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Retail Merchandising and Distribution

Merchandising Week 6
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Developing & Implementing Merchandise Plans


Lecture 6 Outline

Implementation of merchandise plans Financial Merchandise Management


1. 2. 3.

Financial Merchandise Management Cost and Retail Methods of Accounting Merchandise Forecasting and Budgeting Process
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Process for Implementing Merchandise Plans

3 Source : Barry Berman, Joel R. Evans, Retail Management A Strategic Approach (11th Edition), Prentice Hall, 2010

1. Financial Merchandise Management


specifies exactly which products are purchased when products are purchased how many products are purchased 2 kinds of controls:

Dollar control - involves planning and monitoring a retailers merchandise investment over a stated time period Unit control - monitors the quantities for merchandise handled during a stated time period

Dollar controls usually precede unit control, because the retailer must make dollar investment decision
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2.Inventory valuation : Cost & Retail Method of Accounting

Retail inventory accounting systems can be complex since they involve a great amount of data There are two accounting systems cost accounting system values merchandise at cost plus in-bound transportation charges retail accounting system values merchandise at current retail prices In a profit and loss statement, the following information should be included:
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Profit-and-Loss statement
Sales less cost of goods sold: Beginning inventory (at cost) Purchase (at cost) Transportation charges Merchandise available for sale Ending inventory Cost of goods sold Gross profit Less operating expenses Net profit 1 2 3 4 (2+3+4)= 5 6 (5-6)=7 (1-7)=8 9 (8-9)=10

Profit-and-Loss statement

7 Source : Barry Berman, Joel R. Evans, Retail Management A Strategic Approach (11th Edition), Prentice Hall, 2010

2.1 Cost method

each items cost is recorded when it is purchased, when it is sold, and when an inventory is conducted to determine total inventory value this method is good for firms whose turnover is low and sell the big-ticket items such as furniture can be used in i) determining physical (actual count) ii) book (record-keeping entries) inventories

2.1 Cost method


i) Physical inventory system: ending inventory is measured by an actual count of merchandise still in stock at close of selling period ending stock is recorded at cost Gross profit is computed until ending inventory is valued

2.1 Cost method


ii) Book (perpetual) inventory systems avoids the problem of infrequent financial analysis by keeping a running total of the value of all inventory on hand at cost is kept by regularly recording purchases and adding them to existing inventory value ; sales are subtracted to arrive at the new current inventory value

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2.1 Cost method


Opening inventory + Inventory increase (Beginning-of-month Inventory)
(Net monthly purchase)

Inventory decrease = Closing inventory (End-of-month Inventory) (Monthly Sales) closing inventory of this month becomes the beginning inventory next month

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Perpetual Inventory System


Date 7/1/06 Beginning-of-Month Inventory $90,500 68,100 57,700 56,500 71,700 81,300 Net Monthly Purchases $40,000 Monthly Sales $ 62,400 End-of-Month Inventory $68,100

8/1/06 9/1/06 10/1/06 11/1/06 12/1/06

28,000 27,600 44,000 50,400 15,900

38,400 28,800 28,800 40,800 61,200

57,700 56,500 71,700 81,300 36,000

TOTAL

$205,900

$260,400

(as of 12/31/06)

(Beginning-of-month Inventory)+(Net monthly purchase)-

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(Monthly Sales)=(End-of-month Inventory)

Applying FIFO and LIFO Inventory Methods

13 Source : Barry Berman, Joel R. Evans, Retail Management A Strategic Approach (11th Edition), Prentice Hall, 2010

2.1 Cost method

FIFO (first-in-first-out) method

Assume old merchandise is sold first, while newer items remain in inventory Assume new merchandise is sold first, while older stock remains in inventory

LIFO (last-in-first-out) method

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Disadvantages of Cost-Based Inventory Systems


Require 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

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2.2 Retail method

closing inventory value is determined by calculating the average relationship between the cost and retail value of merchandise for sale during the period overcomes the disadvantage of the cost method, but requires a detailed bookkeeping system ending inventory is first valued in retail dollars and then converted to cost in order to determine gross margins

