Key Issues
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Financial Strategy 6.1
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 own
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?
Financial Strategy 6.2
A Simplified Cash Flow Diagram
Financial Strategy 6.3
Cash
Inventory
Accounts
Receivable
Sales
Increasing the Value of Money
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
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?
Margin
Leveraging Our Investment
Adding Stock Turnover (“turns”)
Financial Strategy 6.4
Increasing the Value of Money
Strategic Element
ROI
/ Investment)
(
Result
Margin (no leverage or turnover)
Leverage (no turnover)
Investment = $1000
( = profit)
Turnover (no leverage)
Margin, Leverage, Turnover
Strategic Profit Model
ROI = Margin x Leverage x Turnover = 20% x 11.0 x 3.64 = 800%
Financial Strategy 6.5
Components of Gross Margin
Gross Sales
Less Returns
Less
customer
allowances
Gross Margin
Net
Sales
COGS
Financial Strategy 6.6
Retail Profit Accelerators:
How Can Retailers Increase Profits?
Increase Volume
Increase Price
Decrease COGS
Decrease Expenses
Sales
COGS
Gross margin
Expenses
Profit
Profit increase $
Profit increase %
Base
Period
$1,000,000
700,000
300,000
280,000
20,000
-----
Decrease
COGS 5%
Sales
COGS
Gross margin
Expenses
Profit
Profit increase $
Profit increase %
Financial Strategy 6.7
$1,000,000
665,000
335,000
280,000
55,000
35,000
175%
Increase
Unit Volume 5%
$1,050,000
735,000
315,000
280,000
35,000
15,000
75%
Decrease
Expenses 5%
$1,000,000
700,000
300,000
266,000
34,000
14,000
70%
Increase
Prices 5%
$1,050,000
700,000
350,000
280,000
70,000
50,000
250%
Developing Financial Objectives
• The Objectives Themselves
• The Plan to Meet the Objectives
Profits?
How should they be measured?
Financial Strategy 6.8
Who is Most Successful?
Store
Total Sales Comp Store Gross
Inventory Sales per
Growth % Growth % Margin % Turnover
Sq Ft $
JCPenney
Dayton’s
Toys R Us
Home Depot
-1
9
11
35
-2
2
2
11
33
26
30
28
3.4
4.6
3.1
5.6
137
198
na
348
Circuit City
The Limited
Wal-Mart
Kmart
Costco
18
17
35
8
26
1
3
10
4
14
26
29
21
25
9
4.7
6.0
4.5
3.0
11.8
1,083
302
279
na
670
1994 Data
Financial Strategy 6.9
Examples of Performance
Measures Used by Retailers
Level of
Output
Input
Organization
(Output/Input)
Corporate
Net sales
(measures of
entire corporation)
Net profits
Growth in sales,
profits
Financial Strategy 6.10
Productivity
Square feet of
store space
Return on assets
Number of
employees
Asset turnover
Inventory
Sales per employee
Advertising
expenditures
Sales per square
foot
Examples of Performance
Measures Used by Retailers
Level of
Output
Input
Productivity
Organization
(Output/Input)
Corporate
(chief executive
officer)
Net profit
Owners’ equity
Merchandising
Gross margin
Inventory
*
Square foot
*Inventory = Average inventory at cost
Financial Strategy 6.11
Gross margin /
inventory* =
GMROI
(merchandise
manager and
buyer)
Store operations Net sales
(director of stores,
store manager)
Net profit /
owners’ equity =
return on owners’
equity
Net sales /
square foot
Income Statements: Wal-Mart vs Tiffany
(2000, in millions)
Wal-Mart
Net sales
Tiffany
$ 139,208
$ 1,173
$ 108,725
$
515
$ 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
Less: Cost of goods sold
Gross margin
Tax rate
38.21%
Net profit after tax
$
4,430
42.31%
$
90
* Effective tax rates often differ among corporations due to different tax breaks and advantages.
Which has the higher net margin?
Source: Levy & Weitz
Financial Strategy 6.12
Profit Margin Model: Wal-Mart vs Tiffany
(2000, in millions)
Net Sales
$139,208
$1,173
Cost of
goods sold
$108,725
$515
Operating
expenses
$22,363
$493
+
Interest
expenses
$950
$9
Financial Strategy 6.13
Gross
margin
$30,493
$658
Total
expenses
$23,313
$502
Top Number
= Wal-Mart
Bottom Number = Tiffany
Net profit
before tax
$7,170
$156
-
Taxes
$2,740
$66
Net profit
after taxes
$4,430
$90

Net sales
$139,208
$1,173
Net profit
margin
3.18%
7.68%
Return on Assets Model
Net Profit
Margin
Provo Bakery
Zales Jewelry
Financial Strategy 6.14
10%
90%
X
Asset =
Turnover
Return on
Assets
X
9 times =
90%
1 time
90%
X
=
ROA: Turnover vs Margin
High Turnover
Unattainable
Low
Margin
High
Margin
Failure
Low Turnover
Financial Strategy 6.15
Asset Turnover Model: Wal-Mart vs Tiffany
(2000, in millions)
What does this
represent?
Accounts
receivable
$1,118
$108
Top Number
= Wal-Mart
Bottom Number = Tiffany
+
Merchandise
inventory
$17,076
$481
+
Cash
$1,878
$189
Total current
assets
$21,123
$816
+
+
Other current
assets
$1,059
$37
Financial Strategy 6.16
Fixed assets
$28,864
$241
Net sales
$139,208
$1,173

