DC Lecture Six: Managing a Retailer's Finances

MKTG 1058:
DISTRIBUTION
CHANNELS

6-1

Distribution Channels MKTG 1058
LECTURE SIX

Managing a Retailer’s
Finances
(Dunne Chapter Eight)

6-2
2

Learning Objectives for Chapter 8:

• Describe the importance of a merchandise
budget and know how to prepare a six-month
merchandise plan.
• Explain the differences among and the uses of
these three accounting statements: income
statement, balance sheet, and statement of
cash flow.
• Explain how the retailer is able to value
inventory.

6-3

Note:

 This is a very practical and technical chapter
 Based on accounting concepts (you should have
covered this before)
 Much of the content covers the preparation of the
merchandise budget and inventory planning
 Lots of detail- read slowly and work out the
exercises at the end of the chapter
 Formulas shown in Exhibit 8-3 (page 262) is very
important

6-4

The Merchandise Budget

• Merchandising is the planning and control of
the buying and selling of gods and services to
help the retailer realize its objectives.
• Merchandise budget is a plan of projected
sales for an upcoming season, when and how
much merchandise is to be purchased, and
what markups and reductions will likely occur.
• Gross margin is the difference between net
sales and cost of goods sold.

6-5

Five Major Merchandising Decisions

1. What will be the anticipated sales for the
department, division, or store?
2. How much stock on hand will be needed to
achieve this sales plan, given the level of
inventory turnover expected?
3. What reductions, if any, from the original
retail price must be made in order to dispose
of all the merchandise brought into the
store?

6-6

Five Major Merchandising Decisions

4. What additional purchases must be made
during the season?
5. What gross margin ( the difference between
sales and cost of goods sold) should the
department, division, or store contribute to
the overall profitability of the company?

6-7

Four Rules in Preparing the Merchandise Budget

• Always be prepared in advance of the selling
season.
• The language of the budget must be easy to
understand.
• Must be planned of a relatively short period of
time (six months is the norm used by most
retailers).
• Flexible enough to permit changes.

6-8

Sample Six-Month Merchandise Budget
Exhibit 8.1(a)

6-9

Exhibit 8.1(b)

6-10

Exhibit 8.1(c)

6-11

Two-Seasons Department Store, Dept.353, Six-
Month Merchandise Budget
Exhibit 8.2

6-12

Formulas for the Six-Month
Merchandise Budget Exhibit 8.3

6-13

Determining the Merchandise
Budget
Working out the key steps

“ THE EIGHT STEP PROCESS”

1
4

Exhibit 8.2

Lets break up the table into different parts; we
focus on February only figures
6-15

Lets focus on February

6-16

STEP ONE:

Determining Planned Sales for the Month

(Planned Sales Percentage for the Month )
X (Planned Total Sales)
= (Planned Sales for the Month)

6-17

How to Figure: Planned Sales for the Month

(Planned Sales Percentage for the Month )
X (Planned Total Sales)
= (Planned Sales for the Month)

15% X 500,000

= 75,000

6-18

STEP TWO:

Determining Planned BOM Stock for the
Month

(Planned Sales for the Month ) X
(Planned BOM Stock-to-Sales Ratio for the
Month)
= (Planned BOM Stock for the Month)

6-19

How to Figure: Planned BOM Stock for the Month

(Planned Sales for the Month )
X (Planned BOM Stock-to-Sales Ratio
for the Month)
= (Planned BOM Stock for the Month)

75,000 X 3

= 225,000

6-20

STEP THREE:

Determining Planned Retail Reductions
for the Month

(Planned Sales for the Month ) X
(Planned Retail Reduction Percentage for the
Month)
= (Planned Retail Reduction for the Month)

6-21

How to Figure: Planned Retail Reductions for the Month

X (Planned Retail Reduction Percentage
for the Month)
= (Planned Retail Reduction for the
Month)

75,000 X 10%

= 7,500

6-22

STEP FOUR:

Determining Planned EOM Stock for the
Month

(Planned BOM Stock for the Following Month )
= (Planned EOM Stock for The Current Month)

