Part II of a three-part series on business terminology
This month, we continue covering the basic terms of retail financial management. Mastering these should make you more comfortable in discussions with your sources of financing.
Current assets usually consist of unrestricted cash or other assets that could easily be converted into cash within one year. Inventory and accounts receivable are common examples of current assets.
Example: Jacob was headed to his banker’s office for a scheduled meeting. He was pleased that he would be able to tell his banker that his accounts receivable had risen for the third consecutive month. Now, that might not be in the best interest of every retailer, but Jacob’s banker had been pressuring him to increase his current assets, a weak spot on Jacob’s balance sheet. And now, with the increase in accounts receivable, he knew that particular aspect of his business was improving.
Short-term debts (including accrued and deferred liabilities) and unearned revenue that are due within one year or less. Accounts payable is an example of a current liability.
Example: When Jacob showed up for the meeting, his banker had something else on his mind: current liabilities. Jacob’s debt to his suppliers was running rather high — too high for the banker to be comfortable. The banker knew that if Jacob’s suppliers were to demand payment immediately, Jacob would be wiped out. His current assets were increasing, but the relationship between his current assets and current liabilities (called the “current ratio”) wasn’t satisfactory.
The current ratio is calculated as current assets divided by current liabilities. It is a financial ratio taken from the balance sheet that measures the liquidity of a business — the ability of the business to pay its bills on time. A current ratio of 1.5 or higher would indicate that the business is probably “liquid” enough to meet its obligations as they become due. (Also see “working capital.”)
Example: Jacob’s current assets were $16,500. His current liabilities were $28,300. His current ratio was 0.58. See why his banker was concerned? For each dollar of debt owed within one year, Jacob had only 58 cents to pay it.
This ratio is calculated as total liabilities divided by total equity (or net worth). It is a financial ratio taken from a balance sheet that compares the amount loaned to a business by creditors to the amount invested in the business by the owners, plus their previous profits (retained earnings). Interpreted by bankers as a measure of safety, a decrease in debt-to-worth ratio is generally considered favorable. When it’s at 1:1, the company and the bankers can sleep at night.
Example: Sam grimly contemplated his balance sheet. His liabilities were nearly triple what the owners had put into the business, giving him a debt-to-worth Ratio of 3:1. Nobody in their right mind would be happy with that level of risk. He was highly “leveraged,” as they say. When the mortgage on your house is three times your equity, you probably sleep okay. But, when it’s that high in your business, you probably don’t.
This can be understood as a way of expressing the “lost usefulness” of a fixed asset. The usefulness is gone forever in that it won’t be restored or repaired and is usually the result of wear and tear, obsolescence or inadequacy. Depreciation is expressed in a dollar amount and is subtracted from the value of fixed assets on a balance sheet.
Example: Harry was considering purchasing new computer equipment. The old equipment had been around several years and had depreciated to the extent that its full market value was nearly accounted for.
Desired ending inventory
This is the approximate amount of retail inventory that the turnover rate suggests having on hand at month end to cover the next complete cycle of sales. For example, if a company’s planned annual turnover rate is 3, at any given month end, it would want enough inventory at retail on hand to cover the next four months of sales (12 months divided by 3 equals 4).
Example: Joanne, a new buyer, was struggling with her purchase plan for the next six months. The numbers just didn’t seem to make sense. She went to her boss for help, who took one look at her formula and said, “Joanne, you’ve simply forgotten to specify your desired ending inventory — how much inventory you want to have at the end of each month.”
Also called “net worth,” equity is total assets minus total liabilities. It is the financial interest of an owner in a property or business.
Example: Jason was about to make his first visit to the bank to secure a line of credit. He had always shied away from bankers, but now was in a position where he must ask for a loan. Although he had invested what seemed like a lot of his own money into the business, Jason knew his equity might not be substantial enough to satisfy the bank.
Excess ending inventory
The probable or actual ending inventory minus the desired (or planned) ending inventory. This inventory is considered “excess” because it exceeds your desired ending inventory based on your sales forecast and projected inventory turns.
Example: It had been a very slow month, and Susan inwardly groaned at the amount of inventory she had planned to sell but still had on hand at month end. It represented slow-moving, low-appeal, high-cost merchandise — in short, a simple case of excess.
The balance sheet and the profit-and-loss statement (or income statement) are the minimum two parts of a financial statement. They reflect both the company’s current financial status at the end of the accounting period (balance sheet) and the financial activity during the accounting period (income statement) preceding the date of the balance sheet. They are critical in summarizing the progress and condition of a business.