Total assets
$49,996
$1,057
From income
statement
Asset
turnover
2.78
1.11
From balance
sheet
The sales $ generated
by each $ of assets
Financial Objectives:
The Strategic Profit Model
Return on
Investment
=
Net Profit
Net Worth
Return on
Assets
x
Net Profit
Total Assets
=
Net Profit
Total Assets
Asset
Turnover
Net Sales
Total Assets
The $ sales
generated
by each $ of assets
Financial Strategy 6.17
Return on
Assets
Leverage
Ratio
Total Assets
Net Worth
x
Net Profit
Margin
Net Profit
Net Sales
The net profit
generated
by each $ of sales
and so ...
The Strategic Profit Model:
The Financial Objective & Financial Program
Rate of Return on Assets
Return on
Investment
Net Profit
Net Worth
The Financial
Objective
=
Net Profit
Margin
Net Profit
Net Sales
x
Asset
Turnover
x
Net Sales
Total Assets
The Financial Program
(The SPM)
Implications for Profitability?
Financial Strategy 6.18
Leverage
Ratio
Total Assets
Net Worth
The Cougar Boutique
Assets
Current
Cash & other
Inventory
Accounts receivable
Total
Fixed
Total Assets
Balance Sheet
$ 50,000
500,000
200,000
750,000
250,000
$1,000,000
Liabilities
Current
Accounts payable
Notes payable
Other
Total
Long term
Total liabilities
Net worth
Total liab. & NW
$ 300,000
25,000
25,000
350,000
125,000
475,000
525,000
$1,000,000
Income Statement
Net sales
Less: cost of sales
Gross margin
Less: expenses
Variable
Fixed
Total
Net profit
Financial Strategy 6.19
Dollars
Percent
$2,500,000
2,000,000
500,000
100
80
20
450,000
$50,000
18
2
$250,000
200,000
What is the ROI?
The Cougar Boutique: ROI
Simple Way:
Diagnostic Way, Using the SPM:
Financial Strategy 6.20
ROI Model, Including
The Strategic Profit Model
Which is … the income statement? Balance sheet? SPM?
Net Sales
Cost of
goods sold
Gross
margin
Variable
expenses
+
Fixed
expenses
Total
expenses
Income Statement
Balance Sheet
Strategic Profit Model
Net profit

Net profit
margin
Net Sales
x
Inventory
+
Accounts
receivable
+
Other current
assets
Financial Strategy 6.21
Net sales
Total current
assets
+
Fixed
assets

Total
assets
Return on
assets
x
Asset
turnover
Financial
Leverage
=
Return on
Net Worth
Effect of Changes in the SPM on ROI
Return on
Investment
=
Net Profit
Margin
Asset
Turnover
x
Leverage
Ratio
x
Basic Example:
9.5%
=
2%
x
2.5
x
1.9
2%
x
2.5
x
3
Leverage Increased:
15%
=
Profit Margin Increased:
23.75%
=
5%
x
2.5
x
1.9
=
2%
x
1
x
1.9
ROA Reduced:
3.8%
Financial Strategy 6.22
SPM Examples
Return on
Investment
=
Big Lots:
24.6%
Net Profit
Margin %
x
Asset
Turnover
x
Leverage
Ratio
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
1998 data
Financial Strategy 6.23
Breakeven Analysis
Shows 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):
Avg. variable cost: $100
Tot. fixed cost:
$200,000
Selling price:
$166.67
Unit contribution:
$66.67
BE =
Financial Strategy 6.24
Controlling (Monitoring) Performance
Customer
Feedback
Store
Level
Market Share
Analysis
Operating
Ratios
Sales Variance
(Actual vs Planned)
Department
Level
Sales-to-Expense
Ratios
Analysis of Allocation of Costs
Direct Product
Profitability
Financial Strategy 6.25
E.g., Computing DPP
Dollars per Case
Retail
Less: Cost
Gross margin
Plus: Discounts and allowances
Payment discount
Merchandising allowance
Backhaul allowance
Less: Direct handling costs
Warehouse direct labor
Warehouse inventory expense
Warehouse operating expense
Transportation to stores
Retail direct labor
Retail inventory expense
Retail operating expense
Direct product profit
Financial Strategy 6.26
$ l8.70
14.96
3.74
0.30
0.50
0.00
0.41
0.18
0.12
0.14
1.78
0.15
0.81
$ 0.95
Using DPP to Calculate
Return on Shelf Space
Gross margin per case
Less direct costs per case
Plus discounts and allowances per case
DPP per case
Item A
$9.33
4.22
0.21
5.32
Item B
$8.02
3.80
2.02
6.24
Multiplied by cases per week
DPP per week
Divided by square feet of shelf facing
4.20
22.34
1.68
3.10
19.34
0.84
DPP per week per square foot of shelf space
13.30
23.03
Financial Strategy 6.27
Direct Product Profitability
The per-unit profit of products:
unit price less all direct unit costs
High DPP
per unit
High Unit
Volume
Low Unit
Volume
Low DPP
Financial Strategy 6.28