Financial Strategy Retail

Yasmin S

Business Survival:
There are two key factors for business survival: Profitability Solvency Profitability is important if the business is to generate revenue (income) in excess of the expenses incurred in operating that business. The solvency of a business is important because it looks at the ability of the business in meeting its financial obligations.
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Retail and Financial Management

The income statement and the balance sheet of the retailers contain information regarding the performance of their stores Retailers who take time to study these figures are able to develop business models and generate more profits

Budgeting
Budget is an attempt to forecast income and expenses of the firm. Its a statement of likely income and estimated expenditure

Types of Budget
The Operating Budget:
Sales Budget: its a sales forecast, should be carefully estimated as it affects other forecast; cash flow Merchandise Budget: is the forecast of the goods to be sold Expenses Budget: consist of planned expenditure for the said period

Types of Budget
The Cash Budget: in simple terms its a statement of cash inflow and outflow The Capital Expenditure: such as replacement of or addition to existing assets, modernization, installation of MIS is necessary in the long-term interest of the firm

Types of Budget
Reports: a budgetary control system can be made effective if key results are made available regularly
Sales: sales record of each retail store can be produced which give the actual, budgeted and variance values, also helps in finding the fast and the slow movers in the category Expenses: report is prepared for major cost heads like wages, maintenance etc
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Income Statement
Summarizes the financial performance of a company for a given accounting period It shows how much revenue the company earned through its operations, and the expenses associated with bringing in that revenue

Income Statement
Sales : gross sales, net sales, goods returned by customers COGS : direct cost associated with manufacturing/procuring the merchandise for the store, also includes transportation cost. In simple terms its the price paid by the retailer to produce or acquire goods for sale
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Income Statement
Gross margin: difference between net sales and the COGS, indicates the profitability of the retailer. A high gross margin implies that the store is efficient in procuring and selling merchandise Expenses: interest and operating expenses. Operating expenses: selling expenses, general expenses and administrative expenses 10

Income Statement
Salary of staff, salary of sales staff, rent, utilities, office supplies Net profit BOTTOMLINE,

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Balance Sheet
Assets are the items owned by the retailer that have an economic value and are expected to produce some economic benefit to the firm. Current assets= Accounts Receivable + Merchandise Inventory + cash + other current assets

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Merchandise Inventory
It constitutes the major part of the total assets Inventory to asset ratio= inventory/ total asset Inventory turnover= net sales/ average inventory Average inventory= inventory/ (1- gross margin)
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Merchandise Inventory
Inventory turnover indicates the speed at which the inventory is moving out of the stores It is used to evaluate the efficiency of an organization in managing its investment in inventory The inventory cycle usually consists of ordering of inventory, stacking in the store, 14 and selling to customers.

Fixed Assets
Represent those assets that require more than one year to be converted into cash Over the years the value of the fixed assets depreciate Asset Turnover= Net Sales/ Total Assets

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Liabilities and Owners Equity

Refers to items that a company owes to creditors and suppliers Current liabilities: refer to debts that need to be paid within one year, accounts payable, accrued expenses Long term liability Owners equity: common stock and retained earnings
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Financial Statement Analysis

Financial Statement Analysis will help business owners and other interested people to analyse the data in financial statements to provide them with better information about such key factors for decision making and ultimate business survival.

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Financial Statement Analysis

Purpose: To use financial organisations
Financial performance Financial position.

statements

to

evaluate

an

To have a means of comparative analysis across time in terms of:

Intracompany basis (within the company itself) Intercompany basis (between companies) Industry Averages (against that particular industrys averages)

To apply analytical tools and techniques to financial statements to obtain useful information to aid decision making. 18

Tools of Financial Statement Analysis:

The commonly used tools for financial statement analysis are: Financial Ratio Analysis Comparative financial statements analysis:
Horizontal analysis/Trend analysis Vertical analysis/Common size analysis/ Component Percentages

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Financial Ratio Analysis

Financial ratio analysis involves calculating and analysing ratios that use data from one, two or more financial statements. Ratio analysis also expresses relationships between different financial statements. Financial Ratios can be classified into 5 main categories:
Internal Liquidity ratios Profitability Ratios Earning Coverage Ratios Financial Leverage Ratios
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Internal Liquidity ratios

Short-term funds management Working capital management is important as it signals the firms ability to meet short term debt obligations. For example: Current ratio The ideal benchmark for the current ratio is 2:1 where there are Rs.2 of current assets (CA) to cover Rs.1 of current liabilities (CL). The acceptable benchmark is 1:1 but a ratio below 1CA:1CL represents liquidity riskiness as there is insufficient current assets to cover 1 of current liabilities.

