session 8 financial strategy

8/13/2019 Session 8 Financial Strategy

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Financial StrategyRetail

Yasmin S

Business Survival:

There are two key factors for business survival:• Profitability• Solvency

• Profitability is important if the business is togenerate revenue (income) in excess of theexpenses incurred in operating that business.

• The solvency of a business is importantbecause it looks at the ability of the business inmeeting its financial obligations.

Retail and FinancialManagement

• The income statement and the balancesheet of the retailers contain informationregarding the performance of their stores

• Retailers who take time to study thesefigures are able to develop businessmodels and generate more profits

Budgeting

• Budget is an attempt to forecast incomeand expenses of the firm.

• It’s a statement of likely income andestimated expenditure

Types of Budget

• The Operating Budget: – Sales Budget : it’s a sales forecast, should be

carefully estimated as it affects other forecast ;cash flow

– Merchandise Budget : is the forecast of thegoods to be sold

– Expenses Budget: consist of plannedexpenditure for the said period

Types of Budget

• The Cash Budget: in simple terms it’s astatement of cash inflow and outflow

• The Capital Expenditure : such asreplacement of or addition to existingassets, modernization, installation of MISis necessary in the long-term interest ofthe firm

Types of Budget

• Reports: a budgetary control system canbe made effective if key results are madeavailable regularly – Sales : sales record of each retail store can be

produced which give the actual, budgeted and

variance values, also helps in finding the fastand the slow movers in the category – Expenses: report is prepared for major cost

heads like wages, maintenance etc7

Income Statement

• Summarizes the financial performance ofa company for a given accounting period

• It shows how much revenue the companyearned through its operations, and theexpenses associated with bringing in thatrevenue

Income Statement

• Sales : gross sales, net sales, goodsreturned by customers

• COGS : direct cost associated withmanufacturing/procuring the merchandisefor the store, also includes transportationcost. In simple terms it’s the price paid bythe retailer to produce or acquire goods forsale

Income Statement

• Gross margin : difference between netsales and the COGS, indicates theprofitability of the retailer. A high grossmargin implies that the store is efficient inprocuring and selling merchandise

• Expenses: interest and operatingexpenses. Operating expenses: sellingexpenses, general expenses and

administrative expenses 10

Income Statement

• Salary of staff, salary of sales staff, rent,utilities, office supplies

• Net profit ‘BOTTOMLINE ’,

Balance Sheet

• Assets are the items owned by the retailerthat have an economic value and areexpected to produce some economicbenefit to the firm.

• Current assets= Accounts Receivable +Merchandise Inventory + cash + othercurrent assets

Merchandise Inventory

• It constitutes the major part of the totalassets

• Inventory to asset ratio= inventory/ totalasset

• Inventory turnover= net sales/ averageinventory

• Average inventory= inventory/ (1- grossmargin)

Merchandise Inventory

• Inventory turnover indicates the speed atwhich the inventory is moving out of the

stores• It is used to evaluate the efficiency of an

organization in managing its investment in

inventory• The inventory cycle usually consists of

ordering of inventory, stacking in the store,

and selling to customers. 14

Fixed Assets

• Represent those assets that require morethan one year to be converted into cash

• Over the years the value of the fixedassets depreciate

• Asset Turnover= Net Sales/ Total Assets

Liabilities and Owners Equity

• Refers to items that a company owes tocreditors and suppliers

• Current liabilities: refer to debts that needto be paid within one year, accountspayable, accrued expenses

• Long term liability• Owners equity: common stock and

retained earnings16

Financial Statement Analysis

• Financial Statement Analysis will help businessowners and other interested people to analyse

the data in financial statements to provide themwith better information about such key factors fordecision making and ultimate business survival.

Financial Statement Analysis

Purpose:• To use financial statements to evaluate an

organisation’s – Financial performance

– Financial position.• To have a means of comparative analysis across time

in terms of: – Intracompany basis (within the company itself)

– Intercompany basis (between companies) – Industry Averages (against that particular industry’s averages)

• To apply analytical tools and techniques to financialstatements to obtain useful information to aid decisionmaking.

Tools of Financial Statement

Analysis:The commonly used tools for financial statementanalysis are:• Financial Ratio Analysis

• Comparative financial statements analysis: – Horizontal analysis/Trend analysis – Vertical analysis/Common size analysis/ Component

Percentages

Financial Ratio Analysis

• Financial ratio analysis involves calculating andanalysing ratios that use data from one, two ormore financial statements.

