Part III of a three-part series on business terminology
By now, if you’ve read the first two parts of this series, published in the September and October 2019 issues of Marijuana Venture, you have two-thirds of a small “dictionary” of basic retail terminology. These are words every retailer should feel comfortable using, especially when talking with their lender, investors or other sources of financing.
This installment completes our list of basic definitions and simple, real-world examples.
Net operating income
Net sales minus net cost of goods sold, less all operating expenses and income taxes. (Operating income is pre-tax profit; net operating oncome is post-tax profit.)
Example: Jill looked delightedly at her income statement. The total sales of her company were nearly double the previous year’s. Then she noted what the merchandise had cost the store and what it had cost to keep it in operation over the year. Sales had zoomed, but so had merchandise costs and operating expenses, so her net operating income was actually less than it had been the year before.
Also called “equity,” net worth is total assets minus total liabilities. (A balance sheet entry showing the owner’s share of a company.)
Example: Mark decided to sell his store but had no idea how to put a price on it. He walked through his store with his consultant. “I trained these salespeople,” Mark said. “I developed relationships with those customers. How can you put a price on such things?”
The consultant said, “The factors you mention need to be taken into account, but let’s start at the beginning. Exactly how much do you have into this operation? Let’s start with your net worth.”
A ledger account or balance sheet item itemizing the amounts owed to banks and others, secured in the form of a promissory note. They can be short-term (due within one year) or long-term (due one year or more from the date of the balance sheet).
Example: Anne was late for an appointment with her loan officer. She rushed to the loan officer’s desk and handed her a paper prepared by her bookkeeper. Five minutes later Anne discovered the balance sheet, though complete, didn’t contain enough detail on the amounts owed to others; the banker needed a breakdown on the entry for notes payable.
Expenses related to the use of property — rent, heat, light, depreciation, common area maintenance charges, maintenance, etc.
Example: Pete was tempted to move his store to a location around the corner that was available for rent. The area had less traffic, but the rent was substantially lower. Then a level-headed friend of Pete’s walked through the empty storefront with him, wondering out loud how much it would take to heat the building and keep it well lit. Peter hadn’t thought of that. Doing a little mental math, he concluded the occupancy expense of the empty storefront probably wouldn’t be as low as he thought and certainly not low enough to justify moving to a less desirable location.
Also known as a merchandise plan or merchandise budget. A budget for buying merchandise revolving around inventory levels and planned sales. The basic open-to-buy formula is sales plus desired ending inventory minus beginning inventory equals purchases. This can be made more exact by incorporating on-order, markdowns, shrinkage, etc. into the formula.
Example: Susan saw a million things at the trade show that she wanted to buy for her store. She ordered from one supplier, then from another. Then, she saw a display that would look great in her store window, but unfortunately she’d spent her budget. “I want those products so bad, but we have no money left in our open-to-buy.”
Non-merchandise expenses incurred by a business. These may be generally categorized as selling expenses, occupancy expenses, administrative expenses and depreciation.
Example: Tracy’s supplier had shipped more than double the number of items she’d ordered. She called to see what was going on. The supplier had shipped 18 items instead of eight.
“I’ll have to send 10 of them back to you,” Tracy said.
“Are you sure you wouldn’t like to keep them?” asked the supplier hopefully. “This brand is selling very well right now.”
“No, thanks.” Tracy had learned by bitter experience the impact that excess inventory could have on her store’s profits. “If I start accepting merchandise I haven’t ordered, I’ll have to deal with increased handling, ticketing and advertising — not to mention the cost of warehousing the extra stock. Being over-inventoried makes my operating expenses shoot up.”
A general term for the excess of revenue over the cost of the merchandise and all operating expenses and taxes.
Example: Sam had been in business for about a month. Every night Sam cleaned out the till and went to the bank, noting proudly how the balance rose. He could hardly wait to talk to his father-in-law, who had been functioning as his adviser in the new venture.
“I never guessed making a profit could be so easy,” he told his father-in-law.
“Slow down, Sam,” Mr. Jones said patiently. “Have you paid your store’s rent yet? Have you paid for your merchandise? Take care of all the expenses you incurred this month, then call and tell me about your profit.”
Also known as a P&L or income statement. A financial statement that indicates the operating results of a business over a period of time (one month to one year). The P&L begins with sales and deducts the cost of the merchandise. The resulting gross margin covers expenses and leaves a profit for the business. If expenses aren’t covered, a loss is incurred.
