Chapter 8 Managing a Retailer’s Finances Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. 0 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. 1 The Merchandise Budget LO 1 • Merchandising is the planning and control of the buying and selling of gods and services to help the retailer realize its objectives. • Merchandise budget is a 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. • Gross margin is the difference between net sales and cost of goods sold. 2 Five Major Merchandising Decisions LO 1 • What will be the anticipated sales for the department, division, or store? • How much stock on hand will be needed to achieve this sales plan, given the level of inventory turnover expected? • What reductions, if any, from the original retail price must be made in order to dispose of all the merchandise brought into the store? • What additional purchases must be made during the season? • What gross margin ( the difference between sales and cost of goods sold) should the department, division, or store contribute to the overall profitability of the company? 3 Four Rules in Preparing the Merchandise Budget LO 1 • Always be prepared in advance of the selling season. • The language of the budget must be east to understand. • Must be planned of a relatively short period of time (six months is the norm used by most retailers). • Flexible enough to permit changes. 4 Determining the Merchandise Budget LO 1 • Determining Planned Sales • Determining Planned BOM and EOM Inventories • Determining Planned Retail Reductions • Determining Planned Purchases at Retail and Cost • Determining the Buyer’s Planned Gross Margin 5 Sample Six-Month Merchandise Budget LO 1 Exhibit 8.1 6 Sample Six-Month Merchandise Budget LO 1 Exhibit 8.1 7 Sample Six-Month Merchandise Budget LO 1 Exhibit 8.1 8 Sample Six-Month Merchandise Budget LO 1 Exhibit 8.1 9 Two-Seasons Department Store, Dept.353, SixMonth Merchandise Budget LO 1 Exhibit 8.2 10 Determining Planned Sales: Formulas for the SixMonth Budget LO 1: Exhibit 8.3 Determining Planned Sales for the Month (Planned Sales Percentage for the Month ) X (Planned Total Sales) = (Planned Sales for the Month) 11 Determining Planned Sales: Formulas for the SixMonth Budget LO 1: Exhibit 8.3 Determining Planned BOM Stock for the Month (Planned Sales for the Month ) X (Planned BOM Stock-to-Sales Ratio for the Month) = (Planned BOM Stock for the Month) 12 Determining Planned Sales: Formulas for the SixMonth Budget LO 1: Exhibit 8.3 Determining Planned Retail Reductions for the Month (Planned Sales for the Month ) X (Planned Retail Reduction Percentage for the Month) = (Planned Retail Reduction for the Month) 13 Determining Planned Sales: Formulas for the SixMonth Budget LO 1: Exhibit 8.3 Determining Planned EOM Stock for the Month (Planned BOM Stock for the Following Month ) = (Planned EOM Stock for The Current Month) 14 Determining Planned Sales: Formulas for the SixMonth Budget LO 1: Exhibit 8.3 Determining Planned Purchases at Retail for the Month (Planned Sales for the Month ) + (Planned Retail Reductions for the Month) + (Planned EOM Stock for the Month) - (Planned BOM Stock for the Month) = (Planned Purchases at Retail for the Month) 15 Determining Planned Sales: Formulas for the SixMonth Budget LO 1: Exhibit 8.3 Determining Planned Purchases at Cost for the Month (Planned Purchases at Retail for the Month ) X (100% Planned Initial Markup Percentage) = (Planned Purchases at Cost for the Month) 16 Determining Planned Sales: Formulas for the SixMonth Budget LO 1: Exhibit 8.3 Determining Planned Initial Markup for the Month (Planned Purchases at Retail for the Month ) X (Planned Initial Markup Percentage) = (Planned Initial Markup for the Month) OR (Planned Purchases at Retail for the Month) (Planned Purchases at Cost for the Month) = (Planned Initial Markup for the Month) 17 Determining Planned Sales: Formulas for the SixMonth Budget LO 1: Exhibit 8.3 Determining Planned Gross Margin for the Month (Planned Initial Markup for the Month) - (Planned retail Reductions for the Month) = (Planned Gross Margin for the Month) 18 How to Figure: Planned Sales for the Month LO 1 Figures to calculate this formula are taken from Exhibit 8.2, Two-Seasons Department Store, Dept. 353, SixMonth Merchandise Budget. 