6-23

How to Figure: Planned BOM Stock for the Following Month

(Planned BOM Stock for the Following Month )
= (Planned EOM Stock for The Current Month)

300,000 = 300,000

6-24

STEP FIVE:

Determining Planned Purchases at Retail
for the Month

(Planned Sales for the Month ) + (Planned
Retail Reductions for the Month) + (Planned
EOM Stock for the Month) - (Planned BOM
Stock for the Month)
= (Planned Purchases at Retail for the Month)

6-25

How to Figure: Planned Purchases at Retail for the Month

+ (Planned Retail Reductions for the Month)
+ (Planned EOM Stock for the Month)
- (Planned BOM Stock for the Month)
= (Planned Purchases at Retail for the Month)

75,000 + 7,500

+ 300,000 - 225,000

= 157,500

6-26

STEP SIX:

Determining Planned Purchases at Cost
for the Month

(Planned Purchases at Retail for the Month )
X (100% minus Planned Initial Markup
Percentage)
= (Planned Purchases at Cost for the Month)

6-27

How to Figure: Planned Purchases at Cost for the Month

X (100% - Planned Initial Markup Percentage)
= (Planned Purchases at Cost for the Month)

157,500 X (100 - 45%)

= 86,625

6-28

STEP SEVEN:

Determining Planned Initial Markup
for the Month
(Planned Purchases at Retail for the Month ) X
(Planned Initial Markup Percentage) =
(Planned Initial Markup for the Month)
OR
(Planned Purchases at Retail for the Month) -
(Planned Purchases at Cost for the Month) =
(Planned Initial Markup for the Month)

6-29

How to Figure: Planned Initial Markup for the Month

First Formula
X (Planned Initial Markup Percentage)
= (Planned Initial Markup for the Month)

157,500 X 45%

= 70,875

6-30

How to Figure: Planned Initial Markup for the Month

Second Formula

(Planned Purchases at Retail for the Month)
- (Planned Purchases at Cost for the Month)
( -) = (Planned Initial Markup for the Month)

= 157,500 - 86,625

= 70,875

6- 31

STEP EIGHT:

Determining Planned Gross Margin
for the Month

(Planned Initial Markup for the Month) -
(Planned retail Reductions for the Month) =
(Planned Gross Margin for the Month)

6-32

How to Figure: Gross Margin for the Month

(Planned Initial Markup for the Month )
- (Planned Retail Reductions for the Month)
= (Planned Gross Margin for the Month)

70,875 - 7,500

= 63,375

6-33

Analysis of Case Study
(Chapter Eight)
Dolly’s Place

See details in your Outline Lecture
Notes- pages 63-65

6- 34

Dolly's Place Date: January 7, 2009
Three-Month Merchandise Budget Season: Spring 2009
Seasonal
Spring February March April Total
1.Planned BOM Stock

2.Planned Sales

3.Planned Retail
Reductions
4.Planned EOM Stock

Step 1: work 5.Planned Purchases
@ Retail

out the Planned 6.Planned Purchases
@ Cost
Sales 7.Planned Initial Markup
8.Planned Gross Margin
9.Planned BOM Stock/Sales 3.0x 5.0x 6.0x _________
Ratio
10.Planned Sales Percentage 33% 40% 27% 100%
11.Planned Retail Reduction 5% 10% 20% 11.05%

Planned Total Sales for the Period $250,000
Planned Total Retail Reduction Percentage For the Period 11.05%
Planned Initial Markup Percentage For the Period 45%
Planned BOM Stock for May $400,000

6-35

Seasonal
1.Planned BOM Stock

2.Planned Sales
82500 100000 67500 2500000

3.Planned Retail
Reductions
4.Planned EOM Stock

@ Retail

@ Cost
Sales 7.Planned Initial Markup
Ratio


6-36

Seasonal
1.Planned BOM Stock

2.Planned Sales
82500 100000 67500 2500000

3.Planned Retail
Reductions
4.Planned EOM Stock

@ Retail

@ Cost
BOM Stock 7.Planned Initial Markup
Ratio


6-37

Seasonal
1.Planned BOM Stock 247500
(82500 x 3)
2.Planned Sales
82500 100000 67500 2500000