Example: Al had been in the business for 35 years, during which sales continued to increase, but lately the store’s net profit had begun to go down. One day his bookkeeper came to him with some numbers showing the problem: administrative expenses and occupancy expenses were roughly the same as always, but selling expenses had increased.
Al cut back on advertising and found that his net profit increased significantly, while sales barely dropped. The company’s profit-and-loss statement had proven to be a valuable diagnostic tool.
A projection or forecast of likely financial events. Pro forma balance sheets can be used to plot the strength of a business, while pro forma income statements can be used to plan profits.
Example: Andrea had been putting almost all her profits back into the business, but she wanted to concentrate on putting her son through college, so she asked her bookkeeper what she could expect over the next year or so in terms of profit.
“Let me prepare a pro forma income statement,” the bookkeeper said. “It’ll help you plan ahead to give Mike the education he deserves.”
Cash plus accounts receivable divided by current liabilities. This financial ratio measures the ability to have cash available quickly to meet current obligations. An increase in your quick ratio is generally favorable.
Example: One of Benjamin’s lines was going at a 30% discount, and he wanted to make a substantial buy to add to his inventory. “I can give you 15% now and the remainder net 10,” he told the supplier.
“How do I know you can afford to do that?” the supplier asked.
Shuffling through his briefcase, Benjamin found his company’s current balance sheet that showed a quick ratio of 1.5:1 put him in great shape to pay an immediate debt.
The study of relationships between different parts of a company’s financial data, used to pinpoint a company’s financial strengths and weaknesses. Particularly valuable for comparing trends over time.
Example: The supplier’s eyes widened as Benjamin explained exactly what a quick ratio was. “I’ve never met a retailer who knew what a quick ratio was,” the supplier said. “Bet you don’t know what current ratio and debt-to-worth ratio are.”
“That’s easy,” said Benjamin, explaining the two ratios, which he had recently learned at a financial management workshop.
“Well, good for you,” said the supplier. “Having a handle on ratio analysis puts you way ahead of the pack.”
Return on total assets
Profit before taxes divided by total assets. Measures the percentage of profit earned on all of the dollars invested in the company. As with any investment, higher is usually better.
Example: After a fairly successful year, Jean felt that if she could invest more money in her store, the business would really take off. But when she went to apply for a loan, the banker took her to task for her reasoning.
“Investing more doesn’t necessarily mean you’ll get more back,” the banker said. “You have to take into account how wisely you buy your merchandise, how quickly your people can sell it and how careful you are to keep your operating expenses down. And besides, what kind of return are you getting on your money right now?”
The banker’s advice was for Jean to forget about borrowing money now and concentrate on improving her return on total assets.
Any expense or class of expense incurred in selling merchandise, including salaries and benefits, advertising, supplies, etc.
Example: Phil was going back to school after quitting his sales job at an audio/video store. Tom, his employer, hated to lose him. Phil was a natural-born salesperson.
“I’ll have to hire two people to sell as much as you did, Phil,” Tom said. “I might even have to take out an ad. Without you, my selling expenses will climb a lot.”
The difference between actual stock on hand and the bookkeeping records of stock on hand. Shrinkage results from damage, obsolescence, wear and tear, theft (external and internal) and bookkeeping errors.
Example: It was the end of the year, and the store was closed for its annual inventory. Rhoda had kept careful records of incoming and outgoing merchandise over the year, so when her manager informed her that she had almost 10% fewer salable items than she expected, Rhoda was disappointed.
“Some of the items we had on display got too shop-worn,” explained the worried manager. “And I’m afraid the shoplifting problem is worse than I realized. It looks like we’ll have to recognize shrinkage.”
Current assets (cash plus accounts receivable plus inventory) minus current liabilities (all debts owed within one year). The amount of money which may be readily available to meet current debt obligations.
Example: Joe, an investor in a small chain of stores, rushed excitedly into one of the stores with a plan for remodeling it.
After analyzing the company’s books, Andrea called Joe with the good news.
“Let’s go for it, Joe,” she said. “We have plenty of working capital.”
Patricia M. Johnson and Richard F. Outcalt are nationally recognized retail strategists and co-founders of The Retail Owners Institute. They launched the WIP, an inventory management resource specifically for cannabis retailers, which can be accessed at CannabisRetailBiz.com. Johnson and Outcalt can be reached at 206-623-3973. They will also be speaking at Marijuana Venture’s Retail and Dispensary Expo in Portland, Oregon on Oct. 23-24. For more information or to register, visit www.TheRADExpo.com or call 425-656-3621.