Chapter 1212Operations Management: Financial Dimensions

Dr. Pointer’s notesDr. Pointer’s notes

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Chapter Objectives

To define operations managementTo discuss profit planningTo describe asset management,

including the strategic profit model, other key business ratios, and financial trends in retailing

To look at retail budgetingTo examine resource allocation

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Operations Management

• Operations Management is the efficient and effective implementation of the policies and tasks necessary to satisfy the firm’s customers, employees, and management and stockholders.

• Managers must be knowledgeable of the major financial ratios and statements which can help in planning and evaluating the success of a retail operations.

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Profit Planning

One of the most important statement to understand is the P & L Statement

Profit-and-loss (income) statement – Summary of a retailer’s revenues

and expenses over a given period of time, usually a year.

– Review of overall and specific revenues and costs for similar periods and profitability

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Major Components of a Profit-and-Loss Statement

• Net Sales• Cost of Goods Sold• Gross Profit

(Margin)• Operating Expenses• Taxes• Net Profit After

Taxes

Net Sales $330,000

CGS $180,000

Gross Profit $150,000

Operating Expenses $ 95,250

Other Costs $ 20,000

Total Costs $115,250

Net Profit before Taxes

$ 34,750

Taxes $ 15,500

Net Profit after Taxes

$ 19,250

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Major Components of P & L Statements

• Net Sales – revenues minuses returns, markdowns and employee discounts

• Cost of Goods Sold- amount paid for merchandise, less discounts.

• Gross profit (margin), the difference between net sales and cost of goods sold.

• Operating expenses – the cost of running a retail business

• Taxes – payments of federal, state and local government taxes

• Net profits after taxes - - profit after all taxes and expenses have been paid

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Asset Management

The Balance Sheet- itemizes a retailers assets, liabilities and network for specific time– Assets- total amount of item with monetary value Current assets – cash on hand Fixed assets – non liquid assets such as property,

building, fixtures, equipment and etc– Liabilities – financial obligations owed by retailer– Net Worth- assets minus liabilities (value of business)– Net Profit Margin- performance measures –ratio Net

profit/total revenue– Asset Turnover- performance measure that – Return on Assets- performance measure– Financial Leverage – performance measurer

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Performance Measures

• Asset Turnover = Net sales

Total assets

Return on Assets = Net profit margin X Asset Turnover

Financial Leverage = Total Assets

Net Worth

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Assessment of Ratios

• Asset Turnover - Best to have ratio greater than 2 because it shows that assets are being used more efficiently

• Return on Assets - Ratios close to 1 are good because it shows that assets are properly being utilized

• Financial Leverage Ratio – around 2 or less is better. High ratios indicate much higher debt. Need to compare ratio with industry average for good assessment

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Figure 12.1 The Strategic Profit Model

Net profit Margin

Return on Net Worth

Asset Turnover

Financial LeverageX X =

Net profit Net Sales Total Assets = Net profit

Net Sales total Assets Net Worth Net Worth

Return on net worth model can help trouble shoot to determine where the major performance problem is.

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Other Key Business Ratios

Quick Ratio- cash+ acct receivable/current liabilities ( > 1 is good)

Current Ratio – current assets/current liabilities (>2 is preferred)

Collection Period – accts receivable /net sales X by 365. 40 or above for a store with 30 day credit term is means slow turning receivables.

Accounts Payable to Net Sales- accounts receivable / net sales – ratio above industry average indicates that firm rely on suppliers to finance operations

Overall Gross Profit –net sales /cost of goods , then divided by net sales

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Financial Trends in Retailing

Slow growth in U.S. economy is adversely affecting retailers ( this causes slow sales, then markdowns, cash flow problems which affects profits)

High number of retail lay offs among workers Funding sources- 3 major types (next slide) Mergers, consolidations, - many stronger retailers buying

smaller retailers. Spinoffs- some retailers spinoff divisions that no longer

meet profit expectations to generate money to use in core businesses.

Bankruptcies and liquidations- safeguard against mounting debts some firms seek bankruptcy protection –Kmart other just sell assets to pay creditors

Questionable accounting and financial reporting practices

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Funding Sources

Mortgage refinance (due to low interest rates)

REIT (retail-estate investment trust) to fund construction– Company dedicated to owning and

operating income-producing real estateInitial public offering (IPO)- selling stock to

finance expansions.

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Budgeting

Budgeting outlines a retailer’s planned expenditures for a given time based on expected performance

Costs are linked to satisfying target market, employee, and management goals\

Successful retailers operate using budgets because they help achieve objectives.

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Figure 12.3 The Retail Budgeting Process

-Who develops budget-Budget

time frame-How often are budgets

planned-What are

the cost categories-What level of detail is

needed-How flexible will budget be

GoalsPlanned

ExpendituresPerformance

Standards

Adjustments

Actual Expenditures

Monitoring Results

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Budget Benefits Expenditures are related to expected performance Costs can be adjusted as goals are revised Resources are allocated to the right areas Spending is coordinated Planning is structured and integrated Cost standards are set Expenditures are monitored during a budget cycle Planned budgets versus actual budgets can be

compared Costs/performance can be compared with industry

averages

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Preliminary Budgeting Decisions

1) Specify budgeting authority

2) Define time frame

3) Determine budgeting frequency

4) Establish cost categories

5) Set level of detail

6) Prescribe budget flexibility

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Cost Categories

Capital expenditures are long term investments in lands, buildings, fixtures and equipments

Fixed costs remain constant for specified period. Variable costs will vary based on performance (cost of goods)

Direct costs- incurred by specific departments, product categories and etc.

Natural account expenses- reported by names of costs, such as salaries,

Functional account expenses – classified on the basis of the purpose of activity for which expenditures are made

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Ongoing Budgeting Process

Set goals based on customer, employee and management needs

Specify performance standards ( usually related to sales forecast)

Plan expenditures in terms of performance goals: Zero based budgeting – new budget developed from scratch or incremental budgeting where past budget is used as a guide and adjusted

Make actual expenditures Monitor results Adjust budget s needed Cash Flow – relates to the amount and timing of revenues

received and expenditures made during a specific time.

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Resource Allocation

• Capital Expenditures– Long-term

investments in fixed assets

• Operating Expenditures– Short-term selling

and administrative costs in running a business

Must have a good estimate of capital and operating expenditures. Need to have the funds needed to run the operations. Must be flexible to take advantage of opportunities.

Opportunity costs – the possible benefits a retailer forgoes if it invests in one opportunity rather another

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Enhancing Productivity

Productivity refers to efficiency with which a retail strategy is carried out.

Big question is how can sales and profitability be maintained and costs be decreased.

A firm can improve employee performance, sales per foot of space, and other factors by upgrading training programs, increasing advertising, etc.

It can reduce costs by automating, having suppliers do certain tasks, etc.

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Questions

Look for class assignment with problems.