its competitors.

VII. Summary

ANSWERS TO DISCUSSION QUESTIONS AND PROBLEMS 1.

Why does a retailer need to use multiple performance measures to evaluate its performance? Many factors contribute to the overall performance of a retailer. Thus it is difficult to find one measure that adequately evaluates performance. For instance, sales is a global measure of how much activity is going on in the store. However, a store manager could easily increase sales and inventory turnover by lowering prices, but gross margin would suffer as a result. Clearly, an attempt to maximize one measure may lower another. Managers must therefore understand how their actions affect multiple performance measures. It is usually unwise to use one measure since it rarely tells the whole story. The measures used to evaluate retail operations are different depending on the level of the organization where the decision is being made and the resources that the manager controls. For example, the principle resources controlled by store managers are space and operating expenses such as the wages paid to sales associates and the electricity used to light and heat the store. Thus, store managers focus on performance measures like sales per square foot and employee costs.

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Describe how a multiple-store retailer would set its annual performance objectives. Setting objectives in large retail organizations entails a combination of the top-down and bottom-up approaches to planning. Top-down planning means that goals are set at the top of the organization and filter down through the operating levels.

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In a retailing organization, top-down planning involves corporate officers developing an overall retail strategy and assessing broad economic, competitive, and consumer trends. Armed with this information, they develop performance objectives for the corporation. These overall objectives are then broken down into specific objectives for each merchandise category and each geographic region. The overall strategy determines the merchandise variety, assortment, and service level and the size, location, and level of customer service provided in the stores. Then the merchandise vice-presidents decide on which types of merchandise sales are expected to grow, stay the same, or shrink. Then performance goals are established for each buyer. The director of stores works on the performance objectives with each of the regional store managers. Then, these regional managers develop objectives with their store managers. The process then trickles-down to department managers in the stores. This top-down planning is complemented by a bottom-up planning approach. Buyers and store managers are also estimating what they can achieve. Their estimates are transmitted up the organization to the corporate planners. Frequently there are disagreements between the goals that have trickled down from the top and those set by employees at lower levels of the organization. For example, a store manager may not be able to achieve the 10% sales growth set for the region because a major employer in the area has announced plans to layoff 2,000 employees. When these differences in bottom-up versus top-down plans arise, they must be resolved through a negotiation process involving the corporate planners and operating managers. If the operating managers are not involved in the objective setting process, they will not accept the objective and thus will be less motivated to achieve it. 3.

Buyers' performance is often measured by their gross margin percentage. Why is this figure more appropriate than net profit percentage? A buyer can impact the gross margin percentage because he/she can, to some extent, control the sales and cost of goods sold. Expenses, which do not play a part in determining the gross margin percentage, are often out of the control of the buyer and therefore should not be counted when assessing a buyer’s performance.

4.

How does the strategic profit model assist retailers in planning and evaluating their marketing and financial strategies? The strategic profit model can assist management in 1) evaluating current strategies, and 2) planning future proposed strategies. The SPM combines important information from both the income statement and the balance sheet to establish return on owners’ equity (ROE) as a primary financial performance measure for the retailer. In addition, it suggests ways to improve the ROE and allows the retailer to compare itself against previous years as well as industry-wide performance.

5.

Neiman Marcus (a chain of high-service department stores) and Wal-Mart target different customer segments. Which retailer would you expect to have a higher asset turnover? Net profit margin percentage? Why? Due to the fact that Wal-Mart deals with low margins, it is imperative to have a high asset turnover to yield a profit. This figure should be much higher than that of Neiman Marcus. On the other hand, Neiman Marcus will have a much higher net profit margin

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percentage because they sell high ticket, high markup items such as brand name clothing and furnishings. Since department stores don’t typically have high turnover, they rely on margin to succeed. On the other hand, Wal-Mart focuses on high turnover to succeed.

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What elements in the strategic model are affected if a retailer decides to build and open 10 new stores? Students will likely pose a variety of responses here. It will be very difficult to determine the exact impacts on the strategic model without more information about the new stores, their sizes, locations, etc. Assuming the 10 new stores will sell basically the same merchandise for the same prices, the retailer’s gross margin may still be affected if net sales vary dramatically from one location to the next or if volume discounts for the large increase in merchandise necessary reduce cost of goods sold. Operating expenses, accounts receivable and fixed assets will drastically increase with the increase in number of stores necessitating more salespeople, more expenses to maintain the 10 new locations, and providing many more opportunities for consumer purchases.