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Internal Liquidity ratios

Working Capital = Current assets Current Liabilities Current Ratio = Current Assets Current Liabilities

Quick Ratio = Current Assets Inventory Prepayments Current Liabilities Bank Overdraft Cash Ratio = Cash & Cash Equivalents Current Liabilities
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Profitability Ratios
3 elements of the profitability analysis: Analysing on sales and trading margin
focus on gross profit

Analysing on the control of expenses

focus on net profit

Assessing the return on assets and return on equity

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Profitability Ratios
Gross Profit % = Gross Profit * 100 Net Sales Net Profit % = Net Profit after tax * 100 Net Sales Return on Assets = Net Profit * 100 Average Total Assets

Return on Equity =

Net Profit *100 Average Total Equity

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Asset Management Ratios

Efficiency of asset usage
How well assets are used to generate revenues (income) will impact on the overall profitability of the business.

For example: Asset Turnover

This ratio represents the efficiency of asset usage to generate sales revenue
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Asset Management Ratios

Inventory Turnover = Net Sales Average Inventory

( Avg inventory = Inventory / ( 1- Gross Margin )

Asset Turnover =

Inventory Total Assets

Asset Turnover =

Net Sales Total Assets

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Financial Leverage Ratios

Long term funds management Measures the riskiness of business in terms of debt gearing. For example: Debt/Equity This ratio measures the relationship between debt and equity. A ratio of 1 indicates that debt and equity funding are equal (i.e. there is Rs.1 of debt to Rs.1 of equity) whereas a ratio of 1.5 indicates that there is higher debt gearing in the business (i.e. there is Rs.1.5 of debt to Rs.1 of equity). This higher debt gearing is usually interpreted as bringing in more financial risk for the business particularly if the business has profitability or cash flow problems.
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Financial Leverage Ratios

Debt/Equity ratio = Debt / Equity Debt/Total Assets ratio = Debt *100 Total Assets

Equity ratio =

Equity *100 Total Assets

Interest Coverage Ratio= Earnings before Interest and Tax Interest

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Improving Financial Performance

Profit Management
Sales Productivity Expenses Control

Asset Management
ROA Inventory Turnover Ratio

Debt Management
Debt / Equity RONW

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Limitations of Financial Statement Analysis

We must be careful with financial statement analysis.
Strong financial statement analysis does not necessarily mean that the organisation has a strong financial future. Financial statement analysis might look good but there may be other factors that can cause an organisation to collapse.

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Why it is usually not appropriate to compare ratios to companies is different industries:

Varying ways of doing business in different industries means that ratio values appropriate in one industry are not appropriate in a different industry. For example
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Consider two different retail stores in different industries:

A retail grocery business typically operates with a very small profit margin, but has a very high turnover. A retail jewelry store typically operates with a low turnover, but has a high profit margin. Both stores can achieve the same overall profitability, but they do it in different ways, as appropriate in their respective industries.

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Other Retail Performance Measures

Sales per square foot or meter: sale for a particular period/ floor area= Rs. 60,00,000/ 5000 Sq ft.= Rs 1200 per square ft. this performance parameter is very useful in comparing returns from different branch locations. A more sophisticated measurement would be net profit per square foot, it shows the actual contribution in profit terms 33

Other Retail Performance Measures

Sales per linear foot: measure the sales and profits in relation to the length of wall runs in their stores. Indicates the success of in-store display and merchandising in particular section also helps bring out Hot Spots and Dead Areas

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Other Retail Performance Measures

Sales per assistant: key measurement as it gives a useful comparison between the labor productivity of different branches, eg sales of Rs 75 Lakhs and the number of staff being 25 gives sales per assistant of Rs 3 lakhs

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Other Retail Performance Measures

Sales per checkout: by dividing the periods sales in a supermarket by the number of checkouts the operator can find out whether he/she is under or over-tilled and make adjustments

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Assignment
Visit a local bank and ascertain from them what records a small retailer must produce in order to get a loan

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