Key Issues 3 ways to increase the value of money Asset turnover model Financial objectives and the strategic profit model ROI model Gross margin return on investment Monitoring retail performance Direct product profitability

Value of An Investment How much will your own portfolio be worth if … You start investing 10 years after graduation, & invest $2000 per year @ 10%, every year ‘til you retire? You start now, & invest $2000 per year @ 10%, but only for 10 years, then stop?

A Simplified Cash Flow Diagram Inventory Accounts Receivable Sales

Increasing the Value of Money You have $1000. You’ve found a no-risk investment for which you will get a certain 20 percent ROI in 4 months. Your parents have offered to lend you $10,000 more, for 1 year. By how much can you grow your $1000 in a one-year period? And what’s your ROI? Margin Leveraging Our Investment Adding Stock Turnover (“turns”)

Increasing the Value of Money Strategic Element ROI (/ Investment) Result Margin (no leverage or turnover) Investment = $1000 ( = profit) Leverage (no turnover) Turnover (no leverage) Margin, Leverage, Turnover Strategic Profit Model ROI = Margin x Leverage x Turnover = 20% x 11.0 x 3.64 = 800%

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

Retail Profit Accelerators: How Can Retailers Increase Profits? Increase Volume Increase Price Decrease COGS Decrease Expenses Base Period Increase Unit Volume 5% Increase Prices 5% Sales $1,000,000 $1,050,000 $1,050,000 COGS 700,000 735,000 700,000 Gross margin 300,000 315,000 350,000 Expenses 280,000 280,000 280,000 Profit 20,000 35,000 70,000 Profit increase $ --- 15,000 50,000 Profit increase % --- 75% 250% Decrease COGS 5% Decrease Expenses 5% Sales $1,000,000 $1,000,000 COGS 665,000 700,000 Gross margin 335,000 300,000 Expenses 280,000 266,000 Profit 55,000 34,000 Profit increase $ 35,000 14,000 Profit increase % 175% 70%

Developing Financial Objectives The Objectives Themselves The Plan to Meet the Objectives Profits? How should they be measured?

Who is Most Successful? Store Total Sales Growth % Comp Store Growth % Gross Margin % Inventory Turnover Sales per Sq Ft $ JCPenney Dayton’s Toys R Us Home Depot Circuit City The Limited Wal-Mart Kmart Costco -1 9 11 35 18 17 8 26 -2 2 11 1 3 10 4 14 33 26 30 28 29 21 25 9 3.4 4.6 3.1 5.6 4.7 6.0 4.5 3.0 11.8 137 198 na 348 1,083 302 279 670 1994 Data

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) 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

Income Statements: Wal-Mart vs Tiffany (2000, in millions) Wal-Mart Tiffany Net sales $ 139,208 $ 1,173 Less: Cost of goods sold $ 108,725 $ 515 Gross margin $ 30,483 $ 658 Less: Operating expense $ 22,363 $ 493 Less: Interest expense $ 950 $ 9 Total expense $ 23,313 $ 502 Net profit, pretax $ 7,170 $ 156 Less: Taxes* $ 2,740 $ 66 Tax rate 38.21% 42.31% Net profit after tax $ 4,430 $ 90 * Effective tax rates often differ among corporations due to different tax breaks and advantages. Which has the higher net margin? Source: Levy & Weitz

Profit Margin Model: Wal-Mart vs Tiffany (2000, in millions) Net Sales $139,208 $1,173 Gross margin $30,493 $658 - Top Number = Wal-Mart Bottom Number = Tiffany Cost of goods sold $108,725 $515 Net profit before tax $7,170 $156 - Net profit after taxes $4,430 $90 Operating expenses $22,363 $493 - Net profit margin 3.18% 7.68% Total expenses $23,313 $502 Taxes $2,740 $66  + Net sales $139,208 $1,173 Interest expenses $950 $9

Return on Assets Model Net Profit X Asset = Return on Margin Turnover Assets Provo Bakery 10% X 9 times = 90% Zales Jewelry 90% X 1 time = 90%

ROA: Turnover vs Margin High Turnover Unattainable Low Margin High Margin Failure Low Turnover

Asset Turnover Model: Wal-Mart vs Tiffany (2000, in millions) What does this represent? Accounts receivable $1,118 $108 Top Number = Wal-Mart Bottom Number = Tiffany + Merchandise inventory $17,076 $481 From income statement Net sales $139,208 $1,173 Total current assets $21,123 $816 Asset turnover 2.78 1.11 +  Cash $1,878 $189 The sales $ generated by each $ of assets Total assets $49,996 $1,057 + From balance sheet + Fixed assets $28,864 $241 Other current assets $1,059 $37

Financial Objectives: The Strategic Profit Model Return on Investment Return on Assets Leverage Ratio = x Net Profit Net Worth Net Profit Total Assets Total Assets Net Worth Return on Assets Net Profit Margin Asset Turnover x Net Sales Total Assets The $ sales generated by each $ of assets The net profit generated by each $ of sales = Net Profit Total Assets and so ...

