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Chapter 06 - Financial Strategy
2. What are examples of the types of objectives that entrepreneurs might have for a retail
business they are launching?
Retailers can have three types of objectives: 1) financial, 2) societal, and 3) personal. Examples
3. Buyers' performance is often measured by their gross margin percentage. Why is this
figure more appropriate than net profit percentage?
A buyer can impact the gross margin percentage because he/she can, to some extent, control
4. A supermarket retailer is considering the installation of self-checkout POS terminals.
How would the replacement of cashiers with these self-checkouts affect the elements in
the retailer’s strategic profit model?
The machinery involved in self-checkout POS terminals would be counted as a long-term
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5. Neiman Marcus (a chain of high-service department stores) and Wal-Mart target
different customer segments. Which retailer would you expect to have a higher gross
margin? Higher expense to sales ratio? Higher inventory turnover? Higher asset
turnover? Net profit margin percentage? Why?
Gross margin gives a retailer a measure of how much profit it is making on merchandise
sales without considering the expenses associated with operating the store and covering
6. Why do investors place more weight on comparable store sales than growth in sales?
Comparable store sales growth compares sales growth in stores that have been open for at
least one year. Growth in sales can result from increasing the sales generated per store or by
7. What metrics should be used to measure the financial risk of a retailer? How is each
metric used?
There are four measures to assess the financial strength of retailers include cash flow, debt-
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8. Blue Nile is a jewelry retailer that only uses an Internet channel for interacting with its
customers. What differences would you expect in the strategic profit model and key
productivity ratios for Blue Nile and Zales, a multichannel jewelry retailer?
On the profit margin path, Blue Nile and Zales might have very different sales numbers, as
Zales is a much larger company than Blue Nile. Also, we would expect to see lower
9. Using the following information taken from the 2012 balance sheet for Urban
Outfitters, develop a strategic profit model. (Figures are in millions of dollars.) You
can access an Excel spreadsheet for SPM calculations on the student portion of the
book’s website.
Net sales $2437.8
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10. Using the following information taken from the 2010 balance sheet and income
statement for Urban Outfitters, develop a strategic profit model. (Figures are in $
millions.) You can access an Excel spreadsheet for SPM calculations on the student side
of the book’s Web site.
Net sales $1,937.80
Cost of goods sold $1,151.70
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11. A friend of yours is considering buying some stock in retail companies. Your friend
knows that you are taking a course in retailing and asks for your opinion about Costco.
Your friend is concerned that Costco is not a good firm to invest in because it has such a
low net operating profit. What advice would you give your friend? Why?
When compared to Macy’s, Costco has a lower net operating profit but it is because the margins
on items sold at Costco is much lower than the margin on items sold at Macy’s. Students should
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ANCILLARY LECTURES AND EXERCISES
-------------------------------------------------
LECTURE # 6-1: THE STRATEGIC PROFIT MODEL (SPM)
Instructor’s Note: Instructors may wish to use this ancillary lecture in lieu of the annotated
outline. This is fairly complex material for students to grasp. This lecture is presented with a
simple example. Instructors might want to use this exercise as a stimulus to a class discussion on
the topic. The chapter 6 Power Point slides can be used with this lecture.
-------------------------------------------------
Background
• Also known as the DuPont model, it was developed by the DuPont family around 1920.
Purpose of the SPM
• The SPM serves two managerial purposes:
• Identifies three profit paths a firm can take to increase O.E. by increasing:
1. profit margin
2. rate of asset turnover
3. financial leverage
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• Let us take each of the three categories and break them down.
Margin management
• This information is taken from the income statement:
• Cost of goods sold:
• Invoice costs
• Freight in (transportation cost of bringing in merchandise)
• Workroom costs (alterations, set up)
• Gross margin:
• Gross margin = Net sales - Cost of goods sold
• Can be expressed as a percentage of sales:
• Gross margin, gross margin percent, and inventory turnover are extremely important in
the world of retailing. They represent aspects of the business with which buyer has direct
control.
• Total expenses (two types—variable and fixed):
1. Variable—(varies with sales) -- the cost of doing business; e.g., sales commission
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• Net profit (after tax):
• How to evaluate profit margin
3. Firm’s past history
4. Compare with similar stores or departments. Should be really much better than
average for industry considering there are many bad stores.
Asset Management
• To obtain a better idea of what asset management is about, examine the Asset
Management Model.
• Objective: The objective in asset management is to turn inventory into accounts
receivable or cash by making sales rapidly.
• Current assets—“cycle”
1. cash to inventory
2. inventory to cash or
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6. maximize sales through
selection (depth + breadth)
minimize stock-outs (service level)
• Accounts receivable = Merchandise sold on credit. Want to minimize accounts
receivable because may be an unproductive asset. Most retailers offer credit because:
1. tradition
• Bankcard—Visa, MasterCard, or American Express (T&E—travel and entertainment
card); can be converted to cash immediately, but card company charges retailer a
percentage of sales.
• Factor—accounts receivables are sold to private-label credit card companies known as
“factors.” When a retailer’s accounts receivable is sold to another firm, it allows the
retailer to get money up-front and retain its own store identity. Also, information from
the credit cards can be used to target customers. Factoring is very popular now because
an intermediary company takes care of accounts receivable hassles for the retailer.
• Cash: keep to a minimum
Fixed assets:
1. fixture
2. store (if owned, not rented)
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Asset turnover:
• Net sales/ total assets = Asset turnover.
Return on assets
• ROA uses both asset management and margin management.
• Used for evaluating and programming performance of profit centers (like stores), used to
evaluate managers, not owners because owners also have control over financial
leverage—to be discussed below.
• Total assets
• The question here is, how much profit are you able to generate from retailer’s assets?
• Return on assets is an extremely important measure of how a retailer is performing.
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Financial leverage management
• Leverage ratio = Total assets/O.E. or (Total liabilities +O.E.)/O.E.
• How to manage leverage:
Conclusion
• Depending where one is in the firm, different managers will use different performance
ratios.