3.Planned Retail
Reductions
4.Planned EOM Stock

@ Retail

@ Cost
BOM Stock 7.Planned Initial Markup
Ratio


6-38

Seasonal
(82500 x 3)
2.Planned Sales 82500 100000 67500 2500000

3.Planned Retail
Reductions
4.Planned EOM Stock

@ Retail

@ Cost
Retail 7.Planned Initial Markup

Reductions for 8.Planned Gross
9.Planned BOM
Margin
Stock/Sales 3.0x 5.0x 6.0x _________
the Month Ratio


6-39

Seasonal
(82500 x 3)
2.Planned Sales 82500 100000 67500 2500000

3.Planned Retail 4125
Reductions (82500x 0.05)
4.Planned EOM Stock

@ Retail

@ Cost
Retail 7.Planned Initial Markup

Reductions for 8.Planned Gross
9.Planned BOM
Margin
Stock/Sales 3.0x 5.0x 6.0x _________
the Month Ratio


6-40

Seasonal
(82500 x 3)
2.Planned Sales 82500 100000 67500 2500000

4.Planned EOM Stock

5.Planned Purchases
@ Retail
6.Planned Purchases
@ Cost
7.Planned Initial Markup

Step 4: work 8.Planned Gross Margin

out the Planned
Ratio

EOM Stock 10.Planned Sales
11.Planned Retail
Percentage
Reduction
33%
5%
40%
10%
27%
20%
100%
11.05%


6-41

Seasonal
1.Planned BOM Stock 247500 (10000 x 5.0)
500000
(82500 x 3)
2.Planned Sales 82500 100000 67500 2500000

4.Planned EOM Stock
500000

5.Planned Purchases
@ Retail
6.Planned Purchases
@ Cost


out the Planned
Ratio

EOM Stock 10.Planned Sales
11.Planned Retail
Percentage
Reduction
33%
5%
40%
10%
27%
20%
100%
11.05%


6-42

Seasonal
500000
(82500 x 3)
2.Planned Sales 82500 100000 67500 2500000

4.Planned EOM Stock
500000

5.Planned Purchases
@ Retail
6.Planned Purchases
@ Cost


out the Planned
Ratio

Purchases at 10.Planned Sales
11.Planned Retail
Percentage
Reduction
33%
5%
40%
10%
27%
20%
100%
11.05%
Retail

6-43

Seasonal
500000
(82500 x 3)
2.Planned Sales 82500 100000 67500 2500000

4.Planned EOM Stock
500000

5.Planned Purchases 82500+4125+500000-247500
@ Retail 339125

6.Planned Purchases
@ Cost


out the Planned
Ratio

11.Planned Retail
Percentage
Reduction
33%
5%
40%
10%
27%
20%
100%
11.05%
Retail

6-44

Seasonal
500000
(82500 x 3)
2.Planned Sales
82500 100000 67500 2500000

4.Planned EOM Stock
500000

5.Planned Purchases
@ Retail 339125

6.Planned Purchases
@ Cost


out the Planned
Ratio

11.Planned Retail
Percentage
Reduction
33%
5%
40%
10%
27%
20%
100%
11.05%
Cost

6-45

Seasonal
500000
(82500 x 3)
2.Planned Sales
82500 100000 67500 2500000

4.Planned EOM Stock
500000

5.Planned Purchases 339125 x (1-0.45)
@ Retail 339125 339125x 0.55=
186519
6.Planned Purchases 186519
@ Cost


out the Planned
Ratio

11.Planned Retail
Percentage
Reduction
33%
5%
40%
10%
27%
20%
100%
11.05%
Cost

46

Seasonal
500000
(82500 x 3)
2.Planned Sales 82500 100000 67500 2500000


Step 7: work
4.Planned EOM Stock
500000

@ Retail 339125

Initial Markup 6.Planned Purchases
@ Cost
186519

Ratio


6-47

Seasonal
500000
(82500 x 3)
2.Planned Sales 82500 100000 67500 2500000


Step 7: work 4.Planned EOM Stock
500000

@ Retail 339125

Initial Markup 6.Planned Purchases 186519
@ Cost 339125 x
7.Planned Initial Markup 0.45
152606
Ratio