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2.2 Retail method


3 Basic Steps to Determining Ending Inventory Value
1. 2. 3.

Calculating the cost complement Calculating deductions from retail value Converting retail inventory value to cost

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2.2 Retail method


1) calculate the cost complement

it is calculated by examining beginning inventory and purchase figures at both retail and cost levels cost complement = total cost valuation / total retail valuation

this is the average relationship between cost and retail value


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Calculating Merchandise Available for Sale at Cost and at Retail


At Cost At Retail

Beginning Inventory Net Purchases Additional Markups Transportation Charges

$ 90,500 205,900 __ 3,492

$139,200 340,526 16,400 __

Total Merchandise Available

$299,892

$496,126

Cost complement = 299,892/496,126 =0.6045

if it is 60.45%, it means that for each retail sales dollar , 19 an average of 60.45 cents is made on the merchandise cost

2.2 Retail method


2) calculate deductions from retail

value

ending retail value of inventory must reflect all deductions from the total merchandise available for sale at retail

markdowns (e.g.. on sales , end-of-seasons, discontinued items) employee discounts stock shortages (e.g. pilferage, unrecorded breakage and spoilage etc)

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2.2 Retail method


2) calculate deductions from retail

value

markdown and employee discounts can be monitored through book inventory, shortages cannot be assessed until a physical inventory is conducted. If book value exceeds the physical inventory, shortages exists So both shortages and overages are estimated monthly the retail book value is then adjusted after a physical inventory is taken
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Calculating Merchandise Available for Sale at Cost and at Retail


Merchandise available for sale (at retail) Less deductions: Sales Markdowns Employee discounts Total deductions Ending retail book value of inventory $422,540 11,634 2,400 436,574 $ 59,552 $496,126

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Stock Shortages and Adjusting Retail Book Value


Ending retail book value of inventory Physical inventory (at retail) Stock shortages (at retail) Adjusted ending retail book value of inventory $ 59,552 56,470 3,082 $ 56,470

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2.2 Retail method


3)

converting retail inventory value to cost

ending inventory (at cost)= adjusted ending retail book value x cost complement $56,470 x 0.645 = $34,136 this is for the purpose of calculating the gross profit it is not the exact amt. but approximates

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Profit-and-Loss Statement
Sales Less cost of goods sold: Total merchandise available for sale Adjusted ending inventory ($56,470 x 0.645 ) Cost of goods sold Gross profit Less operating expenses: Salaries Advertising Rental Other Total operating expenses Net profit before taxes $ 70,000 25,000 16,000 28,000 139,000 $ 17,784
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$422,540

$299,892

34,136 $265,756($299892-34136) $156,784($422540-265756)

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
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Limitations of the Retail Method


Bookkeeping burden Ending book inventory is 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

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3.Merchandise Forecasting and Budgeting Process: Dollar Control

The process should be taken in sequential process


28 Source : Barry Berman, Joel R. Evans, Retail Management A Strategic Approach (11th Edition), Prentice Hall, 2010

3.1) Control units


The merchandise categories for which data are gathered the units should be narrow enough to isolate opportunities and problems with specific lines of merchandise Record data on dollar allotments separately on each category can be set on the base of : Set up the merchandise classification -this includes skirts, pants, sweaters etc
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3.2) Sales Forecast


accurate sales forecast is very important statistical forecasting technique include trend analysis, time series analysis, and multiple regression and small retailers rely on guesstimates a storewide forecast is made and then broken down further external factors should be considered:

consumer demographic life-style trends competitors actions- what other store sells by doing comparison shopping state of the economy employment condition fashion factors

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3.2) Sales Forecast


changes in taste of target market - by asking and observing e.g.. by consumer surveys, consumer panels, scan the trade publication new products offered from supplier internal factors: addition and deletion of merchandise lines changes in promotion and credit facilities changes in hours of business opening of new shops remodeling of existing stores seasonal variation review and analyze past sales performance for the same time period want book record may be useful because customer inquiries are recorded

