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INTRODUCTION
The objective of this white paper is to review various aspects of retail financial management and to draw important lessons for small and mid-size retailers. The paper addresses a wide range of topics that impact a retailer's financial success. Many of these are common to retailers of all sizes, but some are specific to mid to small tier businesses and many cautionary notes are given. The topics covered include:
- Key financial metrics and their importance.
- Budgeting and financial planning.
- Relationship of financial plans to merchandise and Open-To-Buy plans.
- Purchasing management.
- Invoice matching.
- Vendor management and its relationship to cash flow.
- Co-op funds and vendor advertising support.
- Operational monitoring.
- Monday morning and end of month routines.
- Financial danger signs and how to avoid pitfalls.
- Managing the store at the Trading Statement level.
- Adding new stores and the implications for profitability and cash flow.
- Dealing with reverse premiums.
- Balance sheet management.
- Inventory?an asset or a liability?
- The role of computer systems in modern financial management.
- Compliance and the implications of Sarbanes-Oxley.
KEY FINANCIAL METRICS
The table that follows shows the key metrics used by most retailers to track and manage their performance. In particular, The Finance Function is very concerned with Return on Capital Employed or Return on Net Assets, Inventory Turn, Gross Margin Percent, Expenses Percent To Sales and expenses measured by line item and expressed as a percent to sales. They may also be concerned with other measures such as the Quick Ratio, Acid Ratio, Gearing and Interest Cover. This latter set tends to be examined infrequently, perhaps quarterly, half yearly or annually.
Return on Capital Employed
Return on Capital Employed (ROCE) is defined as:
ROCE = Pre-tax Profit x 100/Capital Invested
Retailers make widely varying returns but as a sweeping generalization, a business should be making at least 16% to be considered a successful business. A good analogy is to consider that you could invest $100 in a retail business or you could put it in a savings institution. In a savings institution you might currently earn 3% to 8% depending on investment, country and the prevailing level of inflation. To invest that money in a retail business carries a higher level of risk and should therefore, earn a higher level of reward.
The capital is invested in fixed assets and working capital. Fixed assets include buildings, fixtures and fittings, trucks, refrigeration units, etc. In retail, the biggest part of working capital is usually inventory. Accounts payable is another component, as is accounts receivable, which for most retailers is the balances outstanding on credit and debit cards that haven't been settled yet.
A variant on this measure is Return on Net Assets. This measures the pre-tax profit divided by the net asset value expressed as a percentage. For the purposes of this paper, they lead you to the same conclusions. To improve the performance of your business, you can improve pre-tax profit, or reduce the capital employed to achieve the same profit, or do a mixture of the two. Improving pre-tax profit requires some mix of:
- Growing sales.
- Increasing gross margin percent.
- Reducing expenses as a percent to sales.
Reducing the level of capital employed to make a given profit involves:
- Squeezing more productivity out of fixed assets such as selling space and fixtures.
- Reducing the inventory investment necessary.
- Collecting settlement faster from the credit card companies and banks.
Inventory Turn
Inventory (Stock) Turn is the most usual measure of the efficiency of inventory control. It is the number of times within a period, usually one year, that the average inventory is sold.
Normally, higher stock turn rates are associated with products that sell at a lower gross margin percentage, for example, groceries. Conversely, a higher turn has to be associated with a low margin; otherwise, the retailer will not stay in business. Department stores are an example of this lower turn, higher margin model. Inventory turn is calculated based on the retailers accounting method.
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