Translating Operations into Financial Statements

Good systems show themselves by not showing themselves at all. In a well run store, product, people, and purchases flow in and out in a seemingly effortless ebb and flow. Only from the inside does one know that, unlike the ocean tides, it is not the moon that is making the whole thing move, it is the systems, organization and hard work of management and staff.

One set of systems that may get too little attention is those used to accurately translate a store's daily operations into numbers on the financial sheets. Some otherwise effective storekeepers fail to see any relation between the color and cacaphony of their everyday store life and the lifeless rows of figures on their financial statements. The truth is that the one is just another way of looking at the other -- a "chart" to make your way through the tides.

Now, it has been a number of years since either of us swept the floor, culled the produce, or weighed and wrapped cheese in our local co-ops. We're not about to tell you how to run your store. What we will tell you is that accurate translation of co-op staff's sales floor activities to the black and white numbers of the balance sheet and income statement is crucial. That's what makes financial statements a useful tool for the analysis of your business. We need to understand how each person's actions on the floor affect the bottom line.

While pretty much everything that goes on in your store works its way onto the financial statements in some way, some areas of operations have much greater impact than do others. Let's start with one of the biggest items on the balance sheet -- inventory.

Unless you are running a traveling circus, inventory is going to be your biggest asset that regularly walks in and out of the store. This in itself makes it difficult to keep track of. The fact that cost of goods is a retail's largest single expense also means that keeping good track of it is one of the most important things a store can do to improve the accuracy and quality of its financial statements and financial situation. Irregular counts, improper coding, incorrect bookkeeping or sloppy ringing can all lead to errors on the balance sheet.

A mistaken inventory figure not only leads to inaccuracies in other important figures (gross margin and inventory turns among them). It also means that if you ever do get a good count you will have a whopping big adjustment to make on your books. This can send your gross margin and net income figures reeling and leave you feeling a little seasick.

A closely related element where attention on the shop floor has potential for the most dramatic results on profitability is clearly the management of gross margin. A few percentage points in margin can mean the difference between a healthy profit and a significant loss. Of all the elements of store operations, gross margin is probably the one most amenable to a little creative and proactive manipulation to get a better result.

Margin management doesn't begin or end at the pricing gun. Achieving a higher margin doesn't necessarily mean pricing higher, just pricing smarter, and not just smarter but more accurately. Remember, it's long way from the delivery truck to the checkout lane. The only way you are going to know if you are achieving your margin goals is if your financial statements are timely and accurate, and this is only going to happen if your systems for coding, ringing, pricing, counting, buying and receiving are accurate.

Other operational practices such as variable pricing also can have a dramatic effect on overall profitability. If you're not already pricing according to margin rather than mark-up, the time to start is now. What you really need to know from your pricing strategy is how much will be left for you after you make the sale. Margin pricing will tell you your share just like that.

Your labor budget is probably your second largest expense next to cost of goods, and it is another area where a lot of analysts will tell you to cut by this percentage or that. In truth, labor is a much more difficult figure to manipulate and control. In part this is because productivity can vary greatly between different people, different tasks, even different times of the day. In part it's also because people don't usually come in discreet one-hour labor packages. The packages they do come in are the people you work alongside every day. There is no magic number for labor, and nothing is too high so long as you can achieve the gross margin to pay for it.

To take a simple illustration: Ishmael, the manager of MoonTides Co-op, is faced with a problem. With sales of $20,000 per month, a gross margin of 30% after discounts, and a labor budget of $4,400, the store is losing money. At 22% of sales, he knows his labor is "too high." To get labor down to 19% of sales he needs to cut $600 a month. Unfortunately that $600 translates to co-op worker Venus' job. Venus hand paints the beautiful signs in the co-op, works that extra evening shift no one wants, knows half the customers by name and helps out cheerfully with all kinds of things. Although only a part-time workers, Venus would be missed by everyone, and Ishmael is reluctant to let her go.

Ishmael knows intuitively that there must be some other way to eke out the extra income the co-op needs. Instead of cutting staff, he looks to his margin. If he can bring his margin up to 33%, he won't have to lay anyone off. By doing some thoughtful variable pricing in the bulk and HABA departments (representing 50% and 10% of overall sales, respectively), he raises their departmental margins by 4% each, achieving an overall growth in margin of 2%.

The produce department (20% of store sales) has always had a weak margin at MoonTides, so next Ishmael turns his attention there. By aggressively reducing waste and adding some specialty high margin items, he increases the overall produce margin by 5%, adding another 1% to the store's total margin. With these actions, Ishmael achieves his 33% margin and the same result he would have had he laid off Venus and lowered his labor budget to 19%. In fact, with a cleaned-up produce department, more specialty items and friendly Venus at the cash register, sales at MoonTides actually go up. Ishmael can give Venus a raise and still keep his labor at 19%.

The most obvious thing that folks in the store do every day that translates in a big way onto the financial statements is to make sales. With no sales there's no show. As staffer Venus knows, sales are everyone's job, and all staff need to understand the value of their work in this area.

There are many ingredients that go into financial statements, but if your sales are strong, your labor productive, your margin on target and your inventory well chosen and well tracked, you are going to be a success. And if you have good systems for getting good numbers, those numbers can turn around and help you make your store even better.

See other articles from this issue: #069 March - April - 1997