“Conversational Banker-ese”
N through W
By now, if you’ve read the first two parts of this series, you have two-thirds of a small “dictionary” of basic retail terminology. These are words every retailer should feel comfortable using, especially when talking with your banker.
This installment will complete our list of basic definitions. So, put on your thinking cap, roll up your sleeves, and let’s go!
1. Jill looked delightedly at her income statement. The total sales of her company were nearly double the previous year’s. Then she looked down a few lines, noting what the merchandise had cost the store and what it had cost to keep it in operation over the year. Jill sat down. Yes, sales had zoomed, but so had merchandise costs and operating expenses. Her Net Operating Income (or Net Profit) was actually less than it had been the year before!
Net Operating Income: Net sales minus net Cost of Goods Sold, less all Operating Expenses, less Income Taxes. (Operating Income is pre-tax profit; Net Operating Income is post-tax profit.)
2. Mark decided to sell his store but had no idea how to put a price on it. He walked through his store with his consultant. “I trained these salespeople,” Mark said. “I developed relationships with those customers. How can you put a price on such things?”
The consultant said, “The factors you mention need to be taken into account, but let’s start at the beginning. Exactly how much do you have into this operation? Let’s start with your Net Worth.”
Net Worth (also called Equity). Total Assets minus Total Liabilities. A Balance Sheet entry showing the owner’s share of a company.
3. Anne was late for an appointment with her loan officer. She rushed to the loan officer’s desk and handed her a paper prepared by her bookkeeper. Five minutes later Anne discovered the Balance Sheet, though complete, didn’t contain enough detail on the amounts owed to others. “I’m sorry,” the banker said, pointing to a line on the page. “I’ve got to have a breakdown on this entry for Notes Payable.”
Notes Payable: A ledger account or Balance Sheet item itemizing the amounts owed to banks and others, secured in the form of a promissory note. They can be short-term (due within one year) or long-term (due one year or more from the date of the Balance Sheet).
4. The storefront around the corner was for rent. Pete was tempted to move his store. The area had less traffic, but the rent was substantially lower. Then a level-headed friend of Pete’s walked through the empty storefront with him. “Drafty isn’t it? I wonder how much it would take to heat this barn. And there aren’t any windows. What would it cost to keep it lit up?”
Peter hadn’t thought of that. Doing a little mental math, he concluded the Occupancy Expense of the empty storefront probably wouldn’t be as low as he’d thought and certainly not low enough to justify moving to a less desirable location.
Occupancy Expenses: Expenses related to the use of property—rent, heat, light, depreciation, CAM charges, maintenance, etc.
5. Susan saw a million things at the trade show that she wanted to buy for her store. She ordered from one supplier, then from another. Then, she saw a display of what would look great in her store window, but unfortunately she’d spent her budget. “I want those products so bad I can taste it, but we have no money left in our Open-To-Buy.”
Open-To-Buy: Also known as Merchandise Plan, Merchandise Budget. A budget for buying merchandise revolving around inventory levels and planned sales. The basic Open-To-Buy formula is Sales plus Desired Ending Inventory minus Beginning Inventory equals Purchases. This can be made more exact by incorporating on-order, markdowns, shrinkage, etc into the formula.
6. Tracy’s supplier had shipped more than double the number of items she’d ordered. She called to see what was going on. “Whoops,” responded the man who answered the phone. “Let me pull your order…. Oh, I guess that was an 8 and not a 18!”
“I’ll have to send 10 of them back to you,” she said.
“Are you sure you wouldn’t like to keep them?” asked the supplier hopefully. “This brand is selling very well right now.”
“No, thanks.” Tracy had learned by bitter experience the impact that excess inventory could have on her store’s profits. “If I start accepting merchandise I haven’t ordered, I’ll have to deal with increased handling, ticketing, and advertising—not to mention the cost of warehousing the extra stock. Being over-inventoried makes my Operating Expenses shoot up!”
Operating Expenses: Non-merchandise expenses incurred by a business; may be generally categorized as Selling Expenses, Occupancy Expenses, Administrative Expenses and Depreciation.
7. Sam had been in business for about a month now. Every night he cleaned out the till and went to the bank, noting proudly how the balance rose. He could hardly wait to talk to his father-in-law, who had been functioning as his advisor in the new venture. Finally he could resist no longer. He made a phone call. “Mr. Jones? This is Sam. I though you might be interested in knowing that my bank balance after just a month in business is up in the thousands. I never guessed making a profit could be so easy!”
“Slow down, Sam,” Mr. Jones said patiently. “Have you paid your store’s rent yet? Have you paid for your merchandise? Take care of all the expenses you incurred this month, then call and tell me about your Profit.”
Profit: A general term for the excess of revenue over the cost of the merchandise and all operating expenses and taxes. (Also see #1 above, Net Operating Income.)
