UNDERSTANDING RETAIL VIABILITY

Learning Objectives
• Explain the concept of retail economics
• Understand the measures of financial performance
• Outline the measures of retail performance evaluation
• Evaluate the strategic profit model
THE CONCEPT OF RETAIL ECONOMICS
This covers the planning for new ventures.
Financial planning may also be needed for acquiring
an existing business for expansion.
The primary tool used for assessing whether a
retailer should venture into new markets or business
areas is a Feasibility Report.
FEASIBILITY REPORT
A retailer may create a feasibility report for any
of the following reasons:
The basic purpose of a feasibility report is to determine
the economic viability of the business in designated
markets.
To provide guidance to the new business planner in
organizing and controlling various planning activities.
To serve as a tool for obtaining the necessary financing.

Continued...
Typically, a feasibility report comprises the following
areas:
 A description of the business
 Economic considerations for the business
 Market factors
The cost of new premises
Start up costs and operating expenses
Cost of inventory
 Cash flow requirements
FEASIBILITY STUDY
A feasibility study is designed to provide an
overview of the primary issues related to a
business idea.
A thorough feasibility analysis provides a lot of
information necessary for the business plan.
A feasibility study looks at three major areas:
Market issues
 Organizational/technical issues
Financial issues

Continued...
A feasibility study starts with defining the basic
business that the retailer is in and helps him
understand the complete market and economic
factors, which may be critical for the success of his
business.
An estimation is also made in terms of the cost of
premises and the cost of the inventory, which needs
to be sold.
Feasibility studies require a lot of hard work, and the
market analysis research is the most difficult part of
the process.
THE MEASURES OF FINANCIAL PERFORMANCE
To the investor in the business, financial
performance is an indicator of the health of the
organization.
Analysing financial performance is necessary for the
following reasons:
To help identify the gaps in the targets
To identify the opportunities for improvement
To evaluate past and present performances
METHODS OF EVALUATING
FINANCIAL PERFORMANCE

INCOME STATEMENT OR PROFIT AND LOSS STATEMENT

• Indicator of the profitability of the business

BALANCE SHEET

• Indicator of the turnover

THE INCOME STATEMENT
The income statement is a record of the revenues earned by an
organization and the expense incurred. It is the snapshot of a company’s
operational performance for a particular period of time.
It takes the company’s revenues and expenses and gives profits as output.
It is popularly known as the ‘profit and loss statement’ and is always
created for a particular period of time.
The chief components of an income statement are:
 Sales
 Cost of goods sold
 Gross margin
 The operating expenses
 The net profit
Continued…
COMPONENTS OF AN INCOME STATEMENT
Sales: The total money received by the retailer from the sale of
merchandise.
Cost of Goods Sold: Cost of goods sold are the expenses incurred by the
organization for making the goods. It includes the money the company
spent to buy the raw materials needed to produce its products, the money
it spent on manufacturing its products and labor costs.
Gross Margin: This is the difference between all the revenue the company
earns from the sales of its products minus the cost involved to produce
those goods.
Gross Profit on Sales = Net Sales ─ Cost of Goods Sold
Operating Expenses: These are the expenses incurred in producing the
goods like labor, fuel, power etc. The difference between the net sales and
the operating expenses is the operating profit, which is a commonly used
statistic to judge the operational performance of the company.
THE BALANCE SHEET
The balance sheet is like a financial snapshot of
the company’s financial situation at a particular
point of time.

