1. Financial Strategy CHAPTER 06 McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2. Questions
How is a retail strategy reflected in retailers’ financial objectives?
How do retailers need to evaluate their performance?
What is the strategic profit model, and how is it used?
What measures do retailers use to assess their performance?

3. Objectives and Goals
Financial – not necessarily profits, but return on assets (ROA) is the primary focus. ROA is the profit generated by the assets possessed by the firm.
Societal – helping to improve the world around us. Societal objectives are related to broader issues that make the world a better place to live. (Tom’s Shoes)
Personal – include self-gratification, status, respect

4. Components of the Strategic Profit Model
is a method for summarizing the factors that affect a firm’s financial performance, as measured by return on assets.

5. 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
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

6. Different Approaches for ROA

7. Fiscal Annual Income Statement for Costco and Macy’s

8. Profit Management Path for Costco and Macy’s

9. Profit Margin Management Path
Net Sales = Gross Sales + Promotional Allowances – Returns, Discounts, and Credits for Damaged Goods
Cost of Good Sold (COGs) – Amount a retailer pays to vendors for the merchandise it sells.
Gross Margin (GM) = Net Sales – COGs
Important measure in retailing because it indicates how much profit the retailer is making on merchandise sold without considering operating costs and expenses.

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

11. Profit Margin Management Path
Operating profit margin
Operating profit margin = Gross margin - Operating expenses - Extraordinary (recurring) operating expenses
Also called EBITDA
Net profit margin = Operating profit margin – Extraordinary (nonrecurring) expenses - Taxes - Interest – Depreciation

12. Profit Margin Management Path
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 %

13. Profit Margin Management Path
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 %

14. Profit Margin Management Path
Operating income percentage is gross margin minus operating expenses divided by net sales
Gross margin - Operating expenses
Net sales
= Operating income percentage

15. Asset Management Path Assets: Current Asset and Fixed Asset
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
Current Assets can easily be converted to cash within one year.

16. Average inventory at cost
Asset Management Path
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
Inventory Turnover = COGS/Avg. Inventory (cost)
Net sales
Total assets
= Asset turnover
Cost of goods sold
Average inventory at cost
= Inventory turnover

17. Asset Information from Costco and Macy’s
* ($ millions) *

18. Asset Management Path for Macy’s and Costco

19. 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)
Merchandise Inventory-is a critical retailer asset that provides benefits to customers
Inventory Turnover = COGS/avg inventory (cost)
Inventory Turnover = Sales/ avg inventory (retail)

20. Strategic Profit Model Ratios for Selected Retailers

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

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

23. Analysis of Financial Strength
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.

24. Analysis of Financial Strength
Debt-Equity Ratio
The retailer’s short- and long-term debt divided by the value of the owners’ or stockholders’ equity.
Liabilities-are a company’s debts such as its accounts payable which is the money it owes its vendors for merchandise.
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.

25. Analysis of Financial Strength
Quick Ratio
“acid-test ratio”
(Short-term assets – inventory)/ Short-term liabilities
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.

26. 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

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

28. 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

29. 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).

30. 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

31. Examples of Performance Measures Used by Retailers

32. Assessing Performance
Growth in Stockholder Value – Stock Price
Accounting Measures – ROA (Risk adjusted)
Benchmark
Performance Over Time
Compare performance indicator for three years
Performance Compared to Competitors
Compare performance indicators with major competitors for one year, most recent

33. Performance Measures for Costco and Macy’s Over Time