1. Chapter 6 Financial Strategy McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

2. 6-2 Questions ■What are financial objectives? ■Why focus on ROA when assessing a retailer’s financial performance? ■What is the strategic profit model, and how is it used? ■What is an income statement and its major components? ■What is a balance sheet and its major components? ■What measures do retailers use to assess their financial performance?

3. 6-3 Financial Objectives Why should retailers set financial objectives? What sort of financial objectives do most people focus on? Why is return on investment a more appropriate financial performance measure? Return on assets is a commonly used measure for return on investment What is return on assets? The profit return on total assets possessed by the firm.

4. 6-4 What is The Strategic Profit Model? A method for summarizing the factors that affect a firm’s Return on Assets. The model breaks ROA into two components: 1.) net profit margin 2.) asset turnover

5. 6-5 What is a Net Profit Margin ? How much net profit a firm makes divided by its net sales. Net Profit Margin = Net Profit / Net Sales Remember, use net profit after tax. Reflects the profits generated from each dollar of sales. Compare Tiffany’s and Blue Nile: Which has the better profit margin?

6. 6-6 What is Asset Turnover? The retailer’s net sales divided by its total assets. Asset Turnover = Net Sales / Total Assets Reflects how many sales dollars are generated by each dollar of assets. Compare Tiffany’s and Blue Nile: Which has the better asset turnover?

7. 6-7 Return on Assets - achieved by various combinations of net profit margin and asset turnover

8. 6-8 The Strategic Profit Model: An Overview Profit Margin xAsset turnover = Return on assets Net profitxNet sales (crossed out) = Net profit Net sales (crossed out) Total assets Total assets Compare return on assets between Tiffany’s and Blue Nile

9. 6-9 Profit Margin Management Information used to analyze a firm’s profit margin management comes from the income statement. What is an income statement? Summarizes a firm’s sales, expenses, and profits over a period of time.

10. 6-10 The Strategic Profit Model: Profit Margin Management Net Profit Margin Sales Net Profit Gross Margin Total Expenses Sales Cost of Goods Sold 15% 15 40 100 60 10025 - -

11. 6-11 Profit Margin Management ■What are Net Sales? Net Sales = Gross Sales + Promotional Allowances – Return Compare Tiffany’s and Blue Nile Net Sales ■What are Cost of Goods Sold (COGs)? ■What is Gross Margin? Gross Margin (GM) = Net Sales – COGs Compare Tiffany’s and Blue Nile’s Gross Margin ■What is the Gross Margin % Gross Margin% = Gross Margin / Net Sales Compare Tiffany’s and Blue Nile’s GM% Why does Tiffany’s have a higher Gross Margin %

12. 6-12 Profit Margin Management: cont. ■What are Operating Expenses? Includes selling, general, and administrative expenses, plus depreciation of assets. Examples – salaries, advertising, utilities, rent, office supplies ■What is the Operating Expenses %? Operating expenses% = Operating expenses / Net Sales Compare Tiffany’s and Blue Nile Why does Tiffany’s have a higher Operating Expenses percentage?

13. 6-13 Profit Margin Management: cont. ■What is Net Profit? Net Profit = Gross Margin – Operating expenses – Interest – Taxes Compare Tiffany’s and Blue Nile Net Profit. ■What is the net profit margin? Net Profit Margin = Net Profit / Net Sales Compare Tiffany’s and Blue Nile Net Profit Margins

14. 6-14 Asset Management Information used to analyze a firm’s asset management primarily comes from the balance sheet. What is a balance sheet? A balance sheet is a snapshot of the retailer’s assets, liabilities, and owner’s equity at a particular point in time. Assets = Liabilities + Owner’s equity

15. 6-15 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

16. 6-16 Asset Management ■What are Assets? Economic Resources (e.g., inventory, buildings, computers, store fixtures) owned by the retailer Current Asset and Fixed Asset ■What are Current Assets? - Assets that can be converted to cash within one year. Inventory + Cash + Account Receivable ■What are Accounts Receivable? Money due to the retailer from selling merchandise to customers on credit. ■What is merchandise inventory? The value of the merchandise on hand at the time of the balance sheet statement preparation.

17. 6-17 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) ■Which retailer would you expect to have a higher inventory turnover, Tiffany’s or Blue Nile?

18. 6-18 Importance of Inventory turnover ■How do retailers increase Inventory Turnover? Increase Sales Decrease Inventory Decrease delivery lead-time Drive waist out ■It’s important to have an efficient turnover rate: not so slow that things seem stale and shopworn, yet not so fast that the floor looks half-empty.

19. 6-19 Asset Management, cont. ■What are Fixed Assets? Assets that require more than a year to convert to cash. Examples – buildings, fixtures, equipment, long-term investments Compare the fixed assets of Tiffany’s to Blue Nile. ■What is Asset Turnover? Assesses the productivity of the firm’s investment in its assets Indicates how many sales dollars are generated by each dollar of assets Compare asset turnover of Tiffany’s to Blue Nile. What accounts for these differences?

20. 6-20 Return on Assets Net Profit Margin x Asset Turnover = Return on Assets Blue Nile5%x2.06 = 10.30% Tiffanys10%x.93 =9.30% Return on Assets is a very important performance measure because it shows how much money the retailer is making on its investment

21. 6-21 Strategic Profit Model Ratios for Selected Retailers