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3.2) Sales Forecast


after a 6 months sales is projected, it is broken into quarterly or monthly planning period a beat last years sales approach may be appropriate for the store as a whole, but it is not an appropriate method for individual category variable adjustment method - starts with an examination of the past sales history determine a % change that appears reasonable adjust the figure upward or downward by a degree that depends on the nature of the merchandise and its exposure and sensitivity to environmental influences Seasonal planned sales = last year (LY) sales x planned increase % determine the monthly sales by using the past record on the % distribution of sales by month
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Sales Forecast Using Product Control Units


Product Control Units Actual Sales 2006 ($) 200,000 128,000 108,000 88,000 88,000 68,000 48,000 40,000 36,000 36,000 840,000 Projected Growth/ Decline (%) +10.0 + 3.0 +8.0 -4.0 +6.0 +4.0 -6.0 +4.0 +6.0 +9.0 +4.9 Sales Forecast 2007 ($) 220,000 131,840 116,640 84,480 93,280 70,720 45,120 41,600 38,160 39,240 881,080
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Lawn movers/snow blowers Paint and supplies Hardware supplies Plumbing supplies Power tools Garden supplies/chemicals Housewares Electrical supplies Ladders Hand tools Total year

Sales by Month
Month January February March April May June July August September October November December Total yearly sales Average monthly sales Average monthly index Monthly Actual Sales ($) 46,800 40,864 48,000 65,600 112,196 103,800 104,560 62,800 46,904 46,800 66,884 94,792 840,000 70,000 100
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Sales Index 67 58 69 94 160 148 149 90 67 67 96 135

Sales Forecast by Month


Month January February March April May June July August September October November December Total Sales Average monthly sales Actual Sales 2006 ($) 46,800 40,864 48,000 6,600 112,196 103,800 104,560 62,800 46,904 46,800 66,884 94,792 840,000 70,000 Monthly Sales Index 67 58 69 94 160 148 149 90 67 67 96 135 Total sales forecast Average monthly forecast Monthly Sales Forecast 2007 73,423 * 73,423 * 73,423 * 73,423 * .67 = .58 = .69 = .94 = 49,193 42,585 50,662 69,018

73,423 * 1.60 = 117,477 73,423 * 1.48 = 108,666 73,423 * 1.49 = 109,400 73,423 * 73,423 * 73,423 * 73,423 * .90 = .67 = .67 = .96 = 66,081 49,193 49,193 70,486 99,121 881,080 73,423
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73,423 * 1.35 =

3.3) Inventory Planning


inventory must be sufficient to meet sales expectations, allowing a margin for error avoid out-of-stock conditions guard against overstock conditions keep inventory investment at an acceptable level

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3.3) Inventory Planning


Methods in stock planning i) Basic stock method planned sales for that month + a safety stock in case actual sales exceed the estimated sales

Basic stock (at retail) = Avg. monthly stock at retail- Avg. monthly sales =(73,423*1.10) - $73,423 =7,342 (want extra stock = 10% of its average monthly forecast) BOM (Jan) planned stock level (at retail ) = Planned monthly Sales + Basic stock =$49,193 + $7,342 = $56,535

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3.3) Inventory Planning


ii) Weeklys Supply Method involves forecasting average sales on a weekly basis, so beginning inventory is equal to several weeks expected sales applicable to staple merchandise that does not fluctuate much in sales volume from week to week assume the inventory carried is in direct proportion to sales thus, too much merchandise may be stocked in peak selling periods and too little during slow selling periods
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3.3) Inventory Planning

Beginning of month (BOM) planned inventory level (at retail) = Average estimated weekly sales x Number of weeks to be stocked

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3.3) Inventory Planning


iii) Stock-to-sales ratio method A method for planning how much stock should be on hand at a particular time a retailer wants to maintain a specified ratio of goods-on-hand to sales past record is the best source to find the reliable stock-to-sales ratio stock-to-sales is figured for a single month it is based on stock on hand at a specific time, usually the beginning of the month Stock/sales ratio =Retail stock at given time in the period / sales for the period BOM stock=planned monthly sales x stock-to-sales 40 ratio

