Tracking retail financial data enables business owners and senior managers to make decisions and control organisational performance. Effective retail managers spend a lot of time collecting and analysing information to better manage their business. Managing retail financials entails setting realistic goals and objectives based on factual information, planning and budgeting, and controlling performance.
Below are some useful tips from the ARA Retail Institute on effectively managing your retail financials.
Financial performance
Retailers have the potential to continually receive information about their performance. For example, they may count how many customers enter their store each day and then check their register receipts at the end of the day to see how many were converted into sales. Large sophisticated retailers can get instantaneous sales information for each item at every store using modern data communications systems linked to point of sale (POS) equipment.
Retailers use this information to evaluate their performance relative to their objectives. If the retailer is achieving his or her objectives, changes in strategy or implementation programs aren’t needed. But if the performance information indicates the objectives aren’t being met, the retailer needs to analyse their plans and programs. For example, if after reviewing the accountant’s reports the owner feels he or she is not getting a fair return on their time, effort and the money they have invested into the shop, they may choose to adopt a different strategy.
The retailer may decide to change their strategy by appealing to a different target market, change components of their product range, pursue an alternative assortment strategy, change their ticketing and communication, adjust stock levels or lower or raise the average price point of the goods they are offering. The key to these changes is to use data to first understand how the business is tracking, use financial tools to plan desired outcomes resulting from the changes and then use data to measure the impact of the changes and to determine if the outcomes are being met.
Without financial reports, systems and measures it is often difficult to provide any specific advice or assistance to improve a retailer’s financial position or business performance. All too often the retailer is simply left with – treat your customers better; improve your store’s visual appeal; have a sale – as their path to improving the business. Without any of the performance tools and metrics, they may well be accelerating down a dead end street.
Areas of financial performance
There are various aspects of a business’s financial performance commonly measured. These include:
1. Liquidity
Testing whether the business is able to pay its debts as they fall due.
2. Management efficiency
Examining how well working capital is managed – how quickly inventory is sold and how speedily cash is collected from customers (accounts receivable).
3. Financing Comparing the proportion of debt to equity – and whether or not borrowings contribute to the return to shareholders.
4. Profitability
Assessing the profitability of the business – or parts of the business – and analysing the factors that contribute to relative profitability.
5. Market performance
Examining the returns to investors or owners – in the form of dividends or payments – and changes in the value of shares or owners equity.
Profit and Loss
The profit and loss statement summarises a business’s financial performance over time (one month, quarterly or annually are most common) and details the sales, gross profit, expenses and net profit of the business.
Since the level of sales achieved, the gross profit percentage and the management of expenses are a critical component of successfully running a retail business, the profit and loss statement is the report most often utilised by retailers. In some cases, it is the only report small retailers use and indeed it is not uncommon for some small business owners to be unaware of their current level of profitability.
The more astute retailer will develop a budgeted profit and loss pro-forma by month for the coming year and at the end of each month will track how their business is performing relative to their plan, relative to year-to-date and often in comparison to the previous comparative period from last year.
They will identify areas of concern and take corrective action to guide their business back in line with their budget. Where factors out of their control have impacted their business (such as a centre redevelopment or aggressive new competitor) they will re-work their budget to ensure the business is still viable with these new factors considered and then track their on going performance relative to this new plan.
This is a typical profit and loss statement from a reasonably successful small retail business.
If this business were to run at a 50% margin it would make a profit of $37,000 before tax and if it were run at a 45% margin it would make a loss of -$12,350 before tax. This highlights how important the gross margin management is to a retailer. If it were to maintain a 55% margin but achieve net sales of less than approx $830,000 it would run at a loss. In other words if this business dropped sales by over $150,000 per year it would be in serious trouble. It is only this last $150,000 worth of sales that makes any profit at all for the owner. Clearly retailers need to continue to strive for sales growth and take immediate action if sales fall.
The impact of financial awareness on profit
What you do matters. Let’s say you were able to decrease your business’s expenses by 5%. In a store that has annual expenses of $228,434, this equates to an increase in profit of $10,000 for the year. What if you could improve your sales by 6%, what if you increase your margin by 1%?
The 6:1:5 rule – What would be the impact of?
- Increasing sales 6%?
- Increasing margin 1%?
- Reducing costs 5%?
Let’s look at a basic Retail Profit and Loss Statement to see the impact of these changes.
Cash flow
One of the biggest problems facing small to medium sized retail businesses is the level of liquidity they have or in other words their ability to meet their financial obligations when they fall due. Often these businesses will still be trading and may show a profit on paper but find themselves insolvent.
The cash-flow statement tells how the business used and generated its most important asset – cash. Without cash to pay the bills when they are due, a business cannot continue and must go into liquidation. Consequently, cash management is just as important as being able to generate profit. Some argue that it is more important, because it is possible to be profitable and still not have enough cash to continue to operate.
