Accounting

web site updated 3 July 2007

Retail Accounting's Impact on Inventory

If you are like most golf retailers, you probably need to review some basics tenets of accounting to understand accounting’s impact on some of our decisions. Specifically, we will address the Profit and Loss Statement. Rather than think about dollars on the P&L, focus on the percentages.

The first sermon relates to how we read the Profit & Loss statement. On the P&L, the top of the report shows Revenue or Income. All percentages are calculated as a percentage of this number. Therefore, Revenue is always 100% (100% of itself). The next line is Cost of Goods Sold (COGS). It represents the money that you paid for the items that were sold. COGS is also represented as a percentage of sales. This example excludes green fees and cart fees as if you were a retailer.

PROFIT & Loss statement April 1 – September 30
Total Sales	$ 150,000	100.0%
Cost of Goods Sold	$ 96,700	64.5%
Gross Profits	$ 53,300	35.5%

So for this 6-month period (theoretically-since this is not cash flow), we have earned $53,300 to spend on all of our operating expenses. In order for us to be profitable, the sum total of our operating expenses cannot be more than $53,300 or 35.5% of sales.

When we analyze Gross Profits and their relationship to Operating Expenses, we can deduct the percentages and review how we will eventually arrive at Net Profits. For example,

Our Operating Expenses (relatively “fixed”) do not have a direct correlation to Total Sales. Operating Expenses (in terms of actual dollars) will not necessarily change as a result of Sales increases. For example, our rent does not typically increase in dollars if Sales double. Our payroll might increase (but not double) because we need more staff to handle the sales volume.

PROFIT & Loss statement April 1 – September 30
Total Sales	$ 150,000	100.0%
Cost of Goods Sold	$ 96,700	64.5%
Gross Profits	$ 53,300	35.5%
Operating Expenses
Rent	$ 9000	6.0%
Payroll	$ 16.500	11.0%
Bank Service Chg	$ 1,200	0.8%
Casual Labor	$ 3,600	2.4%
Credit Card Fees	$ 3,900	2.6%
Freight	$ 3,000	2.0%
Insurance	$ 2,400	1.6%
Meals & Ent	$ 3,450	2.3%
Supplies	$ 1,500	1.0%
Taxes	$ 4,800	3.2%
Telephone	$ 2,250	1.5%
Gas & Electric	$ 4,500	3.0%
Total Operating Expenses	$ 56,100	37.4%

Net Profit (Loss)	($ 2,800)	-1.9%

This exercise is to help us better understand the relationship between our Operating Expenses and the gross profits and we have to earn to cover those expenses. By looking it them as percentages of sales, the relationship and decisions are simpler.

Let’s review The Big Picture.

PROFIT & Loss statement April 1 – September 30
Total Sales	$ 150,000	100.0%
Cost of Goods Sold	$ 96,700	64.5%
Gross Profits	$ 53,300	35.5%
Total Operating Expenses	$ 56,100	37.4%

Net Profit (Loss)	($ 2,800)	-1.9%

In The Big Picture, if Sales increase:

	Total Sales% will not increase (since it is always divided by itself),
	COGS% and Gross Profit% will likely stay close, unless you took significant markdowns,
	Operating Expenses % will decrease (because the Fixed expense dollars did not change and we are dividing by a larger Sales number,
	Net Profits should increase.

In The Big Picture, if COGS decreases:

	Total Sales% will not increase (since it is always divided by itself),
	Gross Profit% will increase (it is calculated as Sales Minus COGS Divided by Sales),
	Operating Expenses% will stay the same (because the Sales number we divide into the Expenses did not change),
	Net Profits will increase because we have more Gross Profit dollars to pay operating expenses.

In The Big Picture, if Operating Expenses decrease:

	Total Sales% will not change (since it is always divided by itself),
	COGS% and Gross Profit% will not change,
	Operating Expenses % will decrease,
	Net Profits will increase because while Gross Profits did not change, the Expenses% we paid decreased.

Therefore, our solutions to lack of profits are as follows:

	Increase sales volume. As sales volume increases, the gross profit dollars increase, allowing us to pay “fixed” operating expenses. As a result, the percentages for “fixed” expenses will reduce.
	Decrease Cost of Goods Sold. If we can decrease our Cost of Goods Sold, even without increasing Sales, we increase the dollars that we have to pay Operating Expenses.
	Decrease Operating Expenses. At the top of “fixed” operating expenses are Rent and Payroll. Since these normally represent the largest singular items on the P&L, they are the ones that we have to watch closely. Since we have lease agreements for rent, Payroll may be the only Operating Expense over which we maintain a high degree of control.

The third sermon is a simple statement if you understand the relationships referenced above.

If we look at our Operating Expenses as a percentage of Sales, we cannot afford to carry vendors or products lines that do not consistently provide us with a Gross Margin% that is higher than our Operating Expense%.

Simply stated (using the example above), vendors who provide us with products that earn more than 37.4% in gross profits, allow us to gain net profits. Suppliers, whose gross profits are below that point, cause us to be in a loss situation. Makes decisions much easier, doesn’t it?

It is important to review these percentage relationships over a longer period of time (such as a 12-month period or a selling season) since an individual month may not be indicative of the year. For example, the first month of a new season should have relatively low markdowns while the last month of that season will have higher markdowns. The COGS for those months will be low for the first month and high for the last month.

I hope this posting helps you understand how you can use your P&L to impact your buying and analysis. It is important that you understand these concepts (particularly the third sermon) as we go forward. If any of this is unclear, please email me and ask your questions.