10. Planned Sales Percentage for February 15% Planned Sales for the period $500,000 2. Planned Sales for the month of February $75,000 19 How to Figure: Planned Sales for the Month LO 1 (Planned Sales Percentage for the Month ) X (Planned Total Sales) = (Planned Sales for the Month) 15% = X 500,000 75,000 20 How to Figure: Planned BOM Stock for the Month LO 1 Figures to calculate this formula are taken from Exhibit 8.2, Two-Seasons Department Store, Dept. 353, SixMonth Merchandise Budget. 2. Planned Sales for February $75,000 9. Planned BOM Stock-to-Sales Ratio for February 3 1. Planned BOM Stock for the Month of February $225,000 21 How to Figure: Planned BOM Stock for the Month LO 1 (Planned Sales for the Month ) X (Planned BOM Stock-to-Sales Ratio for the Month) = (Planned BOM Stock for the Month) 75,000 = X 3 225,000 22 How to Figure: Planned Retail Deduction for the Month LO 1 Figures to calculate this formula are taken from Exhibit 8.2, Two-Seasons Department Store, Dept. 353, SixMonth Merchandise Budget. 2. Planned Sales for February $75,000 11. Planned Retail Deduction Percentage for February 10% 23 How to Figure: Planned Retail Deduction for the Month LO 1 (Planned Sales for the Month ) X (Planned Retail Reduction Percentage for the Month) = (Planned Retail Reduction for the Month) 75,000 = X 10% 7,500 24 EOM Stock…BOM Stock LO 1 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. 25 EOM Stock…BOM Stock LO 1 Figures to calculate this formula are taken from Exhibit 8.2, Two-Seasons Department Store, Dept. 353, SixMonth Merchandise Budget. 4. Planned EOM Stock for February $300,000 1. Planned BOM Stock for March $300,000 26 EOM Stock…BOM Stock LO 1 (Planned BOM Stock for the Following Month ) = (Planned EOM Stock for The Current Month) 300,000 = 300,000 27 How to Figure: Planned Purchases at Retail for the Month LO 1 Figures to calculate this formula are taken from Exhibit 8.2, Two-Seasons Department Store, Dept. 353, SixMonth Merchandise Budget. 2. Planned Sales for February $75,000 3. Planned Retail Deduction for February $7,500 4. Planned EOM Stock for February $300,000 1. Planned BOM Stock for February $225,000 5. Planned Purchases at Retail for February $157,500 28 How to Figure: Planned Purchases at Retail for the Month LO 1 (Planned Sales for the Month ) + (Planned Retail Reductions for the Month) + (Planned EOM Stock for the Month) - (Planned BOM Stock for the Month) = (Planned Purchases at Retail for the Month) 75,000 + + 300,000 = 7,500 - 225,000 157,500 29 How to Figure: Planned Purchases at Cost for the Month LO 1 Figures to calculate this formula are taken from Exhibit 8.2, Two-Seasons Department Store, Dept. 353, SixMonth Merchandise Budget. 5. Planned Purchases at Retail for Month of February $157,500 Planned Initial Markup Percentage 45% 30 How to Figure: Planned Purchases at Cost for the Month LO 1 (Planned Purchases at Retail for the Month ) X (100% - Planned Initial Markup Percentage) = (Planned Purchases at Cost for the Month) 157,500 X = (100 - 45%) 86,625 31 How to Figure: Planned Initial Markup for the Month, First Formula LO 1 Figures to calculate this formula are taken from Exhibit 8.2, Two-Seasons Department Store, Dept. 353, SixMonth Merchandise Budget. 5. Planned Purchases at Retail for February $157,500 Planned Initial Markup Percentage 45% 7. Planned Initial Markup for February $70,875 32 How to Figure: Planned Initial Markup for the Month, First Formula LO 1 (Planned Purchases at Retail for the Month ) X (Planned Initial Markup Percentage) = (Planned Initial Markup for the Month) 157,500 X = 45% 70,875 33 How to Figure: Planned Initial Markup for the Month, Second Formula LO 1 Figures to calculate this formula are taken from Exhibit 8.2, Two-Seasons Department Store, Dept. 353, SixMonth Merchandise Budget. 