6-48

Seasonal
500000
(82500 x 3)
2.Planned Sales 82500 100000 67500 2500000


Step 8: work 4.Planned EOM Stock
500000

@ Retail 339125

Gross Margin 6.Planned Purchases 186519
@ Cost
7.Planned Initial Markup 152606
Ratio


6-49

Seasonal
500000
(82500 x 3)
2.Planned Sales 82500 100000 67500 2500000


Step 8: work
4.Planned EOM Stock
500000

@ Retail 339125

Gross Margin 6.Planned Purchases
@ Cost
186519

7.Planned Initial Markup 152606
152606 - 4125
8.Planned Gross Margin 148481
Ratio


6-50

Retail Accounting Statements

•Income Statement
•Balance Sheet
•Statement of Cash Flow

6-51

Income Statement

• Income Statement is a financial statement that
provides a summary of the sales expenses for a given
time period, usually a month, quarter, season, or year.
• Gross Sales are the retailer’s total sales including
sales for cash or credit.
• Returns and Allowances are the refunds of the
purchase price or downward adjustments in selling
prices due to customers returning purchases, or
adjustments made in the selling price due to customer
dissatisfaction with the product or service
performance.

6-52

Income Statement

• Net Sales is the gross sales less returns and
allowances.
• Cost of Goods Sold is the cost of merchandise
that has been sold during the period.
• Operating Expenses are those expenses that a
retailer incurs in running the business other
than the cost of the merchandise.

6-53

Income Statement

• Operating Profit is gross margin less operating
expenses.
• Other Income or Expenses includes income or
expense items that the firm incurs which are
not in the course of its normal retail operation.
• Net Profit is operating profit plus or minus
other income or expenses.

6-54

Retailers’ Basic Income
Statement Format

Exhibit 8.5A

6-55

Sample Income Statement
Exhibit 8.5B

6-56

These are critical in retailing:

Each of these elements of COGS have implications for
retail operations, particularly on merchandise
management

6-57

What can the retailer do to improve
the GM?

 It has a lot to do with:
 Buying and selling the right merchandise (hence
Chapter 9)
 Setting the right mark-ups and avoiding excessive
mark-downs
 Managing the inventory
 Above all being able to add value through
differentiation and customer service

6-58

Retailing operations can influence the GM and OP

Returns &

Gross Allowances

Sales
Cost of Goods

Net Sold

Sales
Operating
Gross Expenses

Margin Operating
Profit

6-59

GMROI
Inventory Productivity Measures

GMROI = Gross Margin Percent x sales to stock ratio

= gross margin x net sales
net sales avg inventory at cost

= gross margin
avg inventory at cost

6-60

ROI and GMROI
Asset Productivity Measures
Strategic Corporate Level
• Return on Assets = Net Profit
Total Assets

Merchandise Management Level
• GROI = Gross Margin
Average Inventory

6-61

Controlling Expenses
Why do
we need
to monitor
these cost
items in
Retailing?

6-62

Balance Sheet

 Balance Sheet identifies and quantifies all of the firm’s
assets and liabilities at a particular point in time.
 Asset is anything of value that is owned by the retail
firm.
 Current Assets are assets that can be easily converted
into cash within a relatively short period of time
(usually a year or less).
 Accounts and/or Notes Receivable are amounts that
customers owe the retailer for goods and services.

6-63

Balance Sheet

 Prepaid Expenses are those items for which the
retailer has already paid, but the service has not been
completed.
 Retail Inventories comprise merchandise that the
retailer has in the store or in storage and is available
for sale.
 Noncurrent Assets are those that cannot be converted
to cash in a short period of time (usually 12 months) in
the normal course of business.

6-64

Balance Sheet

 Goodwill is an intangible asset, usually based on
customer loyalty, that a retailer pays for when buying
an existing business.
 Total assets equal current assets plus noncurrent
assets plus goodwill.
 Liability is any legitimate financial claim against the
retailer’s assets.
 Current Liabilities are short-term debts that are
payable within a year.