• Ratio analysis also expresses relationshipsbetween different financial statements.

• Financial Ratios can be classified into 5 maincategories:

– Internal Liquidity ratios – Profitability Ratios – Earning Coverage Ratios – Financial Leverage Ratios

Internal Liquidity ratios

• Working Capital = Current assets – Current Liabilities

• Current Ratio = Current AssetsCurrent Liabilities

• Quick Ratio = Current Assets – Inventory – PrepaymentsCurrent Liabilities – Bank Overdraft

• Cash Ratio = Cash & Cash EquivalentsCurrent Liabilities

Profitability Ratios

3 elements of the profitability analysis:• Analysing on sales and trading margin

– focus on gross profit

• Analysing on the control of expenses – focus on net profit

• Assessing the return on assets and return on

equity

Profitability Ratios

• Gross Profit % = Gross Profit * 100Net Sales

• Net Profit % = Net Profit after tax * 100Net Sales

• Return on Assets = Net Profit * 100 Average Total Assets

• Return on Equity = Net Profit *100 Average Total Equity

Asset Management Ratios

• Efficiency of asset usage – How well assets are used to generate revenues

(income) will impact on the overall profitability of thebusiness.

For example: Asset Turnover

• This ratio represents the efficiency of assetusage to generate sales revenue

Asset Management Ratios

• Inventory Turnover = Net Sales Average Inventory

( Avg inventory = Inventory / ( 1- Gross Margin )

• Asset Turnover = InventoryTotal Assets

• Asset Turnover = Net SalesTotal Assets

Financial Leverage RatiosLong term funds management• Measures the riskiness of business in terms of debt

gearing.

For example: Debt/Equity

• This ratio measures the relationship between debt andequity. A ratio of 1 indicates that debt and equity fundingare equal (i.e. there is Rs.1 of debt to Rs.1 of equity)whereas a ratio of 1.5 indicates that there is higher debtgearing in the business (i.e. there is Rs.1.5 of debt to Rs.1of equity). This higher debt gearing is usually interpretedas bringing in more financial risk for the businessparticularly if the business has profitability or cash flowproblems .

Financial Leverage Ratios

• Debt/Equity ratio = Debt / Equity

• Debt/Total Assets ratio = Debt *100

Total Assets

• Equity ratio = Equity *100

Total Assets

• Interest Coverage Ratio= Earnings before Interest and TaxInterest

Improving Financial Performance

• Profit Management – Sales Productivity – Expenses Control

• Asset Management – ROA – Inventory Turnover Ratio

• Debt Management

– Debt / Equity – RONW

Limitations of Financial Statement

Analysis• We must be careful with financial statement

analysis.

– Strong financial statement analysis does notnecessarily mean that the organisation has a strongfinancial future.

– Financial statement analysis might look good but theremay be other factors that can cause an organisation tocollapse.

Why it is usually not appropriate to

compare ratios to companies is differentindustries:

Varying ways of doing business indifferent industries means that ratiovalues appropriate in one industry are notappropriate in a different industry.

For example …

Consider two different retail storesin different industries:

• A retail grocery business typicallyoperates with a very small profit margin,

but has a very high turnover.• A retail jewelry store typically operates

with a low turnover, but has a high profitmargin.

• Both stores can achieve the same overallprofitability, but they do it in differentways, as appropriate in their respective

industries. 32

Other Retail PerformanceMeasures

• Sales per square foot or meter : sale fora particular period/ floor area= Rs.

60,00,000/ 5000 Sq ft.= Rs 1200 persquare ft. this performance parameter isvery useful in comparing returns from

different branch locations. A moresophisticated measurement would be netprofit per square foot, it shows the actualcontribution in profit terms

• Sales per linear foot: measure the salesand profits in relation to the length of ‘wallruns’ in their stores. Indicates the successof in-store display and merchandising inparticular section also helps bring out ‘ Hot

Spots’ and ‘ Dead Areas’

• Sales per assistant: key measurement asit gives a useful comparison between thelabor productivity of different branches, egsales of Rs 75 Lakhs and the number ofstaff being 25 gives sales per assistant ofRs 3 lakhs

• Sales per checkout: by dividing theperiod’s sales in a supermarket by thenumber of checkouts the operator can findout whether he/she is under or over-tilledand make adjustments

Assignment

• Visit a local bank and ascertain from themwhat records a small retailer must producein order to get a loan

session 8 financial strategy

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