5. Planned Purchases at Retail for February $157,500 6. Planned Purchases at Cost for February $86,625 7. Planned initial Markup for February $70,875 34 How to Figure: Planned Initial Markup for the Month, Second Formula LO 1 (Planned Purchases at Retail for the Month) - (Planned Purchases at Cost for the Month) = (Planned Initial Markup for the Month) 157,500 - = 86,625 70,875 35 How to Figure: Planned Gross Margin for the Month LO 1 Figures to calculate this formula are taken from Exhibit 8.2, Two-Seasons Department Store, Dept. 353, SixMonth Merchandise Budget. 3. Planned Retail Reduction for February $7,500 7. Planned Initial Markup for February $70,875 8. Planned Gross Margin for February $63,375 36 How to Figure: Planned Gross Margin for the Month LO 1 (Planned Initial Markup for the Month ) - (Planned Retail Reductions for the Month) = (Planned Gross Margin for the Month) - 70,875 = 7,500 63,375 37 Blank Six-Month Merchandise Budget LO 1 Six-Month Merchandise Budget Date_____________________ Season____________________ Spring/Summer Feb Mar Apr May Jun Jul Seasonal Fall/ Winter Aug Sep Oct Nov Dec Jan Total 1. Planned BOM Stock 2. Planned Sales 3. Planned Retail Reductions 4. Planned EOM Stock 38 Blank Six-Month Merchandise Budget LO 1 Six-Month Merchandise Budget Date_____________________ Season____________________ Spring/Summer Feb Mar Apr May Jun Jul Seasonal Fall/ Winter Aug Sep Oct Nov Dec Jan Total 5. Planned Purchases @ Retail 6. Planned Purchases @ Cost 7. Planned Initial Markup 8. Planned Gross Margin 39 Blank Six-Month Merchandise Budget Six-Month Merchandise Budget LO 1 Date_____________________ Season____________________ Spring/Summer Feb Mar Apr May Jun Jul Seasonal Fall/ Winter Aug Sep Oct Nov Dec Jan Total 9. Planned BOM Stock/Sales Ratio 10. Planned Sales Percentage 11. Planned Retail Reduction Planned Total Sales for the Period ____________________ Planned Total Retail Reduction Percentage for the Period ____________________ Planned Initial Markup Percentage for the Period ____________________ Planned BOM Stock for ________________ ____________________ 40 Blank Three-Month Merchandise Budget LO 1 Three-Month Merchandise Budget Date_____________________ Season____________________ Spring/Summer February Fall/ Winter August March September April October Seasonal Total 1. Planned BOM Stock 2. Planned Sales 3. Planned Retail Reduction 4. Planned EOM Stock 41 Blank Three-Month Merchandise Budget LO 1 Three-Month Merchandise Budget Date_____________________ Season____________________ Spring/Summer February Fall/ Winter August March September April October Seasonal Total 5. Planned Purchases @Retail 6. Planned Purchases @ Cost 7. Planned Initial Markup 8. Planned Gross Margin 42 Blank Three-Month Merchandise Budget Three-Month Merchandise Budget LO 1 Date_____________________ Season____________________ Spring/Summer February Fall/ Winter August March September April Seasonal October Total 9. Planned BOM Stock/Sales Ratio 10. Planned Sales Percentage 11. Planned Retail Reduction Planned Total Sales for the Period ____________________ Planned Total Retail Reduction Percentage for the Period ____________________ Planned Initial Markup Percentage for the Period ____________________ Planned BOM Stock for ________________ ____________________ 43 Retail Accounting Statements LO 2 • Income Statement • Balance Sheet • Statement of Cash Flow 44 Income Statement LO 2 • Income Statement is a financial statement that provides a summary of the sales expenses for a given time period, usually a month, quarter, season, or year. • Gross Sales are the retailer’s total sales including sales for cash or credit. • Returns and Allowances are the 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 the product or service performance. 