1. McGraw-Hill/Irwin Retailing Management, 6/e Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6 Financial Strategy

2. 6-2 Retailing Strategy Retail Market Strategy Chapter 5 Financial Strategy Chapter 6 Retail Locations Chapters 7,8 Human Resource Management Chapter 9 Information and Distribution Systems Chapter 10 Customer Relationship Management Chapter 11

3. 6-3 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

4. 6-4 Financial Tradeoff Made by Retailers to Increase ROI Asset Turnover Net Profit Margin

5. 6-5 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

6. 6-6 Components of the Strategic Profit Model

7. 6-7 The Strategic Profit Model: Profit Management Net Profit Margin Sales Net Profit Gross Margin Total Expenses Sales Cost of Goods Sold 15% 15 40 100 60 10025 - -

8. 6-8 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

9. 6-9 The Strategic Profit Model: Return on Assets Net Profit Margin Sales Net Profit Gross Mar Total Exp. Sales Cost Goods Sold 15% 15 40 100 60 10025 - - Asset Turnover Total Assets Sales Current Assets Fixed Assets Inventory A/R 2.5 100 10 5 4 40 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 Total Assets ( ) Net Profit Net Sales ( ) Net Profit Total Assets ( ) ÷ ÷

10. 6-10 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%

11. 6-11 Income Statements for Federated Department Stores and Costco

12. 6-12 Profit Management Path for Federated and Costco

13. 6-13 Net Sales Gross Margin Gross Sales Less Returns Less customer allowances COGS Components of Gross Margin

14. 6-14 Gross Margin for Federated and Costco Gross Margin = Gross Margin % Net Sales Federated:$ 6,333= 40.5% $15,630 Costco:$ 6,014= 12.5% $48,107 Gross Margin = Gross Margin % Net Sales Federated:$ 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?

15. 6-15 Operating Expenses Operating Expenses = Operating Expenses % Net sales Federated: $4,933 = 31.6% $15,630 Costco: $4,629 = 9.6% $48,107

16. 6-16 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

17. 6-17 Net Profit Net Profit = Net Profit % Net sales Federated: $689 = 4.4% $15,630 Costco: $882 = 1.8% $48,107

18. 6-18 Asset Information from Federated’s and Costco’s Balance Sheet

19. 6-19 Asset Management Path for Federated and Costco

20. 6-20 Inventory Turnover Cost of Goods = Inventory Turnover Average inventory Federated: $9,297 = 3.0 $3,120 Costco: $42,093 = 11.6 $ 3,644

21. 6-21 Inventory Turnover

22. 6-22 Asset Turnover Net Sales = Asset Turnover Total Assets Federated: $15,630 = 1.1 $14,885 Costco: $48,107 = 3.2 $15,093

23. 6-23 Return on Assets 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%

24. 6-24 Strategic Profit Model Ratios for Selected Retailers

25. 6-25 Income Statement for Gifts to Go

26. 6-26 Gross Margin Percent Gross Margin = Gross Margin Percent Net Sales Stores: $350,000 = 50% $700,000 GiftstoGo.com $220,000 = 50% $440,000

27. 6-27 Operating Expense Percent Operating Expenses = Operating Expenses % Net Sales Stores: $250,000 = 35.7% $700,000 GiftstoGo.com: $150,000 34.1% $440,000

28. 6-28 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

29. 6-29 Balance Sheet Information for Gifts to Go and Proposed Internet Channel

30. 6-30 Inventory Turnover Cost of Goods = Inventory Turnover Average Inventory Stores: $350,000 = 2.0 $175,000 GiftstoGo.com: $220,000 = 3.1 $ 70,000

31. 6-31 Asset Turnover Net Sales = Asset Turnover Total Assets Stores: $700,000 = 1.84 $380,000 GiftstoGo.com: $440,000 = 2.09 $211,000

32. 6-32 Return on Assets 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%

33. 6-33 Profit Management Asset Management The Strategic Profit Model Net Sales Cost of goods sold Variable expenses Fixed expenses Gross margin Total expenses Net profit Net Sales Net profit margin Asset turnover Return on assets - - + Inventory Accounts receivable Other current assets Total current assets Fixed assets Net sales Total assets + + + x

34. 6-34 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

35. 6-35 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

36. 6-36 Setting Objectives in Large Retail Organizations Top Down Planning Corporate Developmental Strategy Category, Departments and sales associates implement strategy

37. 6-37 Setting Objectives in Large Retail Organizations Bottom Up Planning Buyers and Store managers estimate what they can achieve Corporate Operation managers must be involved in objective setting process

38. 6-38 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

39. 6-39 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

40. 6-40 Performance Objectives and Measures Used by Retailers

41. 6-41 Examples of Performance Measures Used by Retailers Level ofOutputInputProductivity Organization(Output/Input) CorporateNet salesSquare feet ofReturn on assets (measures ofstore space entire corporation) Net profitsNumber ofAsset turnover employees Growth in sales,InventorySales per employee profits AdvertisingSales per square expendituresfoot

42. 6-42 Examples of Performance Measures Used by Retailers Level ofOutputInputProductivity Organization(Output/Input) MerchandiseNet salesInventory levelGross Margin managementReturn on (measures for aInvestment (GMROI) merchandise category)Gross marginMarkdownsInventory turnover Growth in salesAdvertisingAdvertising as a expensespercentage of sales * Cost of Markdown as a merchandisepercentage of sales* * These productivity measures are commonly expressed as an input/output.

43. 6-43 Examples of Performance Measures Used by Retailers Level ofOutputInputProductivity Organization(Output/Input) Store operationsNet salesSquare feet ofNet sales per (measures for aselling areassquare foot store or departmentGross marginExpenses forNet sales per within a store)utilitiessales associate or per selling hour Growth in salesNumber of salesUtility expenses as associatesa percentage of sales * * These productivity measures are commonly expressed as an input/output.

44. 6-44 Illustrative Productivity Measures Used by Retailing Organizations Level ofOutputInputProductivity Organization(Output/Input) CorporateNet profitOwners’ equityNet profit / (chief executiveowners’ equity = officer) return on owners’ equity MerchandisingGross marginInventory*Gross margin / (merchandiseinventory* = manager andGMROI buyer) Store operationsNet salesSquare footNet sales / (director of stores,square foot store manager) *Inventory = Average inventory at cost

45. 6-45 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

46. 6-46 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/comp anysearch.htmlhttp://www.sec.gov/edgar/searchedgar/comp anysearch.html

47. 6-47 Federated’s and Costco’s Financial Performance Over Three Years

48. 6-48 Financial Performance of Federated and Other National Department Store Chains