The data shown in a balance sheet can be

interpreted in two halves:

The first half indicates the money being used in the

business, i.e., the net assets and the second half shows
the capital employed or where the money has been
secured.
The value of the two halves needs to be the same.
MEASURES OF RETAIL PERFORMANCE EVALUATION

CURRENT
FIXED ASSEST
ASSEST

LONG-TERM SHORT-TERM
LIABILITIES LIABILITIES

NET WORTH
MEASURES OF PERFORMANCE EVALUATION
In retail, there are three areas, which are
important in the measurement of performance.
They are:

 Merchandise

 Store and retail space

 People
 RATIO ANALYSIS
Ratio analysis is not just comparing different numbers from the balance
sheet, income statement, and cash flow statement.
It is comparing the number against previous years, other companies, the
industry, or even the economy in general.
Ratios look at the relationships between individual values and relate them
to how a company has performed in the past, and might perform in the
future.
Ratios are highly important profit tools in financial analysis that help
financial analysts implement plans that improve profitability, liquidity,
financial structure, reordering, leverage, and interest coverage.
Although ratios report mostly on past performances, they can be
predictive too, and provide lead indications of potential problem areas.
KEY RATIOS
Key ratios which are usually analyzed are as follows:
Profitability ratios: Profitability ratios speak about the profitability of
the company. Typical ratios, which are considered to be measures of
profitability, are the ratios which measure the margins earned in the
business and the returns earned.
The chief among them are:
Gross Profit Margin which is calculated as:
Gross Profit Margin = Gross Profit / Sales
Operating Profit Margin, which is calculated as:
Operating Profit/Sales
This ratio is an indicator of the ability of the business to control.

Continued…
Net Profit Margin: It is calculated by dividing the net profit by the
sales for the said period. This ratio would invariably represent the
bottom line profitability of the business.
Return on Capital Employed (“ROCE”) : It is calculated as:
 Net profit before tax, interest and dividends (“EBIT”)/total
assets (or total assets less current liabilities its other operating
cost or overheads.
Liquidity Ratios: These ratios are used to judge the short-term
solvency of a firm. These ratios give an indication as to how liquid a
firm is. The most commonly used ratios are – Current ratio and the
quick ratio.

Continued…
Current Ratio: It is calculated as: Current Assets / Current
Liabilities
This ratio is a simple measure that estimates whether the
business can pay debts due within one year from assets that it
expects to turn into cash within that year. A ratio of less than
one is often a cause for concern, particularly if it persists for any
length of time.
Quick Ratio (or “Acid Test” Ratio)
The quick ratio, therefore, adjusts the current ratio to eliminate
all assets that are not already in cash (or “near-cash”) form.
Once again, a ratio of less than one would start to send out
danger signals.
This ratio is calculated by adding Cash + Accounts
Receivable/Current Liabilities

Continued…
Financial Leverage Ratios: These ratios are used to judge the long-
term solvency of a firm.

 The most commonly used ratios are :

 Debt equity ratio = Long term debt/Total equity

 Long-term debt-total equity ratio = Long-term debt/total

long-term capital

Earnings Coverage Ratios: There are several ratios commonly used

by investors to assess the performance of a business.

Continued…
Earnings per share (“EPS”) = Earnings (profits) attributable to
ordinary shareholders/ weighted average ordinary shares in issue
during the year.
Price-Earnings Ratio (“P/E Ratio”) = Market price of share/earnings
per share At any time, the P/E ratio is an indication of how highly the
market “rates” or “values” a business.
A P/E ratio is best viewed in the context of a sector or market
average.
Dividend Yield = (Latest dividend per ordinary share/current market
price of share) ×100
OTHER MEASURES OF PERFORMANCE
GMROI (Gross Margin Return on Investment)
It is calculated as Gross Margin/Average Inventory, where
the average inventory may be valued at cost or at retail
prices. In most cases inventory is valued at retail prices.
Inventory Turnover Ratio
It is calculated as Inventory Turnover = Net Sales/Average
Inventory at retail OR Cost of goods sold / Average
inventory at cost.
MEASURING RETAIL STORE AND SPACE PERFORMANCE
GMROF
 Sales per square foot
The conversion ratio
Average sales per transaction or the average
ticket size
THE STRATEGIC PROFIT MODEL
The Strategic Profit Model combines the
information provided by the balance sheet and
the income statement into one comprehensive
model.
It is based on three important financial ratios:
The Net Profit Margin
The Asset Turnover Ratio
The Return on Assets