Key Issues

Financial Strategy 6.1

Key Issues

3 ways to increase the value of money Asset turnover model Financial objectives and the strategic profit

model ROI model Gross margin return on investment Monitoring retail performance Direct product profitability


Value of An Investment

How much will your ownHow much will your ownportfolio be worth if …portfolio be worth if …

You start investing 10 years after graduation, & invest $2000 per year @ 10%, every year ‘til you retire?

You start now, & invest $2000 per year @ 10%, but only for 10 years, then stop?


A Simplified Cash Flow Diagram

Cash Inventory

AccountsReceivable

Sales


Increasing the Value of Money

MarginMargin

Leveraging Our InvestmentLeveraging Our Investment

Adding Stock Turnover (“turns”)Adding Stock Turnover (“turns”)

You have $1000. You’ve found a no-risk investment for which you will You have $1000. You’ve found a no-risk investment for which you will get a certain 20 percent ROI in 4 months. Your parents have offered to get a certain 20 percent ROI in 4 months. Your parents have offered to lend you $10,000 more, for 1 year. By how much can you grow your lend you $10,000 more, for 1 year. By how much can you grow your $1000 in a one-year period? And what’s your ROI?$1000 in a one-year period? And what’s your ROI?


Increasing the Value of Money

Margin Margin (no leverage or turnover)(no leverage or turnover)

Leverage Leverage (no turnover)(no turnover)

Turnover Turnover (no leverage)(no leverage)

Margin, Leverage, TurnoverMargin, Leverage, Turnover

Strategic Profit ModelROI = Margin x Leverage x Turnover = 20% x 11.0 x 3.64 = 800%

Strategic Element ResultROI (/ Investment)

Investment = $1000( = profit)


Components of Gross Margin

Gross Sales

Less ReturnsLess customer allowances Net

Sales

COGS

Gross Margin


Increase VolumeIncrease VolumeIncrease PriceIncrease PriceDecrease COGSDecrease COGSDecrease ExpensesDecrease Expenses

Retail Profit Accelerators:How Can Retailers Increase Profits?

Sales $1,000,000 $1,050,000 $1,050,000COGS 700,000 735,000 700,000Gross margin 300,000 315,000 350,000Expenses 280,000 280,000 280,000Profit 20,000 35,000 70,000Profit increase $ --- 15,000 50,000Profit increase % --- 75% 250%

Sales $1,000,000 $1,000,000COGS 665,000 700,000Gross margin 335,000 300,000Expenses 280,000 266,000Profit 55,000 34,000Profit increase $ 35,000 14,000Profit increase % 175% 70%

BaseBasePeriodPeriod

IncreaseIncreaseUnit Volume 5%Unit Volume 5%

IncreaseIncreasePrices 5%Prices 5%

DecreaseDecreaseCOGS 5%COGS 5%

DecreaseDecreaseExpenses 5%Expenses 5%


Developing Financial Objectives

• The Objectives ThemselvesThe Objectives Themselves

• The Plan to Meet the ObjectivesThe Plan to Meet the Objectives

Profits?Profits?How should they be measured?How should they be measured?


Who is Most Successful?

StoreStore

JCPenneyDayton’s

Toys R UsHome Depot

Circuit CityThe Limited

Wal-MartKmartCostco

JCPenneyDayton’s

Toys R UsHome Depot

Circuit CityThe Limited

Wal-MartKmartCostco

Total SalesTotal SalesGrowth %Growth %

-19

1135

1817358

26

-19

1135

1817358

26

Comp StoreComp StoreGrowth %Growth %

-222

11

13

104

14

-222

11

13

104

14

GrossGrossMargin %Margin %

33263028

262921259

33263028

262921259

InventoryInventoryTurnoverTurnover

3.44.63.15.6

4.76.04.53.0

11.8

3.44.63.15.6

4.76.04.53.0

11.8

Sales perSales perSq Ft $Sq Ft $

137198na348

1,083302279na670

137198na348

1,083302279na670

1994 Data


Examples of Performance Measures Used by Retailers

Level of Output Input Productivity

Organization (Output/Input)

Corporate Net sales Square feet of Return on assets(measures of store spaceentire corporation)

Net profits Number of Asset turnoveremployees

Growth in sales, Inventory Sales per employeeprofits

Advertising Sales per squareexpenditures foot


Examples of Performance Measures Used by Retailers

Level of Output Input Productivity

Organization (Output/Input)

Corporate Net profit Owners’ equity Net profit /(chief executive owners’ equity =officer) return on owners’

equity

Merchandising Gross margin Inventory * Gross margin /

(merchandise inventory* = manager and GMROIbuyer)

Store operations Net sales Square foot Net sales /(director of stores, square footstore manager)

*Inventory = Average inventory at cost


* Effective tax rates often differ among corporations due to different tax breaks and advantages.

