Measure, Monitor & Manage Your Store's "Vital Signs"
by Patricia M. Johnson, CMC and Richard F. Outcalt, CMC
Heart rate, blood pressure, breathing, body temperature—these are vital signs that give a quick assessment of a person’s health.
Retail businesses have vital signs, too, which owners must carefully measure, monitor, and manage.
Here are five key areas to watch: the income statement, balance sheet, ratio analysis, cash flow budget and inventory plan. These represent the “leading indicators” of the health of your business.
By actively monitoring these, you gain lead time to make appropriate management adjustments. Best of all, you needn't become an accountant to do this!
Here's a Connection to Know and Use: Your Income Statement and Balance Sheet
Often referred to as a profit and loss statement (or "P&L"), your income statement reports your store’s financial accomplishments over a period of time, usually a year. It records gross sales, all related expenses, and the resulting net profit (or loss) for the selected period of time.
As you know, making a profit in your business means carefully controlling operating expenses. The income statement is a valuable tool for monitoring those expenses.
The income statement shows your business’s financial condition over a period of time (e.g., a month, a quarter, a year).
On the other hand, the balance sheet shows your business’s financial condition at a particular point in time. It lists what your store owns (assets) and what it owes (liabilities).
The difference between the two is the net worth or equity of your store. Equity is simply the money in the business that is not owed to anyone, representing the owner’s interest.
The three components of the balance sheet—assets, liabilities, and equity— always fit into the following equation:
Assets = Liabilities + Equity
You can see that the income statement and the balance sheet tell different things about your business. Although each reflects the impact of your past decisions, they each give pictures from different perspectives.
Using the information from both gives you a fairly comprehensive financial view of your business. You can avoid making the same mistakes again, and hopefully, repeat successful actions in the future.
Make the Tools Work for You: Monitor Financial Ratios
Financial ratios are excellent tools used in financial analysis and planning. They commonly compare items on the balance sheet or income statement with other items on these statements.
Good business owners and managers use them to compare and analyze the past and present financial condition of a company.
Use The ROI's online Key Ratios Calculator to calculate your own ratios.
Then, use the format of our “Retailer’s Vital Signs Trend Monitor".
Fill in your Key Ratios for last year, this year, and what they would be next year, based on your plan.
This snapshot of these three business years is invaluable! These indeed are the "vital signs" of your business.
Retailer's "Vital Signs" Trend Monitor
| Current Ratio
Reviewing prior years ratios will pinpoint trends that can be used to forecast the future. You will find this compare-and-contrast exercise quite revealing.
Use these "leading indicators" to have as much advance warning as possible of where you may need to make adjustments in your business.
The Debt-to-Worth Ratio: "How financially strong is my business?"
Look at the Liabilities and Equity portions of your balance sheet to determine your Debt-To-Worth Ratio. That ratio simply shows the relationship between your total liabilities (debt) and your owner’s equity (worth). If your total liabilities are $300,000 and your owner’s equity is $158,000, then your Debt-To-Worth ratio is $300,000 divided by $158,000, or 1.9 to 1. The higher this ratio, the riskier the business. With a Debt-To-Worth ratio of 1.9 to 1, you’d have about $1.90 in liabilities for every dollar in equity.
The Debt-To-Worth ratio is valuable both for what it says about the condition of your store at the moment you create the balance sheet, and for what it tells you about the direction your business is taking. If your goal is to strengthen your business, and your last four balance sheets show a steady decline in the Debt-To-Worth ratio, you are on the right track.
The Current Ratio: "Can I pay my bills on time?"
If you have a Current Ratio of 1.5 to 1, then for every dollar of liabilities due in a year, you’d have $1.50 of current assets (cash plus accounts receivable plus inventory). Adequate working capital varies from store to store, but $2 of current assets for every $1 of current liabilities is generally safe.
The Debt-To-Worth Ratio and the Current Ratio are excellent tools for quickly monitoring the strength of your business. As you know, increased sales do not guarantee improved financial strength, but these ratios will be a sound measuring device (and you can check them in seconds!)
Go to your retail segment here at The Retail Owners Institute (see the Store Benchmarks tab to find yours) to view the "benchmark" performance numbers for your type of store. Compare your store with others in your retail niche; you can gain valuable perspective.
Cash Flow Budget: Peace of Mind Starts Here!
Retailing is a delicate balance between cash and inventory. Too much or too little of either, and you will fall short of the potential return your business can give.
Usually one of two risks is taken in balancing cash and merchandise:
Either you commit money early to large quantities of stock and possibly end up not selling it all;
Or you commit less up front, save more cash for later, and take the risk of not being able to get the goods when you need them.
To achieve just the right balance between cash and merchandise, it is essential to implement a reliable cash flow budget.
Frequently, profits are the only concern of management. However, while your store may be generating a profit, it may also be in a cash bind.
If this cash bind doesn’t take priority over protecting profits, you may end up not having a business to worry about. Therefore, you must monitor both the profits and the cash flow of your business.
Take Control of Your Inventory
Inventory management is just as crucial as cash flow management.
There are several methods of managing inventory.
Many old-school retailers run their businesses intuitively. This works fine until they retire, leave the business, or need to delegate management to others. Unfortunately, intuition and past experience are not transferable to the new manager!
Others use a computer to manage their inventories. But there is a danger in doing this without learning a basic, manual inventory control system first. Why? Primarily because the numbers a computer produces are only as good as the ones you enter.
You may own a computer and be blessed with intuition. Still, effective stock management requires a sound inventory management plan.
The plan should be based on the coming year’s level of forecasted sales to help plan your inventory needs in proportion to the projected sales. This enables you to have what every retailer envies: an optimum amount of stock on hand, with built-in flexibility to reorder, mark down, and adjust orders to meet your needs exactly.
Inventory control is a particularly critical issue for specialty retailers. The relationship between the total cost of inventory sold for a year and the average inventory level at cost during that year is called inventory turnover. This measures how often, at your present rate of sales, your entire inventory is (theoretically) completely sold and replaced (how many times it “turns”) during a given period.
For example, if the overall average turnover rate for stores in your industry is 3.1 turns, this means that inventory was “sold out” and “replaced” almost four times last year, or approximately every three-and-a-half months (twelve months divided by the turn rate).
Lets say that for the past three years the annual number of turns in your store have been 3.3, 3.0, and most recently, 2.8. A dropping turnover rate reveals that, for your sales volume, you are carrying proportionally greater inventory—and carrying too much inventory costs enormously.
Gradually, greater markdowns, increased pilferage, damage, taxes, handling, interest, promotions and so on will offset the benefits of increased sales. Watch those carefully!
The Time Is Now
You can see that getting your store in top financial condition is going to take some work. Still, you needn’t become an accountant.
We encourage you to become familiar with the financial tools necessary for running a retail business:
• your income statement
• balance sheet
• ratio analysis
• cash flow budget
• an inventory management plan.
Check out all the how-to information and resources available here at The Institute.
Meanwhile, keep measuring and monitoring—on a regular basis—all of the "vital signs" of your business.
These represent the “leading indicators” of the health of your business, allowing you the greatest amount of lead time for making appropriate management adjustments.
©Copyright, The Retail Owners Institute® and Outcalt & Johnson: Retail Strategists, LLC.