3.4) Reduction planning


Retail reduction the difference between the merchandise items original retail value and the actual final sales value Planned retail reduction includes : i) Markdowns - reduction in price to simulate sales. The amount can vary considerable depending on the type of merchandise and conditions under which it is sold. can be expressed as a percentage of a total seasons sale An analysis of markdowns enables buyers to locate trouble spots and adjust future assortment
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3.4) Reduction planning


It stimulates sales of slow-moving or inactive stock Dispose of broken assortments, discontinued lines and damaged or shopworn merchandise Provide additional OTB for the purchase of new merchandise Meet competitors' prices of the same or similar merchandise Increase customer traffic Markdown = Previous Price New reduced Price Markdown percent = Dollar markdown/Dollar Net Sales For advertising record, markdown % is referred as a reduction from original retail, but for internal record, 42 markdown percentage use net sales as the base

3.4) Reduction planning


ii) Employee Discount - reductions in the original retai price that are granted to store employees as special fringe benefits and to special customers iii) Shortages - reduction in total value of the retailers inventory as a result of shoplifting, merchandised being soiled and bookkeeping error usually if a firm has less than 2 to 4% stock shortage ,it is deemed to be doing well

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A Checklist to Reduce Inventory Shortages

44 Source : Barry Berman, Joel R. Evans, Retail Management A Strategic Approach (11th Edition), Prentice Hall, 2010

3.4) Reduction planning

a retailer should study the following in planning total reductions for the budget period: past experience with reductions markdown data for similar retailers changes in company polices -a retailer expands its assortment of seasonal and fashion merchandise would probably lead to an increase in markdowns merchandise carryover from one budget period to another price trends stock-shortage trends - generally 1/4 of shortage is from clerical or handling error 45

3.4) Reduction planning

after total reductions are determined, they must be planned by month because reductions as a % of sales would not be same during each month e.g. stock shortages may be much higher during busy periods, when stores are more crowded and transactions happened more quickly sell-through analysis should be carried out for markdown category - a comparison between actual and planned sales a check on retailer buyers estimation on: the demand schedule - how many units would be sold at a certain price
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3.4) Reduction planning


the sales schedule - the speed at which inventories would be depleted by closely supervising these schedules, merchandise managers can determine both when (time) and how much (amount) markdown is appropriate given the relationship between planned and actual sales Estimate of expected retail reduction: Planned reductions = (beginning inventory + planned purchases) (planned sales + ending inventory) After estimating the expected total reductions for the budget period, distribute the estimates by month

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3.5) Planning Purchases

Planned purchases (at retail) = Planned sales for the month + planned reductions for the month + Planned end of month stock - Beginning-ofmonth stock Planned purchase (at cost) =Planned purchases at retail x Merchandise costs as a % of selling price Open to buy (at retail) = planned purchase for the month purchase commitments for that month OTB (at cost) =OTB at retail x merchandise costs as a % of selling48 price

3.5) Planning Purchases


Advantages of OTB concepts:

it maintains a specified relationship between inventory and planned sales is maintained, which avoids overbuying and under-buying it is better to keep at least a small OTB figure for as long as possible because: new lines or items may appear that the buyer wishes to purchase reorders may need to be placed to fill in staple stock or replace fast-selling items special promotions from vendors may become available sometimes an OTB limit must be exceeded due to underestimates of demand (low sales forecasts)
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3.6) Planning Profit Margins


Retail = Cost + Markup Required initial mark-up % =(Planned retail expenses + planned profit + planned reductions) / (Planned net sales + planned reductions) It is a companywide average Retailers do not apply the same markup % to all merchandise, individual items may be priced according to the demand and other factors, as long as the average is met A lower markup may be applied to promotional goods but a higher markup on exclusive or unique items Markup can be used for individual item but an average markup is determined by the total cost 50 and total retail

Sources

Chapter 15 & 16 - Barry Berman, Joel R. Evans, Retail Management A Strategic Approach (11 Edition), Prentice Hall, 2010 Chapter 10 - Lusch. Dunne, Carver, Introduction to Retailing, South-western (7th edition), Cengage Learning, 2011

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ENDS

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