The Balance Sheet
The profit and loss statement summarises the financial performance over a period of time, while the balance sheet summarises a retailer’s financial position at a given point in time, such as the last day of the financial year. The balance sheet shows the following relationship;
Assets = Liabilities + Owners equity
Or
Assets – Liabilities = Owners equity
(The balance sheet is thus named because these equations must always balance.)
Assets are resources (such as stock or store fixtures) owned or controlled by the business as a result of past transactions. Liabilities consist of the business’s obligations (such as accounts or invoices payable) to pay cash or other financial resources, in return for past, current or future benefits. Owner’s equity is the difference between assets and liabilities. It represents the amount belonging to the owner once all obligations have been met.
Typically owners will enter a business to either derive a regular flow of income from the business (profit) or to build up the value of the business to make money when they sell it (equity) or a combination of both. The profit and loss statement will indicate the level of income that can be taken out of the business whilst the balance sheet will indicate the level of owner’s equity that has been generated.
When determining the value of a retail business, the Balance Sheet can be used to evaluate the current level of owner’s equity and the Profit and Loss statement can be used to determine the level of good will in the business.
The three key reports
Early in the budget cycle the owner or management should build the Balance Sheet, Profit and Loss and Cash Flow reports for the coming budget period and test the key financial target areas – cash flow and profitability.
If the results fail to meet the targets they must either change their plans or revise their targets, or both. Once it appears the targets will be met, more detailed budgets can be built with plans for running the business (such as a category buying plan, a marketing plan, and training plan etc).
At the end of the budget period these statements are again prepared, this time comparing actual performance with the budgeted figures for previous periods.
Budget development
A successful business relies on effective planning. A retailer must know the fixed and variable costs of running a business and allocate funds to different activities to achieve expected business outcomes. A small business owner must develop a budget for the whole business, allocating funds to all the different activities of the business. Preparing a budget is essential for planning and controlling activities within an organisation.
Types of budget
Different types of budgets are prepared for different reasons: some to forecast income, others to control expenditure.
Revenue budget
A revenue budget itemises the expected income from sales of products or services, and any other income.
The revenue budget for an organisation will be based on actual income in the previous year; revenue trends over the past few years; economic forecasts; business forecasts; competitor activity; and Government policies.
Revenue items should be broken down into categories to assist in estimating sales for the forthcoming year, such as types of product; territory; and market segment.
The actual figures for the previous year and the specific conditions affecting sales of a particular product in the forthcoming year can be assessed to produce the most accurate estimate of revenue.
It is also important to know when the revenue will be available.
Sales budget
The sales budget includes the forecast revenue from sales of products and services; and the costs incurred in making the sales, such as the salaries of sales and administration staff and travel costs.
You need to consider the target figures for the business when preparing a sales budget. These targets may include: sales, cash flow, net profit, payroll, staff expenditure, capital, and maintenance costs.
The sales budget produces a net revenue figure that can be used to allocate funds across the organisation.
Points on sales forecasting
- Gather data continuously
- Talk to sales people
- Re-forecast frequently
Expenses budget
Departments of a retail organisation which are not directly involved in sales will produce an expense budget. This itemises the costs of running the department effectively and efficiently. The total costs must not exceed the budget allocation, but the departmental manager has control over the allocation to different costs.
Budget items
The total expense budget amount must be split into allocations for specific purposes, based on the requirements for running the department or store. These budget items could include: site leasing costs (including rates), utilities (power, water, communications), labour costs (wages plus costs such as superannuation and overtime payments), consumables (such as office stationary and supplies, packaging, fuel), staff training, plant and equipment hire (lease or maintenance), depreciation of assets, and insurance (such as Workcover and public liability).
Fixed and variable costs:
- a fixed cost does not change with the volume of work done
- A variable cost increases with the volume of work done.
Some budget items are controllable and some are not. A fixed cost such as the rent charged on premises cannot be controlled. Fixed costs may include contributions to other departments such as accounting, or head office. Staff wages is a variable cost changing according to the number of staff required. You may have a fixed cost of permanent staff and a variable cost of casual staff. The numbers of casual staff employed is controllable.
Controlling costs
When developing a budget it is important to plan the most efficient use of variable cost items. The profitability and success of the business depends on logical and cost-effective budgets and planning. You need to consider the costs incurred in the previous year and work out whether these can be reduced.
Do you require assistance?
Managing your retail financials is critical to maintaining a healthy and sustainable business, and good management could mean the difference between prospering or merely ‘keeping your head above water’. If you require assistance in learning how to manage your business’s finances or setting protocols in place, the ARA Retail Institute offers consulting services and a range of course that can help. Call 1300 368 041, email training@retail.org.au or go to www.retail.or.au and follow the links to find out more.
