Chapter 8
Managing a Retailer’s
Finances
Learning Objectives
• Describe the importance of a merchandise
budget and know how to prepare a six-month
merchandise plan
• Explain the differences among and the uses of
these three accounting statements: income
statement, balance sheet, and statement of
cash flow
• Explain how the retailer is able to value
inventory
The Merchandise Budget
• Merchandising: Planning and control of the
buying and selling of goods and services
• Merchandise budget: Plan of projected sales
for an upcoming season:
• When and how much merchandise is to be
purchased
• What markups and reductions will likely occur
LO 1
The Merchandise Budget
• In developing the merchandise budget, the
retailer must anticipate:
• Sales for the department, division, or store
• Stock on hand required to achieve the sales plan,
given the level of inventory turnover expected
• Reductions required in the original retail price
• Additional purchase required
• The gross margin that the store or department is
likely to contribute
LO 1
The Merchandise Budget
• Rules to prepare the merchandise budget:
• Should always be prepared in advance of the
selling season
• Language of the budget must be easy to
understand
• Must be planned for a relatively short period of
time
• Should be flexible enough to permit changes
LO 1
Exhibit 8.3 - Formulas for the SixMonth Budget
LO 1
Exhibit 8.3 - Formulas for the SixMonth Budget
LO 1
The Merchandise Budget
• Determining planned sales
• Estimate planned sales for the entire season as
well as for each month
• Examine the previous year’s recorded sales
• Make adjustments for the upcoming merchandise
budget
• Prediction market: A market where a synthetic
financial security reflects if :
• A future event will or will not occur and individuals
then buy and sell this security
LO 1
Campbell Soup
• “Misery Index”
• incorporates temperature
fluctuations within a given day,
the year-ago difference, the
week-ago difference and extra
credit for snow or "nasty" rain.
• A positive ranking on the index
= miserable area
• When an area becomes about
5% miserable, Campbell will
cue up chicken-soup radio ads
that typically last three to five
days
Zappos
“Cold Weather Outfits Are Hot!”
• focused web site to reflect winter weather
"We planned on having more of a fashion story on our
homepage and e-mail blast, but we're adjusting it to keep
winter products top of mind.“ - Aaron Magness, head of
business development and brand marketing for Zappos.
Google Search
Google working with companies to launch
winter related search campaigns.
Search terms:
“hot chocolate”
“long underwear”
“weather forecast”
Focusing on geographical areas such as the
Northeast before a blizzard
Weather Channel
Weather Channel working with advertisers:
• General Motors
• The Home Depot
• Nationwide Insurance
Viewership up 24% with people watching for
impending storms.
Snuggie
Snuggie cut back advertising.
Demand for the product was
high causing an extreme
shortage.
Snuggie is using the weather
as free publicity.
Slight Relief
• Snuggies not the only brand benefiting
• Space heaters selling out in Palm Beach, Fl
• Snow Blowers out of stock in Kansas City
Ugg Boots
• Classic Uggs selling Smoothly
• Good sales reports from retail stores all over the
country
• People spending Christmas cash and Gift cards
• VP-sales at Ugg Australia. "It's safe to say that the cold
weather is certainly not hurting our business and is
most likely enhancing it."
• cold temperatures temporarily helping
consumers forget about the recession.
• According to Google, recent searches for "snow
boots" began outperforming searches for "cheap
boots”
• first time in almost a year!
The Merchandise Budget
• Determining planned BOM and EOM
inventories
• Stock-to-sales ratio: Depicts the amount of stock
to:
• Have at the beginning of each month to support the
forecasted sales for that month
LO 1
The Merchandise Budget
• Planned average beginning-of-the-month (BOM)
stock-to-sales ratios are:
• Either based on industry averages or are calculated
directly from a retailer’s planned turnover goals
• Fluctuate month to month because sales tend to
fluctuate monthly
• Express inventory levels at retail, not cost
• BOM inventory for one month equals to:
• The end-of-the month (EOM) inventory for the
previous month
LO 1
The Merchandise Budget
• Determining planned retail reductions
• Allowances for reductions in the dollar level of
inventory that results from nonsale events
• Three types - Markdowns, employee discounts,
and stock shortages
• Reflect the additional purchases needed for
sufficient inventory to begin the next month
• Are subject to constant change
LO 1
The Merchandise Budget
• Determining planned purchases at retail and cost
• Add planned sales, planned retail reductions, and
planned EOM inventory
• Subtract planned BOM inventory
• Planned purchase at cost
• Subtract the markup percentage from the retail
percentage of 100 percent
• Buyer’s planned gross margin
• Take planned initial markup and subtract planned
reductions
LO 1
Retail Accounting Statements
• Accounting practices followed depend on:
• Management objectives
• Size of the retailer
• Types of financial statement
• Income statement
• Balance sheet
• Statement of cash flow
LO 2
Income Statement
• Financial statement that provides a summary
of the sales and expenses for a given period
• Comparison of current and prior results
provides trends or changes in:
• Sales, expenses, and profits
LO 2
Exhibit 8.5 a - Retailers’ Basic Income
Statement Format
LO 2
Income Statement
Gross sales
Retailer’s total sales including sales for cash or for credit
Returns and
allowances
Refunds of the purchase price or downward adjustments in
selling prices due to customers returning purchases, or
adjustments made in the selling price due to customer
dissatisfaction with product or service performance
Net sales
Gross sales less returns and allowances
Cost of goods sold Cost of merchandise that has been sold during the period
Gross margin
Difference between net sales and cost of goods sold
LO 2
Income Statement
Operating expenses
Expenses that a retailer incurs in running the business
other than the cost of the merchandise.
