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.
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The Merchandise Budget
Merchandising - Planning and control of the
buying and selling of goods and services to help
the retailer realize its objectives.
Merchandise budget - Plan of projected sales for
an upcoming season, when and how much
merchandise is to be purchased, and what markups
and reductions will likely occur.
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LO 1
The Merchandise Budget
In developing the merchandise budget, the retailer
must answer five major merchandising questions:
What are the anticipated sales for the department,
division, or store?
How much stock on hand is needed to achieve this
sales plan, given the level of inventory turnover
expected?
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LO 1
The Merchandise Budget
What reductions, if any, from the original retail price
are likely to be needed in order to dispose of all
merchandise brought into the store?
What additional purchases must be made during the
season?
What gross margin (the difference between net sales
and cost of goods sold) is the department, division, or
store likely to contribute to the overall profitability of
the company, given this merchandising plan?
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LO 1
The Merchandise Budget
Four rules in preparing the merchandise budget:
It should always be prepared in advance of the selling
season.
The language of the budget must be easy to
understand.
It must be planned for a relatively short period of
time.
The budget should be flexible enough to permit
changes.
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LO 1
Exhibit 8.3 - Formulas for the Six-Month
Budget
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LO 1
Exhibit 8.3 - Formulas for the Six-Month
Budget
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LO 1
The Merchandise Budget
Forecasting is most important for service retailers
because their services are perishable.
It is important to use recent trends when
forecasting sales.
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LO 1
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.
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.
Generally, stock-to-sales ratios will fluctuate month
to month because sales tend to fluctuate monthly.
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LO 1
The Merchandise Budget
Determining planned BOM and EOM inventories
Stock-to-sales ratios always express inventory levels
at retail, not cost.
The BOM inventory for one month is equal to the
end-of-the month (EOM) inventory for the previous
month.
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LO 1
The Merchandise Budget
Determining planned retail reductions
Planned retail reductions fall into three types:
markdowns, employee discounts, and stock shortages.
They are included to reflect the additional purchases
needed for sufficient inventory to begin the next
month and to point out that taking a reduction is not a
bad thing.
Reductions are one of the major items in the
merchandise budget subject to constant change.
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LO 1
Retail Accounting Statements
Income statement
Balance sheet
Statement of cash flow
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LO 2
Income Statement
It is a financial statement that provides a summary
of the sales and expenses for a given time period,
usually a month, quarter, season, or year.
Comparison of current results with prior results
allows the retailer to notice trends or changes in
sales, expenses, and profits.
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LO 2
Exhibit 8.5A - Retailers’ Basic Income
Statement Format
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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.
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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.
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LO 2
Income Statement
Retailers must consider the Generally Accepted
Accounting Principles (GAAP) regulations and
the Internal Revenue Service (IRS) rulings when
presenting their income statement.
The IRS provided a tax break for retailers by
ruling that they may estimate inventory shrinkage.
GAAP allows for variations in how retailers
report certain expenses.
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LO 2
Balance Sheet
A financial statement that identifies and quantifies
all the firm’s assets and liabilities. It shows the
financial condition of a retailer’s business at a
particular point in time.
The basic equation for a balance sheet:
Assets = Liabilities + Net worth
Comparing a current balance sheet with one from
a previous time period enables a retail analyst to
observe changes in the firm’s financial condition.
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LO 2
Exhibit 8.6A - Retailers’ Basic Balance
Sheet Format
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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.
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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.
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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.
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LO 2
Statement of Cash Flow
Lists in detail the sources and types of all cash
revenue and cash expenditures for a given time
period.
When cash inflows exceed cash outflows, the retailer is
said to have a positive cash flow.
When cash outflows exceed cash inflows, the retailer is
said to be experiencing a negative cash flow.
It enables the retailer to project the cash needs of
the firm.
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LO 2
Exhibit 8.7A - Sample Cash Flow
Statement
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LO 2
Exhibit 8.7B - Typical Cash Inflow and
Outflow Categories
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LO 2
Retail Accounting Statements
Differences:
A balance sheet shows the financial condition of a
retailer’s business at a particular point in time, as
opposed to the income statement, which reports on
the activities over a period of time.
In a statement of cash flow, the retailer is concerned
only with the movement of cash into or out of the
firm. An income statement reflects the profitability of
the retailer after all revenue and expenses are
considered.
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LO 2
Inventory Valuation
Accounting inventory system
Inventory pricing systems
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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.
It is difficult to cost out each sale.
It is difficult to 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.
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LO 3
Accounting Inventory System
Retail method - Values merchandise at current
retail prices, which is then converted to cost based
on a formula.
The basic steps:
Calculation of the cost complement.
Calculation of reductions from retail value.
Conversion of the adjusted retail book inventory to cost.
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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 of these
statements.
Physical inventories using retail prices are less
subject to error and can be completed in a shorter
amount of time.
The retail method provides an automatic,
conservative valuation of ending inventory as well as
inventory levels throughout the season.
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LO 3
Accounting Inventory System
Disadvantages of the retail method
It is a ‘‘method of averages.’’
It places a heavy burden on bookkeeping activities.
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LO 3
Inventory Pricing Systems
FIFO (first in, first out) - Values inventory based
on the assumption that the oldest merchandise is
sold before the more recently purchased
merchandise.
LIFO (last in, first out) - Values inventory based
on the assumption that the most recently
purchased merchandise is sold first and the oldest
merchandise is sold last.
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LO 3
Inventory Pricing Systems
In times of rapid inflation, most retailers use the
LIFO method, resulting in lower profits on the
income statement and lower income taxes.
Most retailers also prefer to use LIFO for planning
purposes since it accurately reflects replacement
costs.
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LO 3