Source: Levy & Weitz

Income Statements: Wal-Mart vs Tiffany(2000, in millions)

Which has the higher net margin?

Wal-Mart Tiffany

Net sales $ 139,208 $ 1,173

Less: Cost of goods sold $ 108,725 $ 515

Gross margin $ 30,483 $ 658

Less: Operating expense $ 22,363 $ 493

Less: Interest expense $ 950 $ 9

Total expense $ 23,313 $ 502

Net profit, pretax $ 7,170 $ 156

Less: Taxes* $ 2,740 $ 66

Tax rate 38.21% 42.31%

Net profit after tax $ 4,430 $ 90


Net Sales$139,208

$1,173

Net Sales$139,208

$1,173

Cost ofgoods sold$108,725

$515

Cost ofgoods sold$108,725

$515

Operatingexpenses$22,363

$493

Operatingexpenses$22,363

$493

Interestexpenses

$950$9

Interestexpenses

$950$9

Grossmargin

$30,493$658

Grossmargin

$30,493$658

Totalexpenses$23,313

$502

Totalexpenses$23,313

$502

Net profitbefore tax

$7,170$156

Net profitbefore tax

$7,170$156

Taxes$2,740

$66

Taxes$2,740

$66

Net profitafter taxes

$4,430$90

Net profitafter taxes

$4,430$90

Net sales$139,208

$1,173

Net sales$139,208

$1,173

Net profitmargin

3.18% 7.68%

Net profitmargin

3.18% 7.68%

--

-

+

Top Number = Wal-MartBottom Number = Tiffany

Profit Margin Model: Wal-Mart vs Tiffany(2000, in millions)


Return on Assets Model

Net Profit X Asset = Return onNet Profit X Asset = Return on Margin Turnover Margin Turnover AssetsAssets

Provo Bakery 10% X 9 times = Provo Bakery 10% X 9 times = 90%90%

Zales JewelryZales Jewelry 90% X 1 time = 90% X 1 time = 90%90%


Low Low MarginMargin

High High MarginMargin

Low TurnoverLow Turnover

High TurnoverHigh Turnover

FailureFailure

ROA: Turnover vs Margin

UnattainableUnattainable


Accountsreceivable

$1,118$108

Accountsreceivable

$1,118$108

Merchandiseinventory$17,076

$481

Merchandiseinventory$17,076

$481

Cash $1,878$189

Cash $1,878$189

Other currentassets$1,059

$37

Other currentassets$1,059

$37

Total currentassets

$21,123$816

Total currentassets

$21,123$816

Fixed assets$28,864

$241

Fixed assets$28,864

$241

Net sales$139,208

$1,173

Net sales$139,208

$1,173

Total assets$49,996$1,057

Total assets$49,996$1,057

Assetturnover

2.781.11

Assetturnover

2.781.11

+

+

+

+

Asset Turnover Model: Wal-Mart vs Tiffany(2000, in millions)

Top Number = Wal-MartBottom Number = Tiffany

From income statement

From balance sheet

The sales $ generatedby each $ of assets

What does thisrepresent?


Financial Objectives:The Strategic Profit Model

Return onInvestment

LeverageRatio

Return onAssets= x

Net Profit Net Worth

Net Profit Total Assets

Total AssetsNet Worth

Return onAssets

=

Net Profit Total Assets

and so ...

Net ProfitMargin

AssetTurnover

x

Net Sales Total Assets

Net ProfitNet Sales

The $ salesgenerated

by each $ of assets

The net profitgenerated

by each $ of sales


The Strategic Profit Model:The Financial Objective & Financial Program

Return onInvestment

= x

Net Profit Net Worth

AssetTurnover

Net Sales Total Assets

LeverageRatio

Total AssetsNet Worth

Net ProfitMargin

Net ProfitNet Sales

x

The FinancialObjective

The Financial Program(The SPM)

Rate of Return on Assets

Implications for Profitability?Implications for Profitability?


The Cougar Boutique

AssetsCurrent Cash & other $ 50,000 Inventory 500,000 Accounts receivable200,000 Total 750,000Fixed 250,000

Total Assets $1,000,000

LiabilitiesCurrent Accounts payable $ 300,000 Notes payable 25,000 Other 25,000 Total 350,000Long term 125,000 Total liabilities 475,000 Net worth 525,000Total liab. & NW $1,000,000

Dollars PercentNet sales $2,500,000 100Less: cost of sales 2,000,000 80Gross margin 500,000 20Less: expenses Variable $250,000 Fixed 200,000 Total 450,000 18Net profit $50,000 2

Income Statement

What is the ROI?

