Chapter 6 Financial Strategy

Retailing Strategy Human Resource Management Chapter 9 Retail Locations Chapters 7,8 Retail Market Strategy Chapter 5 Financial Strategy Chapter 6 Information and Distribution Systems Chapter 10 Customer Relationship Management Chapter 11

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

Financial Tradeoff Made by Retailers to Increase ROI Net Profit Margin Asset Turnover

The Strategic Profit Model: An Overview Profit Margin x Asset turnover = Return on assets Net profit x Net sales (crossed out) = Net profit Net sales (crossed out) Total assets Total assets

Components of the Strategic Profit Model

The Strategic Profit Model: Profit Management Net Profit Margin Sales Net Profit Gross Margin Total Expenses Cost of Goods Sold 15% 15 40 100 60 25 -

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

The Strategic Profit Model: Return on Assets Net Profit Margin Sales Net Profit Gross Mar Total Exp. Cost Goods Sold 15% 15 40 100 60 25 - Asset Turnover Total Assets Current Assets Fixed Assets Inventory A/R 2.5 10 5 4 30 + + + Other Cur Assets 1 Return on Assets 37.5% Times Net Profit Net Profit Net Sales Total Assets = Net Sales x Total Assets Net Sales ( )

Financial 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%

Income Statements for Federated Department Stores and Costco

Profit Management Path for Federated and Costco

Components of Gross Margin Gross Sales Less Returns Less customer allowances Gross Margin Gross Margin Net Sales COGS

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 Why does Federated have higher margins than Costco? Does the higher margins mean the Federated’s is more profitable?

Operating Expenses Operating Expenses = Operating Expenses % Net sales Federated: $4,933 = 31.6% $15,630 Costco: $4,629 = 9.6% $48,107

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

Net Profit Net Profit = Net Profit % Net sales Federated: $689 = 4.4% $15,630 Costco: $882 = 1.8% $48,107

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

Asset Management Path for Federated and Costco

Inventory Turnover Cost of Goods = Inventory Turnover Average inventory Federated: $9,297 = 3.0 $3,120 Costco: $42,093 = 11.6 $ 3,644

Inventory Turnover

Asset Turnover Net Sales = Asset Turnover Total Assets Federated: $15,630 = 1.1 $14,885 Costco: $48,107 = 3.2 $15,093

Return on Assets Federated: 4.41 x 1.05 = 4.63% 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%

Strategic Profit Model Ratios for Selected Retailers

Income Statement for Gifts to Go

Gross Margin Percent Gross Margin = Gross Margin Percent Net Sales Stores: $350,000 = 50% $700,000 GiftstoGo.com $220,000 = 50% $440,000

Operating Expense Percent Operating Expenses = Operating Expenses % Net Sales Stores: $250,000 = 35.7% $700,000 GiftstoGo.com: $150,000 34.1% $440,000

Net Profit Percentage Net Profit = Net Profit Percentage Net Sales Stores: $ 59,800 = 8.5% $700,000 GiftstoGo.com: $ 45,500 = 10.3% $440,000

Balance Sheet Information for Gifts to Go and Proposed Internet Channel

Inventory Turnover Cost of Goods = Inventory Turnover Average Inventory Stores: $350,000 = 2.0 $175,000 GiftstoGo.com: $220,000 = 3.1 $ 70,000

Asset Turnover Net Sales = Asset Turnover Total Assets Stores: $700,000 = 1.84 $380,000 GiftstoGo.com: $440,000 = 2.09 $211,000

Return on Assets Stores: 8.54 x 1.84 = 15.7% 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%

The Strategic Profit Model Net Sales Cost of goods sold Variable expenses Fixed expenses Gross margin Total expenses Net profit Net profit margin Asset turnover Return on assets - + Inventory Accounts receivable Other current assets Total current assets Fixed assets Net sales Total assets x Profit Management Asset Management

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

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

Setting Objectives in Large Retail Organizations Top Down Planning Corporate Developmental Strategy Category, Departments and sales associates implement strategy

Setting Objectives in Large Retail Organizations Corporate Bottom Up Planning Buyers and Store managers estimate what they can achieve Operation managers must be involved in objective setting process

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

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

Performance Objectives and Measures Used by Retailers

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 space entire corporation) Net profits Number of Asset turnover employees Growth in sales, Inventory Sales per employee profits Advertising Sales per square expenditures foot

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) merchandise category) Gross margin Markdowns Inventory turnover Growth in sales Advertising Advertising as a expenses percentage of sales * Cost of Markdown as a merchandise percentage of sales* * These productivity measures are commonly expressed as an input/output.

Examples 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 foot store or department Gross margin Expenses for Net sales per within a store) utilities sales associate or per selling hour Growth in sales Number of sales Utility expenses as associates a percentage of sales * * These productivity measures are commonly expressed as an input/output.

Illustrative 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 GMROI buyer) Store operations Net sales Square foot Net sales / (director of stores, square foot store manager) *Inventory = Average inventory at cost

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

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

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

Financial Performance of Federated and Other National Department Store Chains