Chapter 16

1. Chapter 16 Financial Merchandise Management Dr. Pointer’s Notes

2. Chapter Objectives • To describe the major aspects of financial merchandise planning and management • To explain the cost and retail methods of accounting • To study the merchandise forecasting and budgeting process • To examine alternative methods of inventory unit control • To integrate dollar and unit merchandising control concepts

3. Financial Merchandise Management • With Financial Merchandise Mgmt, a retailer specifies which products are purchased, when products are purchased, and how many products are purchased • Dollar control involves planning and monitoring a retailer’s financial investment in merchandise over a stated period • Unit control relates to the quantities of merchandise a retailer handles during a stated period

4. Benefits of Financial Merchandise Plans • The value and amount of inventory in each department and/or store unit during a given period are delineated • The amount of merchandise a buyer can purchase during a given period is stipulated • The inventory investment in relation to planned and actual revenues is studied • The retailer’s space requirements are partly determined by estimating beginning-of-month and end-of-month inventory levels

5. Benefits of Financial Merchandise Plans_2 • A buyer’s performance is rated. Measures may be used to set standards • Stock shortages are determined and bookkeeping errors and pilferage are uncovered • Slow-moving items are classified – leading to increased sales efforts or markdowns • A proper balance between inventory and out-of-stock conditions is maintained

6. Inventory Valuation: The cost and retail methods of accounting • There is a need to develop a retail inventory accounting system • Retailers have different data needs than manufacturers, cost estimation is more difficult, stock shortages higher, sales more frequent and they require monthly not quarterly profit data • Two inventory accounting systems are available

7. Inventory Valuation: The cost and retail methods of accounting • Dollar control system provides data on sales and purchases, value of beginning and ending inventory, markup and markdowns and merchandise shortages. • Merchandise available for sale = beginning inventory, purchases and transportation charges • Cost of goods sold = cost merchandise available minus cost value of ending inventory • Gross profits = sales less cost of goods sold • Net profit = gross profits – operating expenses

8. Table 16.1 Handy Hardware Store Profit-and-Loss Statement

9. Inventory Accounting Systems 1. The cost accounting system values merchandise at cost plus inbound transportation charges 2. The retail accounting system values merchandise at current retail prices

10. Cost Method of Accounting • The cost to the retailer of each item is recorded on an accounting sheet and/or is coded on a price tag or merchandise container • Can be used with physical or book inventories: • Physical inventory – actual merchandise is counted at closed of a specified period of time • Book( perpetual) inventory – keeps a running total of the value of all inventory on hand at cost based on records. No need for actual counting of stock. Frequent financial statements can be prepared.

11. Physical Inventory System • Ending inventory - recorded at cost – is measured by counting the merchandise in stock at the close of a selling period • Gross profit is not computed until ending inventory is valued • Gross profit derived during full merchandise count

12. Book Inventory System • Keeps a running total of the value of all inventory on hand at cost at a given time • End-of-month inventory values can be computed without a physical inventory • Frequent financial statements can be prepared

13. Book Inventory System_2 • Types of book inventories FIFO- logically assumes all old merchandise is sold first. Most reasonable but results in higher taxes LIFO – assumes new merchandise is sold first. Results in lower profits and lower taxes and understated ending inventory Both are acceptable ways to value merchandise

14. Disadvantages of Cost-Based Inventory Systems • Requires that a cost be assigned to each item in stock • Do not adjust inventory values to reflect style changes, end-of-season markdowns, or sudden surges of demand • Works best for retailers low inventory turnover, limited assortment and high average prices (car dealers)

15. Table 16.2 Handy Hardware Store Perpetual Inventory System

16. The Retail Method • Closing inventory is determined by calculating the average relationship between the cost and retail values of merchandise available for sale during a period

17. Determining Ending Inventory Value • 1. Calculating the cost complement Cost Total Cost valuation Complement = Total retail valuation $299,892/496,126 = .6045 therefore, .60 of every retail sale went cover costs (Table 16.3) • 2. Calculating deductions from retail value Table 16.4 shows ending value of $59,552 • 3. Converting retail inventory value to cost $56, 470 X .6046 = $34,136 (Ending Inventory value at cost) This can be used to find gross profit.