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What differences would you expect to see when comparing Gifts To Go’s specialty store strategic profit model with that of two dry cleaning service businesses? Students should identify several differences resulting from the merchandise versus services nature of the retailers described here. They may identify significant differences in terms of fixed assets, the dry cleaning services will have more sophisticated machinery and equipment necessary to provide their services to consumers. On the other hand, Gifts to Go will have all the associated merchandise costs with maintaining inventory that service retailers do not face.

8.

Using the following information taken from Lowe’s 2005 annual report, determine its asset turnover, net profit margin percentage, and ROA. (Figures are in $ millions.) Net sales Total assets Net profit Asset Turnover

$36,464 $21,209 $ 2,176 =

Net Sales/Total Assets

Net Profit Margin Percentage

= 36,464/21,209 = 1.72

= Net Profit/Net Sales = 2,176/36,464 = 6.0%

Return on Assets = Net Profit Margin X Asset Turnover = 6.0 X 1.72 = 10.32% 9.

Using the following information taken from the 2005 balance sheet and 2005 income statement for Urban Outfitters, develop a strategic profit model. (Figures are in $000.) Net Sales

827,750

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Cost of Goods Sold Operating Expenses Interest Expense Inventory Accounts Receivable Other Current Assets Fixed Assets

489,000 198,384 0 98,996 8,364 171,508 271,776

Urban Outfitters, 2005 ($000) Net Sales Less: Cost of Goods Sold Gross Margin Less Operating Expenses Less Interest Expenses Total Expenses Net Profit

827,750 489,000 338,750 198,384 0 198,384 140,366

Net Profit Margin = Net Profit / Net Sales = 140,366 / 827,750 = 16.9% Inventory Add: Accounts Receivable Add: Other Current Assets Total Current Assets Add: Fixed Assets Total Assets

98,996 8,364 171,508 179,872 271,776 550,644

Asset Turnover = Net Sales / Total Assets = 827,750 / 550,644 = 1.50 Return on Assets (ROA) = Net Profit Margin Percentage * Asset Turnover = 16.9% * 1.50 = 25.35%

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ANCILLARY LECTURES AND EXERCISES -------------------------------------------------

LECTURE # 6-1: THE STRATEGIC PROFIT MODEL (SPM) Instructor’s Note: Instructors may wish to use this ancillary lecture in lieu of the annotated outline. This is fairly complex material for students to grasp. This lecture is presented with a simple example. Instructors might want to use this exercise as a stimulus to a class discussion on the topic. Power Point slides 6-5 through 6-9 can be used with this lecture. ------------------------------------------------Background •

Also known as the DuPont model, it was developed by the DuPont family around 1920.

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The DuPonts developed the model because they needed to find a basis for evaluating the financial performance of complex organizations.

Purpose of the SPM •

The SPM serves two managerial purposes:

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Specifies that a firm’s financial objective is to earn adequate or target return on owners equity—also know as return on net worth.

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This does not mean that a retailer wants to necessarily maximize return on Owner’s Equity (O.E.).

This method is only one of many financial objectives. For example, maximizing shareholder wealth is another very important objective. •

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Identifies three profit paths a firm can take to increase O.E. by increasing: 1.

profit margin

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rate of asset turnover

3.

financial leverage

The preceding performance ratios are related to the following three areas of decisionmaking: 4.

margin management

5.

asset management

6.

financial management

Let us take each of the three categories and break them down.

Margin management •

See PPT 6-11. This information is taken from the income statement:

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Net sales means after adjusting for returns and allowances

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Gross sales - Returns = Net sales

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Cost of goods sold

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Invoice cost + freight in + work room costs - vendor’s cash discounts

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Cost of goods sold:

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Invoice costs

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Freight in (transportation cost of bringing in merchandise)

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Workroom costs (alterations, set up)

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Vendors—cash discounts. For example, 2/10 n 30 provides incentives to get retailers to pay quickly for the vendors’ accounts receivable reasons.

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Why are these adjustments made to cost of goods sold?

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Directly affect landed cost of merchandise

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Gross margin:

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Gross margin = Net sales - Cost of goods sold

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Can be expressed as a percentage of sales:

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Gross margin = Gross margin percent

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Sales

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Gross margin, gross margin percent, and inventory turnover are extremely important in the world of retailing. They represent aspects of the business with which buyer has direct control.

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Total expenses (two types—variable and fixed):

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1.

Variable—(varies with sales) -- the cost of doing business; e.g., sales commission and is thus variable with sales).

2.