6-65

Balance Sheet

 Accounts Payable are amounts owed vendors for
goods and services.
 Long-Term Liabilities are debts that are due in a year
or longer.
 Total Liabilities equal current liabilities plus long-term
liabilities.
 Net Worth (owner’s equity) is total assets less total
liabilities.

6-66

Retailers’ Basic Balance Sheet Format

Exhibit 8.6A

6-67

Graphic Presentation of the
Balance Sheet

Current
Current Liabilities
Assets
Long Term
Liabilities
Fixed Assets
Net Worth

6-68

Sample Balance Sheet

Exhibit 8.6B

6-69

Looking at the Assets side of the BS

Credit sales to customers

Above all, effective
management of the
inventory!

Utilization of building and
store facility. Productivity
of store area and use of
technology in the store to
improve efficiency

7-70

Statement of Cash Flow

• Statement of cash flow
lists in detail the sources and type of all
revenue (cash inflows) and the use and type of
all expenditures (cash outflows) for a given
time period.

6-71

Retailing Truism

 Cash “in” must always exceed cash
“out” (if you want to stay in business).

6-72

Sample Cash Flow Statement

Exhibit 8.7A

6-73

Typical Cash Inflow &
Outflow Categories

Exhibit 8.7B

6-74

Comparative Financial Analysis of
Retailers- worked examples

■ The following slides show how to analyze the
financial statements of two different kinds of
retailers and then to draw implications about the
nature of their retailing operations
■ Areas of analysis include
 Profitability analysis
 Gross margins
 Inventory turnover
 Asset turnover

Income Statements for Macy’s and Costco

6-76

Profit Management Path for
Macy’s and Costco

So which retailer has done a
better job in terms of profitability?

6-77

Margin Management

■ Net Sales = Gross Sales + Promotional
Allowances - Return
■ Cost of Good Sold (COGs)
■ Gross Margin (GM) = Net Sales - COGs
■ Expense
 Variable (e.g.. sales commissions)
 Fixed (rent, depreciation, staff salaries)
■ Net Profit = Net Sales – COGS - Expenses

6-78

Gross Margin for
Macy’s and Costco

Gross Margin = Gross Margin %
Net Sales

Macy’s: $ 10,773 = 39.9%
$15,630

Costco: $ 7,406 = 12.3%
$60,151

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

6-79

Operating Expenses

= Selling, general and administrative expenses (SG&A)
+ depreciation + amortization of assets

Includes costs other than the cost of merchandise

Operating Expenses = Operating Expenses %
Net Sales

Macy’s: $8,937 = 33.1%
$26,970

Costco: $5,781 = 9.6%
$60,151
6-80

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

6-81

Net Operating Income

■ Before interest expenses/income, taxes, and extraordinary
expenses
■ A commonly used overall profit measure due to the lack of control
over taxes, interest, and extraordinary expenses
■ Allows for a comparison of financial performance across companies
or divisions within companies

Gross Margin – Operating Expenses = Net Operating Income %
Net Sales

Macy’s: $10,773 – 8,937 = 6.81%
$26,970

Costco: $7,406 - $5,781 = 2.70%
$60,151

6-82

Asset Management

■ Assets:
 Economic Resources (e.g., inventory, buildings, computers, store
fixtures) owned or controlled by a firm
 Current Asset and Fixed Asset
■ Current Assets =
Inventory + Cash + Account Receivable
■ Fixed Assets = Fixture, Stores (owned)
■ Asset Turnover = Sales/Total Assets
■ Inventory Turnover = COGS/Avg. Inventory (cost)

6-83

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

6-84

Asset Management Path for
Macy’s and Costco

6-85

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)

Inventory Turnover = COGS/avg inventory (cost)
Inventory Turnover = Sales/ avg inventory (retail)

6-86

Importance of stock turnover rate

■ Inventory turnover rate differs by
 Industry
 Product categories

■ Most retailers that are having problems achieving
adequate profits have a poor Inventory Turnover
Rate.

■ Managing the inventory effectively and achieving
good turnover rates helps to facilitate better cash
flow for the retailer.

