EVALUATING THE PERFORMANCE OF A MERCHANDISING COMPANY Accounting Help

In evaluating the performance of a merchandising business, managers and investors look at more than just net income. Two key measures of past performance and future prospects . are trends in the company’s net sales and gross profit

Net Sales

Most investors and business managers consider the trend in net sales to be a key i dicator of both past performance and future prospects. Increasing sales suggest the probability of larger profits in future periods. Declining sales, on the other hand, may provide advance warning of financial difficulties.

As a measure of performance, the trend in net sales has some limitations, especially when the company is adding new stores. For these companies, an increase in overall net sales in comparison to the prior year may have resulted solely from sales at the new stores. Sales at existing stores may even be declining. As a result, business managers and investors also focus on measures that adjust for changes in the number of stores from period to period, including:

1. Comparable store sales

Net sales at established stores, excluding new stores opened during the period. Indicates whether customer demand is rising or falling at established locations. (Also called same-store sales.)

2. Sales per square foot of selling space

A measure of how effectively the company is using its physical facilities (such as floor space or, in supermarkets, shelf space).

JclT Greenberg the Image Works

JclT Greenberg the Image Works

Gross Profit Margins

Increasing net sales is not enough to ensure increasing profitability. Some products are more profitable than others. In evaluating the profitability of sales transactions, managers and investors keep a close eye on the company’s gross profit margin (also called gross profit rate

Gross profit margin is the dollar amount of gross profit, expressed as a percentage of net sales revenue. Gross profit margins can be computed for the business as a whole, for specific sales departments, and for individual Image Works products.

Compute gross profit margin and explain Its usefulness

Compute gross profit margin and explain Its usefulness

We also will include in this illustration two products sold in the Software Department: , Report Writer (a word processing program) and Dragon Slayer (a computer game). Perunit information about these products is as follows

Compute gross profit margin and explain Its usefulness

Compute gross profit margin and explain Its usefulness

The Overall Gross Profit Margin

The average gross profit margin (gross profit rate) earned by Computer Barn in 200 1 is 40% (gross profit, $360,000, divided by net sales, $900,000 = 40%). But each sales department may have a gross profit margin that differs from that of the business viewed as a whole .

Departmental Profit Margins

The average gross profit margin (gross profit rate) earned by Computer Barn in 200 1 is 40% (gross profit, $360,000, divided by net sales, $900,000 = 40%). But each sales department may have a gross profit margin that differs from that of the business viewed as a whole .

Departmental Profit Margins

Departmental profit margins are computed using departmental gross profit and net sales information, as follows

Compute gross profit margin and explain Its usefulness

Compute gross profit margin and explain Its usefulness

Profit MargilfS for Individual Products

Finally, profit margins can be computed for specific products using per-unit amounts:

Compute gross profit margin and explain Its usefulness

Compute gross profit margin and explain Its usefulness

Notice that Dragon Slayer has a higher profit margin, even though Report Writer is the more expensive product. This higher profit margin means that at a given dollar of sales voliune (say; $10,000 in sales) Dragon Slayer is the more profitable product

Using Information About Profit Margins

Investors usually compute companies’ overall gross profit rates from one period to the next. High-or increasing-margins generally indicate popular products and successful marketing strategies . A substandard or declining profit margin, on the other hand, often indicates weak customer demand or intense price competition.

Cash Effects

Increasing gross margins do not always result in increased cash flows from operations. In fact, a , company with increasing gross margins may actually have negative operating cash flows if it is experiencing (1) difficulty in collecting outstanding accounts receivable, (2) a buildup of unsold inventory, or (3) rapidly increasing selling and administrative expenses

Management uses information about departments and products for many purposes. These include setting prices, deciding which products to carry and to advertise, and evaluating the performance of departmental managers. ‘By concentrating sales efforts on the products and departments with the highest margins, management usually can· increase the company’s overall gross profit rate.

A Closing Comment

Remember that only a perpetual inventory system provides management, with current information about departmental gross profit and profit margins. This is the primary reason many large companies use perpetual systems.

markiting

markiting

Posted on November 23, 2015 in Accounting for Merchandising Activities

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