Balance SheetBalance Sheet


The Cougar Boutique: ROI

Simple Way:Simple Way:

Diagnostic Way, Using the SPM:Diagnostic Way, Using the SPM:


ROI Model, IncludingThe Strategic Profit Model

Net SalesNet Sales

Cost ofgoods sold

Cost ofgoods sold

Variableexpenses

Variableexpenses

Fixedexpenses

Fixedexpenses

Grossmargin

Grossmargin

Totalexpenses

Totalexpenses

Net profitNet profit

Net SalesNet Sales

Net profitmargin

Net profitmargin

Assetturnover

Assetturnover

Return onassets

Return onassets

-

-

+

InventoryInventory

Accountsreceivable

Accountsreceivable

Other currentassets

Other currentassets

Total currentassets

Total currentassets

Fixedassets

Fixedassets

Net salesNet sales

Totalassets

Totalassets

+

+ +

x

FinancialLeverage

FinancialLeverage

x Return onNet Worth

Return onNet Worth

=

Net SalesNet Sales

Cost ofgoods sold

Cost ofgoods sold

Variableexpenses

Variableexpenses

Fixedexpenses

Fixedexpenses

Grossmargin

Grossmargin

Totalexpenses

Totalexpenses

Net profitNet profit

Net SalesNet Sales

Net profitmargin

Net profitmargin

Assetturnover

Assetturnover

Return onassets

Return onassets

InventoryInventory

Accountsreceivable

Accountsreceivable

Other currentassets

Other currentassets

Total currentassets

Total currentassets

Fixedassets

Fixedassets

Net salesNet sales

Totalassets

Totalassets

Income StatementBalance SheetStrategic Profit Model

FinancialLeverage

FinancialLeverage

Return onNet Worth

Return onNet Worth

Which is … the income statement? Balance sheet? SPM?Which is … the income statement? Balance sheet? SPM?


Effect of Changes in the SPM on ROI

Basic Example:

9.5% = 2% x 2.5 x 1.9

Profit Margin Increased:

23.75% = 5% x 2.5 x 1.9

Leverage Increased:

15% = 2% x 2.5 x 3

ROA Reduced:

3.8% = 2% x 1 x 1.9

Return onInvestment

= xAsset

TurnoverLeverage

RatioNet Profit

Margin x


Big Lots:24.6% 13.1 1.5 1.2

Albertson’s:18.9% 2.1 4.2 2.1

The Dress Barn:32.4% 7.4 2.9 1.5

Land’s End:40.2% 6.8 3.1 1.9

The Limited:32.3% 6.7 2.2 2.2

The Gap:25.5% 6.6 2.4 1.6

SPM Examples

Return onInvestment

= xAsset

TurnoverLeverage

RatioNet ProfitMargin % x

1998 data


Breakeven AnalysisShows number of units which must be produced & sold at a given price to cover all costs.

Formulation: BE = Fixed Cost . Unit Contribution

Example (women’s top coats):Example (women’s top coats):Avg. variable cost: Avg. variable cost: $100$100Tot. fixed cost: Tot. fixed cost: $200,000$200,000Selling price:Selling price: $166.67$166.67Unit contribution:Unit contribution: $66.67$66.67

BE =BE =


Store Level

DepartmentLevel

CustomerFeedback

Market ShareAnalysis

OperatingRatios

Sales Variance(Actual vs Planned)

Sales-to-ExpenseRatios

Analysis of Alloca-tion of Costs

Direct ProductProfitability

Controlling (Monitoring) Performance


E.g., Computing DPP

Dollars per CaseRetail $ l8.70Less: Cost 14.96Gross margin 3.74Plus: Discounts and allowances Payment discount 0.30 Merchandising allowance 0.50 Backhaul allowance 0.00Less: Direct handling costs Warehouse direct labor 0.41 Warehouse inventory expense 0.18 Warehouse operating expense 0.12 Transportation to stores 0.14 Retail direct labor 1.78 Retail inventory expense 0.15 Retail operating expense 0.81Direct product profit $ 0.95


Using DPP to CalculateReturn on Shelf Space

Item A

Item B

Gross margin per case $9.33

$8.02

Less direct costs per case 4.22

3.80

Plus discounts and allowances per case 0.21 2.02

DPP per case 5.32

6.24

Multiplied by cases per week 4.20

3.10

DPP per week 22.34

19.34

Divided by square feet of shelf facing 1.68 0.84

DPP per week per square foot of shelf space 13.30 23.03


Direct Product Profitability

High DPPHigh DPPper unitper unit

Low DPPLow DPP

High UnitHigh UnitVolumeVolume

Low UnitLow UnitVolumeVolume

The per-unit profit of products:unit price less all direct unit costs

Key Issues

Documents

Transcript of Key Issues