The Strategic Profit Model: The Financial Objective & Financial Program Rate of Return on Assets Return on Investment Asset Turnover = Net Profit Margin Leverage Ratio x x Net Profit Net Worth Net Profit Net Sales Net Sales Total Assets Total Assets Net Worth The Financial Objective The Financial Program (The SPM) Implications for Profitability?

The Cougar Boutique What is the ROI? Balance Sheet Assets Current Cash & other $ 50,000 Inventory 500,000 Accounts receivable 200,000 Total 750,000 Fixed 250,000 Total Assets $1,000,000 Liabilities Current Accounts payable $ 300,000 Notes payable 25,000 Other 25,000 Total 350,000 Long term 125,000 Total liabilities 475,000 Net worth 525,000 Total liab. & NW $1,000,000 Dollars Percent Net sales $2,500,000 100 Less: cost of sales 2,000,000 80 Gross margin 500,000 20 Less: expenses Variable $250,000 Fixed 200,000 Total 450,000 18 Net profit $50,000 2 Income Statement What is the ROI?

The Cougar Boutique: ROI Simple Way: Diagnostic Way, Using the SPM:

ROI Model, Including The Strategic Profit Model Which is … the income statement? Balance sheet? SPM? Net Sales Net Sales Cost of goods sold Variable expenses Fixed Gross margin Total Net profit Asset turnover Return on assets Inventory Accounts receivable Other current Total current Net sales Income Statement Balance Sheet Strategic Profit Model Financial Leverage Net Worth Gross margin - Cost of goods sold - Net profit Variable expenses Net profit margin + Total expenses Net Sales Fixed expenses Return on assets x Inventory Return on Net Worth x = Net sales + Asset turnover Financial Leverage Accounts receivable Total current assets Total assets + + Other current assets Fixed assets

Effect of Changes in the SPM on ROI Return on Investment Asset Turnover = Net Profit Margin Leverage Ratio x x Basic Example: 9.5% = 2% x 2.5 x 1.9 Leverage Increased: 15% = 2% x 2.5 x 3 Profit Margin Increased: 23.75% = 5% x 2.5 x 1.9 ROA Reduced: 3.8% = 2% x 1 x 1.9

SPM Examples Return on = Investment x x Big Lots: 24.6% 13.1 1.5 1.2 Asset Turnover = Net Profit Margin % Leverage Ratio x x Big Lots: 24.6% 13.1 1.5 1.2 Albertson’s: 18.9% 2.1 4.2 2.1 The Dress Barn: 32.4% 7.4 2.9 1.5 Land’s End: 40.2% 6.8 3.1 1.9 The Limited: 32.3% 6.7 2.2 2.2 The Gap: 25.5% 6.6 2.4 1.6 1998 data

Breakeven Analysis Example (women’s top coats): Shows number of units which must be produced & sold at a given price to cover all costs. Formulation: BE = Fixed Cost . Unit Contribution Example (women’s top coats): Avg. variable cost: $100 Tot. fixed cost: $200,000 Selling price: $166.67 Unit contribution: $66.67 BE =

Controlling (Monitoring) Performance Customer Feedback Store Level Market Share Analysis Operating Ratios Sales Variance (Actual vs Planned) Department Level Sales-to-Expense Ratios Analysis of Alloca- tion of Costs Direct Product Profitability

E.g., Computing DPP Dollars per Case Retail $ l8.70 Less: Cost 14.96 Gross margin 3.74 Plus: Discounts and allowances Payment discount 0.30 Merchandising allowance 0.50 Backhaul allowance 0.00 Less: Direct handling costs Warehouse direct labor 0.41 Warehouse inventory expense 0.18 Warehouse operating expense 0.12 Transportation to stores 0.14 Retail direct labor 1.78 Retail inventory expense 0.15 Retail operating expense 0.81 Direct product profit $ 0.95

Using DPP to Calculate Return on Shelf Space Item A Item B Gross margin per case $9.33 $8.02 Less direct costs per case 4.22 3.80 Plus discounts and allowances per case 0.21 2.02 DPP per case 5.32 6.24 Multiplied by cases per week 4.20 3.10 DPP per week 22.34 19.34 Divided by square feet of shelf facing 1.68 0.84 DPP per week per square foot of shelf space 13.30 23.03

Direct Product Profitability The per-unit profit of products: unit price less all direct unit costs High DPP per unit Low Unit Volume High Unit Volume Low DPP