Example: Marie was the bookkeeper for a new specialty retail business. The business had been run so informally last year that she hardly knew where to begin; now her boss had just asked for some financial reports summarizing their activity to date and their current overall position.
These are assets acquired by the business in order to provide the facilities to carry on the business. They are not bought to be sold, but rather held as a part of the business over the long term. Examples are office furniture, trucks, computers, buildings and land.
Example: It was stormy out when Marcus unloaded his new office furniture. A brand-new desk, chair and his pride and joy — an oak file cabinet. But as he was carrying his treasure down the steps of the van and onto the sidewalk, he slipped. Marcus went flying, as did several pieces of wood and brass trim. He made a sad but efficient mental note to notify his bookkeeper of the speedy demise of one of their newest fixed assets.
Total net sales minus the total cost of goods sold (COGS). Also known as gross profit (but not the same as “bottom-line” or “net” profit, since it does not take into account the operating expenses of doing business.
Example: Michael let out a whoop as he reviewed this month’s income statement. He had recently tried out a new company’s line of merchandise, and now that he could compare the sale of these products with the associated costs, the profit margin appeared to be much greater than any other line he carried.
Gross margin percent
Gross margin dollars divided by sales dollars. This financial figure indicates the percent of sales dollars remaining after costs related to purchased merchandise are recognized. An increase in gross margin percent is generally favorable.
Example: After carefully calculating what percent of sales his gross margin dollars represented, Michael came up with 38%. Nice!
GMROI stands for gross margin return on (inventory) investment. The formula for this is annual gross margin dollars divided by average inventory at cost (over a year). It shows how many gross margin dollars are generated for each dollar invested in inventory. GMROI is an extremely valuable tool when used to compare various departments or product lines. At a glance, a business can see its true winners and losers and plan strategies accordingly.
Example: Jessica had just come from an advanced financial seminar where she learned all about how to run her retail business. The only thing she was not quite clear on was the term GMROI (often pronounced “gem-roy”). She understood that it was an important measure of the return on her investment in inventory, but she still didn’t quite understand how to identify the parts of the formula.
This part of a financial statement (also called a profit-and-loss statement or P&L) presents the results of a business over a period of up to 12 months. It begins with sales, deducts the cost of goods sold and then deducts the operating expenses of a business to arrive at a profit (or loss).
Example: Ted wasn’t too thrilled at spending another Sunday at work, but he knew his accountant needed a record of the store’s income and expenses over the last three months, and he hadn’t even compiled one month’s worth yet. He could have kicked himself for not keeping up with the monthly financial statements — he knew he was really pressing his luck in more ways than one.
A figure indicating the rate at which merchandise moves into and out of a store or department. Theoretically, the rate of inventory turnover is the number of times during a given period (usually one year) that your inventory has been sold and replaced. Turnover can be calculated in two ways: Sales at retail divided by average inventory at retail; or cost of goods sold divided by average inventory at cost.
Example: Felicia was distressed. She was new to retailing, but knew that it was important to keep her merchandise moving in and out of her store at a good pace in order to cut expenses and keep her margin up. She’d heard some friends talking about getting “good turns” and thought they might be referring to the in-and-out of merchandise, but she wasn’t quite sure enough to risk participating in the discussion.
An obligation to pay a specific dollar amount to another party, usually resulting from a contractual relationship of some kind, whether formal or informal. Accounts payable are liabilities, as are notes payable to the bank and other parties.
Example: Andrew didn’t often stock items that catered specifically to his folksy neighbors, but they still came to his store to see the newest items. One day, a local lady approached him with some custom jewelry, designed with her neighbors in mind. Andrew agreed to give her jewelry a trial run and agreed to purchase her products, which he planned to sell at twice their cost.
Also known as long-term debt, long-term liabilities are those that are due to be paid more than one year from the date of the balance sheet on which they are listed.
Example: Andrew eventually discovered that those folksy locals who were coming to his store were a new, burgeoning market. He decided to renovate a portion of his existing space, creating a nook for these customers to relax and continue to browse. Andrew had a strong mistrust of banks and would only borrow money from family members. He arranged for a loan from his father with a payback period beginning in two years.
A reduction in the original or previous retail price of merchandise. Markdowns are usually stated as a percentage of sales, to make it easier to compare one month to another, one year to another or one category of merchandise to another.
Initial markup is the difference between the cost of the merchandise and its starting selling price, usually expressed as a percentage (selling price minus the merchandise cost, divided by the selling price).
Example: Lisa faithfully worked her inventory plan for the next six months, pinpointing the months where her inventory looked higher than usual. She then carefully trimmed selected months of ending inventory to avoid marking down more of her merchandise than was absolutely necessary.
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.