Fixed—cost of being in business. We have fixed expenses whether or not we sell anything. For example, rent, electricity, administrative salaries, etc.

Net profit (after tax):

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Treat tax as a variable expense—a retailer always needs after tax profit for decisionmaking. Net profit margin is net profit as a percentage of sales, just like gross margin is a percentage of sales. So, if a retailer has $10,000 net profit before tax, and the tax = 40%, the net profit after tax will = $6,000.

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The key in understanding net profit lies in the kind of retail establishment in which one operates. For example, a grocery store having a 1 % net profit after tax would be considered normal. The key is knowing what is good or bad for a retailer compared to competition.

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How to evaluate profit margin 3.

Firm’s past history

4.

Compare with similar stores or departments. Should be really much better than average for industry considering there are many bad stores.

Asset Management •

See PPT 6-19. To obtain a better idea of what asset management is about, examine the Asset Management Model.

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All of these elements come from the balance sheet except for sales.

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The balance sheet is a snapshot of a retailer’s financial position on a particular day, usually the end of the year.

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The income statement represents the performance over a period of time, generally a year.

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Objective: The objective in asset management is to turn inventory into accounts receivable or cash by making sales rapidly.

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Current assets—“cycle”

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1.

cash to inventory

2.

inventory to cash or

3.

inventory to accounts receivable

4.

want to minimize assets relative to sales

Inventory—strive for best selection which 5.

minimize inventory investment

6.

maximize sales through selection (depth + breadth) minimize stock-outs (service level)

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Accounts receivable = Merchandise sold on credit. Want to minimize accounts receivable because may be an unproductive asset. Most retailers offer credit because: 1.

tradition

2.

part of services mix

3.

may be important in making people buy

4.

can make some money if charge interest but usually sold to a factor (will define below) -- most retailers aren’t in business to be a financial institution, so they would rather sell their accounts receivable to a factor.

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Bankcard—Visa, MasterCard, or American Express (T&E—travel and entertainment card); can be converted to cash immediately, but card company charges retailer a percentage of sales.

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Factor—accounts receivables are sold to private-label credit card companies known as “factors.” When a retailer’s accounts receivable is sold to another firm, it allows the retailer to get money up-front and retain its own store identity. Also, information from the credit cards can be used to target customers. Factoring is very popular now because an intermediary company takes care of accounts receivable hassles for the retailer.

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Proprietary—when a retailer keeps its own accounts receivable (private credit card, like “Sears” card). The most common reason for doing this is to collect interest from customers.

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The first two types of credit cards are the most popular with retailers because they generally prefer to stay away from accounts receivable. Naturally, their main interest is converting inventory into sales and profits.

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Cash: keep to a minimum

Fixed assets: 1.

fixture

2.

store (if owned, not rented)

3.

delivery trucks

4.

much slower to change than current assets

Asset turnover: •

Net sales/ total assets = Asset turnover.

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Similar to inventory turnover in that it is like a cycle of assets to cash to assets to cash ...

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Asset turnover rate always has to be less than inventory turnover if there are any fixed assets.

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Inventory turnover = Net Sales / Average Inventory

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Return on assets •

See PPT 6-23. ROA uses both asset management and margin management.

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Used for evaluating and programming performance of profit centers (like stores), used to evaluate managers, not owners because owners also have control over financial leverage—to be discussed below.

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Firms can get their return on assets in many ways. For example: 1.

discount stores have low margin and high turnover

2.

boutiques have high margin and low turnover

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Return on assets (ROA) = Net profit

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Total assets

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The question here is, how much profit are you able to generate from retailer’s assets?

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Return on assets is an extremely important measure of how a retailer is performing.

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The instructor may want to slow down here and give examples all the way through the model like those in the text of high margin/low turnover operations versus low margin high turnover operations.

Financial leverage management •

Leverage ratio = Total assets/O.E. or (Total liabilities +O.E.)/O.E.

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How to manage leverage: 1.

Too leveraged (too much debt) means financial instability, i.e., too much risk.

2.

If not leveraged, then return on owner’s equity suffers

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To illustrate financial leverage, take the case of leveraged buyouts.

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Leveraged buyouts (LBOs) occur when a firm takes on extra debt to finance a buyout.

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More debt means higher leverage.

Conclusion •

Depending where one is in the firm, different managers will use different performance ratios.

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Top management will use leverage to get return on O.E.

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Lower executives will use margin and assets management to get return on assets.

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During the rest of the course we will be concentrating on these ratios, and others that will help the retailers control the financial side of their business.

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