18. Table 16.3 Handy Hardware Store, Calculating Merchandise Available for Sale at Cost and at Retail

19. Table 16.4 Handy Hardware Store, Computing Ending Retail Book Value

20. Table 16.5 Handy Hardware Store, Computing Stock Shortages and Adjusting Retail Book Value

21. Table 16.6 Handy Hardware Store, Profit-and-Loss Statement

22. Advantages of the Retail Method • Valuation errors are reduced when conducting a physical inventory since merchandise value is recorded at retail and costs do not have to be decoded • Because the process is simpler, a physical inventory can be completed more often • Profit-and-loss statement can be based on book inventory • Method gives an estimate of inventory throughout the year and is accepted in insurance claims

23. Limitations of the Retail Method • Bookkeeping burden of recording data • Ending book inventory figures correctly computed only if the following are accurate: • Value of beginning inventory • Purchases • Shipping charges • Markups • Markdowns • Employee discounts • Transfers • Returns • Sales • Cost complement is an average based on the total cost of merchandise available for sale and total retail value

24. Merchandise forecasting and Budgeting: Dollar Control • Dollar control entails planning and monitoring a firm’s inventory investment over time to ensure profitable operations • The six steps involved in the process are outlined

25. Figure 16.2 The Merchandise Forecasting and Budgeting Process: Dollar Control Inventory level planning Designing control units Sales Forecasting Planning profit margins Planning Purchases Reduction Planning

26. Merchandise forecasting and Budgeting: Dollar Control • Control Units –merchandise categories for which data are gathered. Categories is the broadest control units (women’s shoes, men’s suits) Classification merchandising – each department is sub divided into further categories women’s shoes and dress shoes and casual shoes Standard classification – recognized classification by trade association and industry.-

27. Merchandise forecasting and Budgeting: Dollar Control • Forecasting – estimating revenues (companywide, departmental or categories). Yearly sales can be broken down by months. • Monthly sales index, divides ach month’s actual sales by average monthly sales and multiples by 100. • Index allows a retailer to project sales by month

28. Table 16.7 Handy Hardware Store, A Simple Sales Forecast Using Product Control Units

29. Table 16.8 Handy Hardware Store, 2003 Sales by Month

30. Table 16.9 Handy Hardware Store, 2004 Sales Forecast by Month

31. Merchandise forecasting and Budgeting: Dollar Control • Inventory –Level Planning- need to have sufficient inventory to meet sales • Basic Stock Method - carries more inventory than you expect to sales Beg month inventory = planned sales + basic stock Percentage variation method Weeks Supply Method Stock to sale method – maintain a specified ratin of goods on hand to sales ( 1.3 ratio means sales of $69K mean inventory of $89K)

32. Merchandise forecasting and Budgeting: Dollar Control • Reduction Planning – retail reduction is the difference between beginning inventory plus purchases , sales plus ending inventory • Planned Purchases =sales for month= planned reductions + planned end of month stock – beginning of month stock

33. Merchandise forecasting and Budgeting: Dollar Control • Planning profit margins – Determines the average markup needed to reach the projected profits • Required initial markup = planned expenses +planned profits + planned reductions/planned net sales + planned reductions

34. Unit Control Systems • Deals with quantities of merchandise in units rather than in dollars. Information will reveal- best selling items,identify problems and opportunities, optimal time to reorder, book inventory, old merchandise, alternative sources for goods and level of sales of each item in every branch

35. Unit Control Systems • Physical Inventory Systems -counts number of units by item classification • Perpetual Inventory Systems - keepings running total of inventory based on sales and purchases, returns, transfers and other transactions 94% of retailers engage in physical inventory systems 57% of retailers use cost inventory systems 68% of retailers use a perpetual inventory system

36. Financial Control: Integrating Dollar ad Unit concepts • Stock Turnover – number of times during a specific period, usually a yr, that the average inventory on hand is sold. • Computation of stock turnover stock turnover = # of units sold during year units average inventory on hand Annual stock = net yearly sales Turnover $ average inventory on hand

37. Stock Turnover • Average stock turnover will vary by industry • Normally want to have high stock turnover • High stock turnover is usually a sign of success • Gross Margin Return on investment (GMROI) shows relationship between the gross margins in dollars and the average inventory investment by combining profitability anal sales to stock measures good indicator of managers performance

38. When to Reorder • Reorder point – set stock levels at which new orders must be placed • Order lead time- period from the date an order is placed by a retailer to the date merchandise is ready for sale (received, price marked and put on selling floor) • Usage rates –average sales per day, in units of merchandises • Safety stock-the extra inventory that protects against out of stock conditions due to unexpected demand and delays in delivery reorder pt = usage rate X lead time Reorder pt + usage rate X lead time + safety stock Automatic reordering systems – mechanically activated when stock on hand reaches the reorder point

39. Figure 16.6a How Stockouts May Occur • Unexpected Demand • Delayed Delivery

40. How Much to Reorder • Economic Order quantity (EOQ) is the quantity per order that minimizes total inventory costs of processing orders and holding inventory. • EOQ= EOQ= quantity per order D= annual demand S= costs to place an order I= % of yearly carrying cost to unit cost C= unit cost of an item 2DS IC

41. Questions Please read this chapter carefully