45 Income Statement LO 2 • Net Sales is the gross sales less returns and allowances. • Cost of Goods Sold is the cost of merchandise that has been sold during the period. • Operating Expenses are those expenses that a retailer incurs in running the business other than the cost of the merchandise. 46 Income Statement LO 2 • Operating Profit is 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 operation. • Net Profit is operating profit plus or minus other income or expenses. 47 Graphic Presentation of the Income Statement LO 2 Gross Sales Returns & Allowances Net Sales Cost of Goods Sold Gross Margin Operating Expenses Operating Profit 48 Retailers’ Basic Income Statement Format LO 2: Exhibit 8.5a Gross Sales - Returns and Allowances Net Sales - Cost of Goods Sold Gross Margin - Operating Expenses Operating Profit ± Other Income or Expenses Net Profit Before Taxes $____________ $____________ $____________ $____________ $____________ $____________ $____________ $____________ $____________ 49 Sample Income Statement LO 2: Exhibit 8.5b 50 Sample Income Statement LO 2: Exhibit 8.5b 51 Balance Sheet LO 2 Balance Sheet identifies and quantifies all of the firm’s assets and liabilities at a particular point in time. Asset is anything of value that is owned by the retail firm. Current Assets are 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 are amounts that customers owe the retailer for goods and services. 52 Balance Sheet LO 2 Prepaid Expenses are those items for which the retailer has already paid, but the service has not been completed. Retail Inventories comprise merchandise that the retailer has in the store or in storage and is available for sale. Noncurrent Assets are those that cannot be converted to cash in a short period of time (usually 12 months) in the normal course of business. 53 Balance Sheet LO 2 Goodwill is 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 is any legitimate financial claim against the retailer’s assets. Current Liabilities are short-term debts that are payable within a year. 54 Balance Sheet LO 2 Accounts Payable are amounts owed vendors for goods and services. Long-Term Liabilities are debts that are due in a year or longer. Total Liabilities equal current liabilities plus long-term liabilities. Net Worth (owner’s equity) is total assets less total liabilities. 55 Graphic Presentation of the Balance Sheet LO 2 Current Assets Current Liabilities Long Term Liabilities Fixed Assets Net Worth 56 Retailers’ Basic Balance Sheet Format LO 2: Exhibit 8.6a Current Assets Cash Accounts Receivable Inventory Prepaid Expenses Total Current Assets Noncurrent Assets Building (less depreciation) Fixtures and Equipment (less depreciation) Total Noncurrent Assets Goodwill Total Assets $____________ $____________ $____________ $____________ $____________ $____________ $____________ $____________ $____________ $____________ 57 Retailers’ Basic Balance Sheet Format LO 2: Exhibit 8.6a Current Liabilities Accounts Payable Payroll Payable Current Notes Payable Taxes Payable Total Current Liabilities Long-term Liabilities Long-term Notes Payable Mortgage Payable Total Long-term Liabilities Net Worth Capital Surplus Retained Earnings Total Net Worth Total Liabilities and Net Worth $____________ $____________ $____________ $____________ $____________ $____________ $____________ $____________ $____________ $____________ $____________ $____________ 58 Retailers’ Basic Balance Sheet Format LO 2: Exhibit 8.6b 59 Statement of Cash Flow LO 3 • Statement of cash flow lists in detail the sources and type of all revenue (cash inflows) and the use and type of all expenditures (cash outflows) for a given time period. 60 Retailing Truism Cash “in” must always exceed cash “out” (if you want to stay in business). 