Financial Strategy

Financial Strategy

Strategic Profit Model:
Financial Tradeoff Made by Retailers to Increase ROI

Components of the Strategic Profit Model

Operating Expenses

 

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

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

Inventory Turnover

■     A Measure of the Productivity of Inventory:

n  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)

Importance of stock turnover rate

■     Inventory turnover rate differs by

n  Industry

n  Product categories

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

 

Financial Strategy

Strategic Profit Model:
Financial Tradeoff Made by Retailers to Increase ROI

Components of the Strategic Profit Model

 

 

 

Operating Expenses

 

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

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

Inventory Turnover

■     A Measure of the Productivity of Inventory:

n  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)

Importance of stock turnover rate

■     Inventory turnover rate differs by

n  Industry

n  Product categories

 

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

 

Example: Kmart vs. Wal-mart

 

Inventory Turnover

Importance of Inventory turnover

■      Inventory turnover rate differs by

n   Industry

n   Product categories

■      How do retailers increase Inventory Turnover?

n   Increase Sales

n   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.  

Asset Turnover

Return on Assets

Evaluation of Financial Path:
Macy’s and Costco

■      Retailers (and investors) need to consider

n   both net profit margin and asset turnover when evaluating their financial performance

n   the implications of strategic decisions on both components of the strategic fit model

•     EX: Increasing prices =>  gross margin, net profit margin

                                   sales, asset turnover                                                                       

 

 

Profit Margin Management Path:
Gross Margin Percent

Operating Expense Percent

Net Profit Percentage

Asset Turnover Management Path:
Inventory Turnover

Asset Turnover

Return on Assets

 

Setting and Measuring Performance Objectives

Setting Objectives in Large Retail Organizations

Setting Objectives in Large Retail Organizations

Productivity Measures

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

Productivity: Outputs/Input

■       Corporate Level

n   ROA = Profits/Assets 

n   Comparable store sales growth (same-store sales growth)

■       Buyers  (Inventory, Pricing, Advertising)

n   Gross Margin % = Gross Margin/Sales

n   Inv Turnover = COGS/ Avg. Inventory (cost)

n   GMROI = Gross Margin/Average Inventory

n   Advertising as % of sales

■       Stores (Real Estate, Employees)

n   Sales/Square Feet

n   Sales/Employee

n   inv. Shrinkage/sales

n   Average Transaction (sales/# of transactions)

n   Items Per Ticket (total items sold/total transactions)

n   Conversion Rate (total transactions/total traffic)

 

 

 

 

 

 

Evaluating Financial Performance

■     Growth in Stockholder Value – Stock Price

n  Accounting Measures – ROA (Risk adjusted)

■     Benchmark

n  Improvement Over Time

•     Compare performance indicator for three years

n  Performance Relative to Comparable Firms

•     Compare performance indicators with major competitors for one year, most recent

Sources of Information

■     Balance Sheet (Snap Shot at One Time)

n  Asset Management

■     Income Statement (Summary Over Time)

n  Margin Management

■     Annual Reports/ SEC Filings

n  http://www.sec.gov/edgar/searchedgar/companysearch.html

 

Macy’s and Costco’s Financial Performance
Over Three Years

Financial Performance of Macy’s and Other National Department Store Chains

Evaluating Investment Opportunities

■     ROI – Discounted Cash Flow

n  Considers time value of money, cost of capital

■     Breakeven Analysis

n  How much do we have to sell to breakeven (recover investment)?

 

Income Statement

Net Sales       $ 1,000,000

COGS                   800,000      80%

Gross Margin      200,000      20%

 

Operating Expenses

Variable               100,000      10%

Fixed                      80,000        8%

 

Profit                      20,000        2%

Variable and Fixed Operating Expenses

                        Variable    Fixed

Wages & Salaries

    Manager                 20,000 20,000

    Salespeople          60,000 20,000

    Clerical            20,000 10,000

Rent                                 20,000

Maintenance                    10,000

      Total               100,000     80,000

Break Even Analysis

Profit = Sales - COGS-Var Cost - Fixed Cost

0  =  Sales - COGs% x Sales - VC% x Sales - FC

Break-even Sales x (1-COGS% -VC%) = FC

Break-even Sales = FC/(1-COGS% -VC%)

Break-even Sales = FC/(GM%-VC%)

 

                            = $80,000/(.2-.1)

                            =  $800,000

Three Business Decisions
Is the Breakeven Going to Increase or Decrease?

•               Breakeven Sales if Retailer Moves To New Location with Rent = $50,000 Fixed

 

•               Breakeven Sales if Retailer Reduces Prices By 5%

 

•               Sales if Retailer want to make a profit of $100,000

Break-even Sales = FC/(GM%-VC%)

Breakeven Sales if Retailer Moves To New Location with Rent = $50,000 Fixed

=(60,000+50,000)/(.2-.1) = $1,100,000

 

Breakeven Sales if Retailer Reduces Prices By 5%

 

Sales if Retailer want to make a profit of $100,000

Break-even Sales = FC/(GM%-VC%)

■     Breakeven Sales if Retailer Moves To New Location with Rent = $50,000 Fixed

=(80,000+30,000)/(.2-.1) = $1,100,000

 

■     Breakeven Sales if Retailer Reduces Prices By 5%

= 80,000/(.15-.10) = 1,600,000

 

■     Sales if Retailer want to make a profit of $100,000

=(80,000+100,000)/(.2-.1) = 1,800,000