Operating profit
Gross margin less operating expenses.
Other income or
expenses
Includes income or expense items that the firm incurs
which are not in the course of its normal retail
operations.
Net profit
Operating profit plus or minus other income or
expenses.
LO 2
Income Statement
• Regulations to be considered while presenting
income statement
• Generally Accepted Accounting Principles (GAAP)
regulations
• Allows for variations in how retailers report certain
expenses
• Internal Revenue Service (IRS) rulings
• Provides a tax break for retailers by allowing to
estimate inventory shrinkage
LO 2
Balance Sheet
• Financial statement that identifies and
quantifies all the firm’s assets and liabilities
• Shows the financial condition of a retailer’s
business at a particular point in time
• Basic equation for a balance sheet:
Assets = Liabilities + Net worth
• Comparison of current and previous balance
sheets enables to:
• Observe changes in the firm’s financial condition
LO 2
Exhibit 8.6A -Retailers’ Basic Balance
Sheet Format
LO 2
Balance Sheet
Asset
Anything of value that is owned by the retail firm.
Current assets
Assets that can be easily converted into cash within a
relatively short period of time (usually a year or less).
Accounts and/or
notes receivable
Amounts that customers owe the retailer for goods and
services.
Prepaid expenses
Items for which the retailer has already paid, but the
service has not been completed.
Retail inventories
Merchandise that the retailer has in the store or in storage
and is available for sale.
LO 2
Balance Sheet
Noncurrent assets
Assets that cannot be converted to cash in a short period
of time (usually 12 months) in the normal course of
business.
Goodwill
An intangible asset, usually based on customer loyalty,
that a retailer pays for when buying an existing business.
Total assets
Equal current assets plus noncurrent assets plus
goodwill.
Liability
Any legitimate financial claim against the retailer’s
assets.
Current liabilities
Short-term debts that are payable within a year.
LO 2
Balance Sheet
Accounts payable
Amounts owed to vendors for goods and services.
Long-term liabilities
Debts that are due in a year or longer.
Total liabilities
Current liabilities plus long-term liabilities.
Net worth (owner’s
equity)
Total assets less total liabilities.
LO 2
Statement of Cash Flow
• Lists sources and types of all cash revenue and
cash expenditures for a given time period
• Positive cash flow - When cash inflow exceeds cash
outflow
• Negative cash flow - When cash outflow exceeds
cash inflow
• Projects the cash needs of the firm
LO 2
Exhibit 8.7A - Sample Cash Flow
Statement
LO 2
Exhibit 8.7 b -Typical Cash Inflow and
Outflow Categories
LO 2
Dressing up Financial Statement
• Accrual accounting method
• Allotting, revenues and expenses to specific
periods to:
• Allocate income to the quarter or year in which it was
effectively earned
• Provides a more accurate picture of what’s
happening to the business at a given time
• Aggressive accounting methods
• Retailers make their statements look good
LO 2
Dressing up Financial Statement
• Methods to window dress accounting records
• LIFO liquidation
• Improving the current ratio
• Current ratio: Current assets divided by current liabilities
• Massage cash
• Convert short-term loans to long-term loans
• Extend payment time
LO 2
Exhibit 8.8 - Connecting the Retail
Accounting Statements
LO 2
Inventory Valuation
• Retailer must make two major decisions with
regard to valuing inventory:
• The accounting inventory system to be
implemented
• The inventory pricing method to be used
LO 3
Accounting Inventory System
• Cost method
• Provides a book valuation of inventory based
solely:
• On the retailer’s cost of merchandise including freight
• Limitations - It is difficult to:
• Do daily inventories or even monthly inventories
• Cost out each sale
• Allocate freight charges to each item’s cost of goods
sold
• Used by retailers with big-ticket items and a
limited number of sales per day
LO 3
Accounting Inventory System
• Retail method
• Values merchandise at current retail prices, which
is then converted to cost based on a formula
• Basic steps
• Calculation of the cost complement
• Cost complement = Total cost valuation/ Total retail
valuation
• Calculation of reductions from retail value
• Conversion of the adjusted retail book inventory to
cost
• Closing inventory = Adjusted retail X Cost complement
book inventory
LO 3
Accounting Inventory System
• Advantages of the retail method over the cost
method of inventory valuation:
• Accounting statements can be drawn up at any
time
• Inventories need not be taken for preparation
• Physical inventories using retail prices:
• Are less subject to error
• Can be completed in a shorter amount of time
• Provides an automatic, conservative valuation of
ending inventory as well as inventory levels
LO 3
Accounting Inventory System
• Disadvantages of the retail method
• Method of averages
• Closing inventory is valued at the average relationship
between cost and retail
• Large retailers offer many different classifications and
lines with different relationships
• Places a heavy burden on bookkeeping activities
LO 3
Inventory Pricing Systems
• FIFO (first in, first out): Values inventory based
on the assumption that:
• Oldest merchandise is sold before the more
recently purchased merchandise
• LIFO (last in, first out): Values inventory based
on the assumption that:
• Most recently purchased merchandise is sold first
and the oldest merchandise is sold last
LO 3
Inventory Pricing Systems
• Advantage of the LIFO method:
• Results in lower profits on the income statement
and lower income taxes
• Helps retailers in planning process
• Accurately reflects replacement costs
LO 3