61 Sample Cash Flow Statement LO 2: Exhibit 8.7a 62 Typical Cash Inflow and Outflow Categories LO 2: Exhibit 8.7b Cash Inflow Cash sales Collecting accounts receivable Collecting notes receivable Collecting other debts Sales of fixed assets Sale of stock Cash Outflows Paying for merchandise Rent expenses Utilities expenses Wages and Salary expenses Advertising expense Insurance premiums Taxes Interest expenses Supplies and other expenses Purchase of other assets Paying off accounts payable Paying off notes payable Buying back company stocks Paying dividends 63 Inventory Valuation LO 3 • Accounting Inventory System • Inventory Pricing Systems 64 Accounting Inventory System LO 3 • Cost Method is an inventory valuation technique that provides a book valuation of inventory based solely on the retailer’s cost of merchandise including freight. • Retail Method is an inventory valuation technique that values merchandise at current retail prices, which is then converted to cost based on a formula. 65 Steps for Using the Retail Method of Inventory Valuation LO 3 • Calculation of the cost complement. • Calculation of reductions from retail value. • Conversion of the adjusted retail book inventory to cost. 66 Retail Method of Inventory Valuation Example LO 3 Cost Retail $25,000 45,000 Inventory at Beginning of Period $14,000 Purchases During the Period 30,000 Transportation Costs 1,000 Additional Markups 5,000 Merchandise Available for Sale 45,000 75,000 Cost to Retail Ratio and Percentage 45,000 / 75,000 = 60% Net Sales 45,000 Markdowns 5,000 Total Reductions 50,000 Ending Inventory at Retail $25,000 Ending Inventory at Cost ($25,000 X .60) $15,000 67 Advantages of the Cost Method of Inventory Valuation LO 3 • Accounting statements can be drawn up at any time. Inventories need not be take 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 ending inventory as well as inventory levels throughout the season. 68 Inventory Available for Whitener’s Sporting Goods Sale, Fall Season LO 3: Exhibit 8.8 Cost Beginning Inventory Net Purchases Additional Markups Freight-in Total Inventory Available for Sale $199,000 70,000 1,000 $270,000 Retail $401,000 154,000 5,000 $560,000 69 Whitener’s Sporting Goods Sale, Ending Book Value at Retail, Fall Season LO 3: Exhibit 8.9 Cost Inventory Available for Sale at Retail Less Reductions: Sales $145,000 Markdowns 12,000 Discounts $ 2,000 Total Reductions Ending Book Value of Inventory at Retail Retail $560,000 159,000 $401,000 70 Whitener’s Sporting Goods, Stock Shortage (overage) Adjustment Entry, Fall Season LO 3: Exhibit 8.10 Cost Ending Book Value of Inventory at Retail Physical Inventory (at retail) Stock Shortages Adjusting Ending Book Value of Inventory at Retail Retail $401,000 398,000 3,000 $398,000 71 Whitener’s Sporting Goods Income Statements August 1-January 31 LO 3: Exhibit 8.11 Cost Sales Less Cost of Goods Sold: Beginning Inventory (at Cost) $200,000 Purchases (at Cost) 70,000 Goods Available for Sale $270,000 Ending Inventory (at Cost) 191,836 Cost of Goods Sold Gross Margin Less: Operating Expenses Salaries $ 30,000 Utilities 1,000 Rent 19,000 Depreciation (Fixtures + Equipment) 2,200 Total Operating Expenses Net Profit Before Taxes Retail $145,000 78,164 $66,836 52,200 $14,636 72 Inventory Pricing Systems LO 3 • FIFO stands for first in, first out and values inventory based on the assumption that the oldest merchandise is sold before the more recently purchased merchandise. • LIFO stands for last in, first out and values inventory based on the assumption that the most recently purchased merchandise is sold first and the oldest merchandise is sold last. 73 Effect of Inventory Pricing System on Gross Margin LO 3 LIFO FIFO Net sales $8,400 $8,400 Less: Cost of goods sold $4,500 $4,500 4,000 4,000 Goods available $8,500 $8,500 Ending inventory 4,500 4,900 Cost of goods sold 4,000 3,600 $4,400 $4,800 Beginning Inventory Gross Margin 74 Question to Ponder • Retailers are given a choice as to whether to use the LIFO or FIFO method. Given such a choice, would it make a difference in the selection of a method if the retailer were privately owned versus being a publicly traded company? 75 76