Chapter 7

Financial Strategy

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Retailing Strategy

Human Resource
Retail Locations
Management
Chapters 8,9
Chapter 16

Retail Market Strategy

Chapter 6
Financial Strategy
Chapter 7

Information and Customer

Distribution Relationship
Systems Management
Chapter 10 Chapter 11
6-2
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?

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

6-4
Strategic Profit Model:
Financial Tradeoff Made by Retailers to Increase ROI

Outlines Tradeoff Between

Margin Management
Asset (Inventory Management)
Net Profit Margin

Asset Turnover

6-5
Components of the Strategic Profit Model

6-6
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

6-7
The Strategic Profit Model:
Profit Management

Sales

Gross 100
Margin
-
40 Cost of
Net Profit Goods Sold

Net Profit 15 60
Margin -

15% Total
Sales Expenses

100 25

6-8
The Strategic Profit Model:
Asset Management
Inventory

5
Sales
+
Asset 100 Current Accounts
Turnover Assets Receivable

2.5 10 4
Total Assets

40 + +
Other Current
Fixed Assets Assets

30 1

6-9
The Strategic Profit Model:
Return on Assets

Profit Management
Sales

Gross Mar 100

Net Profit

15 40 -
Net Profit Margin Cost Goods Sold
÷ -
15% Sales Total Exp. 60
( Net Profit
Net Sales ) 100 25
Return on
Assets Times
Inventory

Asset Management
37.5% Sales 5
( Net Profit
Total Assets ) Asset Turnover 100 Current Assets
+
A/R
2.5 ÷ 10 4
Total Assets

( Net Sales
) 40 + +
Total Assets Fixed Assets Other Current Assets

Net Profit
=
Net Profit
x
Net Sales 30 1
Total Assets Net Sales Total Assets
6-10
The Strategic Profit Model:
Return on Assets

Profit Management
Sales

Gross Mar 100

Net Profit

15 40 -
Net Profit Margin Cost Goods Sold
÷ -
15% Sales Total Exp. 60
( Net Profit
Net Sales ) 100 25
Return on
Assets Times
Inventory

Asset Management
37.5% Sales 5
( Net Profit
Total Assets ) Asset Turnover 100 Current Assets
+
A/R
2.5 ÷ 10 4
Total Assets

( Net Sales
) 40 + +
Total Assets Fixed Assets Other Current Assets

Net Profit
=
Net Profit
x
Net Sales 30 1
Total Assets Net Sales Total Assets
6-11
Financial Implications of Strategies Used By
a Bakery and Jewelry Store

6-12
Income Statements for Macy’s and Costco

6-13
Profit Management Path for
Macy’s and Costco

6-14
Margin Management

■ Net Sales = Gross Sales – Discounts - 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

6-15
Maintaining/Increasing Margins

■ Pay a Lower Price to Vendor

■ Charge Customers a Higher Price
■ Reduce Price Competition
 Exclusive Merchandise
 Brand Variants
■ Reduce Retailer Costs -- Direct Product
Profitability (DPP), Activity Based Costing
 Floor Ready Merchandise, Vendor Source Tagging
 Packaging -- Shipping, Display

6-17
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 6-19
Types of Retail Operating Expenses

Selling expenses = Sales staff salaries + Commissions +

Benefits + Advertising

General expenses = Rent + Utilities + Miscellaneous

expenses
Administrative expenses = Salaries of all employees other than
salespeople + Operations of buying
offices + Other administrative
expenses

6-20
Inventory Turnover

6-26
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)

■ No of days = 12/Inventory Turnover X 30

Inventory Turnover = COGS/avg inventory (cost)

6-27
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.

Example: Kmart vs. Wal-mart

6-28
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
6-29
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

6-30
Financial Performance of Retailers

Outputs – Performance Inputs Used by Retailers

■ Sales ■ Inventory ($)

■ Profits ■ Real Estate (sq. ft.)
■ ■ Employees (#)
Cash flow
■ Overhead (Corporate
■ Growth in sales, profits Staff and Expenses)
■ Same store sales ■ Advertising
growth ■ Energy Costs
■ MIS expenses

6-50
 Productivity: Outputs/Input

■ Corporate Level
 ROA = Profits/Assets
 Comparable store sales growth (same-store sales growth)
■ Buyers (Inventory, Pricing, Advertising)
 Gross Margin % = Gross Margin/Sales
 Inv Turnover = COGS/ Avg. Inventory (cost)
 GMROI = Gross Margin/Average Inventory
 Advertising as % of sales
■ Stores (Real Estate, Employees)
 Sales/Square Feet
 Sales/Employee
 inv. Shrinkage/sales
 Transactions / Footfall
 Ticket Size(sales/# of transactions)
 Items Per Ticket (total items sold/total transactions)
 Conversion Rate (total transactions/total footfall)
6-51
 What is important in Pakistan?

■ Low Gross Margins (10-15%)*

■ Low ROIs
■ Control Shrinkage
■ Inventory – A, B, C (50 - 60 days)
■ Franchising
■ Store Closure – bottom line analysis

* Fast Food and Fashion Merchandise have better margins

6-68
 Taxes/ Leakages in Pakistan on Retail*
■ Turnover tax – 0.25% of turnover for FMCG, Pharma and
Tobacco retailers (if integrated into FBR software)

■ Corporate Tax rates…29%

■ Sales Tax (VAT) – Provinces (services) & Federal (supply)
■ Gratuity or Provident Fund
■ WPPF – 5% of EBIT (for more than 100 people)
■ WWF – 2% of income (for more than 100 people)
■ 13C bonus (for non management)
■ EOBI
■ SESSI / PESSI
■ Licenses

*Not an exhaustive list. Varies by type of retail

6-69
 Management P&L in Pakistan

■ Net Sales = Gross Sales – Sales Tax - Return

■ Cost of Good Sold (COGs)
■ Gross Margin (GM) = Net Sales – COGs

■ Selling Expenses
 Variable (Marketing, discounts, sales incentives, shrinkage)
 Fixed (Rent, Store depreciation, staff salaries)
■ Store Level Profit = Net Sales – COGS – Selling Expenses
■ General & Admin Expenses
 Variable (warehouse shrinkage, dispatches)
 Fixed (site rentals, Depreciation, Head office, IT, SC)
Discounts
and
■ EBIT Franchise
 Store level profit – GA expenses sales
treated
differently

6-70