6-87

Inventory Turnover Rate of
Three Retailers in 2000

Wal-Mart Stores, Inc. 7.3 times
per year
1 2 3 4 5 6 7

Target Corporation
6.3times
per year
1 2 3 4 5 6

K-Mart
3.6 times
per year
1 2 3
Jan Mar Jun Sep Dec
6-88

Inventory Turnover of Apparel Retailers

■ Zara (Spain’s fashion specialty
store chain)
 Three times faster than Saks Fifth
Avenue or Abercrombie & Fitch
 1.5 times faster than H & M

6-89

Inventory Turnover

Cost of Goods = Inventory Turnover
Average inventory

Macy’s: $16,197 = 3.04
$5,317

Costco: $52,746 = 11.54
$4,569

6-90

Asset Turnover

Net Sales = Asset Turnover
Total Assets

Macy’s: $26,970 = 0.91
$29,550

Costco: $60,151 = 3.44
$17,494

6-91

Return on Assets

Net Profit Margin x Asset Turnover = Return on Assets

Macy’s: 3.70% x 0.91 = 3.37%
Costco: 1.80% x 3.44 = 6.19%

Return on Assets is a very important
performance measure because it shows how
much money the retailer is making on its
investment

6-92

Evaluation of Financial Path:
Macy’s and Costco

Macy’s Costco
Higher net profit margin Higher asset turnover

■ Retailers (and investors) need to consider
 both net profit margin and asset turnover when evaluating their
financial performance
 the implications of strategic decisions on both components of the
strategic fit model
• EX: Increasing prices => gross margin, net profit margin
sales, asset turnover

6-93

Inventory Valuation

1. Accounting Inventory
System
2. Inventory Pricing
Systems

6-94

Accounting Inventory System

•Cost Method is an inventory valuation
technique that provides a book valuation
of inventory based solely on the
retailer’s cost of merchandise including
freight.
•Retail Method is an inventory valuation
technique that values merchandise at
current retail prices, which is then
converted to cost based on a formula.

6-95

Steps for Using the Retail Method of Inventory
Valuation

•Calculation of the cost complement.
•Calculation of reductions from retail
value.
•Conversion of the adjusted retail book
inventory to cost.

6-96

Advantages of the
Cost Method of Inventory Valuation

• Accounting statements can be drawn up at any time.
Inventories need not be take for preparation of these
statements.
• Physical inventories using retail prices are less
subject to error and can be completed in a shorter
amount of time.
• The retail method provides an automatic, conservative
valuation ending inventory as well as inventory levels
throughout the season.

6-98

Some key computations:

(199,000 + 1000)

398,000 x 0.482

7-103

Inventory Pricing Systems

• FIFO stands for first in, first out and values
inventory based on the assumption that the
oldest merchandise is sold before the more
recently purchased merchandise.
• LIFO stands for last in, first out and values
inventory based on the assumption that the
most recently purchased merchandise is sold
first and the oldest merchandise is sold last.

6-104

Computations:

(net sales= 12 x$900)

(15x$500)

Purchases:
(June:8x$525)
+ (Nov:4x$550)
= $6400

6-106

Differences in Ending Inventory- why?

6-107

Ending Inventory under LIFO method:

Under LIFO method the ending inventory would the same as it was at the
beginning of the year ($7500) since we assume that the 12 packages that
were sold were the same as the 12 purchased during the year. Hence the
ending inventory comprises the opening stocks (15 units) that are valued at
$500 per unit.
6-108

Ending Inventory under FIFO method:

Under FIFO method, the ending inventory is computed as follows:
Sales is 12 units. We take 12 units from the opening stock of 15 units.
Therefore balance is 3 units valued at $500. Add this to purchases during
the year. Therefore:
(3x$500) + (8x$525) + (4x$550) = $1500 + $4200 + $2,200= $7900
7-109

Question to Ponder

•Retailers are given a choice as to
whether to use the LIFO or FIFO method.
Given such a choice, would it make a
difference in the selection of a method if
the retailer were privately owned versus
being a publicly traded company?

7-110

DC Lecture Six: Managing a Retailer's Finances

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