8. Al had been in the business for 35 years. All through this time sales continued to increase, but lately the store’s net profit had begun to go down. One day Sheila, his wife (who was also his bookkeeper) came to him with some numbers. “Look, Al,” she said, showing the paper to him, “I think I’ve found our problem. Our administrative expenses are roughly the same as always, our occupancy expenses haven’t gone up—but look at these selling expenses! I think we need to take a long hard look at the TV advertising we’ve been doing.”
“Let me think it over, Sheila,” said Al. In the coming weeks Al did try cutting back on the advertising. He found that his net profit increased significantly, while sales had barely dropped. Sheila had been right. And once again, his Profit and Loss Statement had proven to be a valuable diagnostic tool!
Profit and Loss Statement: Also known as P&L or Income Statement. A financial statement that indicates the operating results of a business over a period of time (one month to one year). The P&L begins with Sales and deducts the cost of the merchandise. The resulting Gross Margin covers expenses and leaves a profit for the business. If expenses aren’t covered, a loss is incurred. See Income Statement.
9. Andrea looked across the store at her son Mike, who was explaining the selling features of an item of merchandise to an eager customer. “Do you realize that next year Mike will be applying for college?” she asked her bookkeeper. “I know I’ve been putting almost all the profits back into the business, but now I want to concentrate on being able to give Mike a good education. What can I expect over the next year or so in terms of profit?”
“Let me prepare a pro forma Income Statement,” said the bookkeeper. “It’ll help you plan ahead to give Mike the education he deserves!”
Pro Forma: A projection or forecast of likely financial events. Pro Forma Balance Sheets can be used to plot the strength of your business; Pro Forma Income Statements can be used to plan your profits.
10. It was a chance in a million. One of her lines was going at a 30% discount and Barbara wanted to make a substantial buy to add to her inventory. “I can give you 15% now and the remainder net 10,” she told the supplier.
“How do I know you can afford to do that?” the supplier said.
Hastily shuffling through her briefcase, Barbara found her company’s current Balance Sheet. She said, “This shows I’m in great shape to pay an immediate debt; my company has a Quick Ratio of 1.5 to 1.”
Quick Ratio: Cash plus Accounts Receivable divided by Current Liabilities. This financial ratio measures the ability to have cash available quickly to meet current obligations. An increase in your Quick Ratio is generally favorable.
11. The supplier’s eyes widened as Barbara explained exactly what a quick ratio was. “I’ve never met a retailer who knew what a Quick Ratio was!” he exclaimed. “Bet you don’t know what Current Ratio and Debt to Worth Ratio are.”
“That’s easy,” said Barbara, explaining the two ratios, which she had recently learned at a financial management workshop. “Well, good for you,” said the supplier. “Having a handle on Ratio Analysis puts you way ahead of the pack!”
Ratio Analysis: The study of relationships between different parts of a company’s financial data. Used to pinpoint a company’s financial strengths and weaknesses. Particularly valuable for comparing trends over time.
12. After a fairly successful year, Jean felt that if she could invest more money in her store, the business would really take off. But when she went to apply for a loan, the banker took her to task for her reasoning.
“Investing more doesn’t necessarily mean you’ll get more back,” the banker said. “You have to take into account how wisely you buy your merchandise, how quickly your people can sell it, and how careful you are to keep your operating expenses down. And besides, what kind of return are you getting on your money right now?”
He sounded just like her father. “I don’t know, but…” Jean began.
The banker interrupted her. “My advice to you is to forget about borrowing money now and concentrate on improving your Return on Total Assets.”
Return on Total Assets (ROA): Profit Before Taxes divided by Total Assets. Measures the percentage of proft earned on all of the dollars invested in the company. As with any investment, higher is usually better.
13. Phil was going back to school and had to quit his sales job at an audio/video store. Tom, his employer, hated to lose him. Phil was a natural-born salesperson.
“I’ll have to hire two people to sell as much as you did, Phil,” Tom said. “I might even have to take out an ad. Without you, my Selling Expenses will climb a lot.”
Selling Expense: Any expense or class of expense incurred in selling merchandise, including salaries and benefits, advertising, supplies, etc.
14. It was the end of the year, and the store was closed for its annual inventory. Rhoda had kept careful records of incoming and outgoing merchandise over the year, so when her manager informed her that she had almost 20% fewer salable items than she expected, Rhoda hit the ceiling. “How can that be?” she asked.
“Some of the ones we had on display got too shopworn,” explained the worried manager. “And I’m afraid the shoplifting problem is worse than I realized. It looks like we’ll have to recognize Shrinkage.”
Shrinkage: The difference between actual stock on hand and the bookkeeping records of stock on hand. Shrinkage results from damage, obsolescence, wear and tear, theft (external and internal), and bookkeeping errors.
15. Joe, an investor in a small chain of stores, rushed into one of the stores practically crackling with excitement. “Andrea, I’ve got a great plan for remodeling the area in front of the store. I can chip in half of what it would cost. Can your business come up with the other half? This will be the best-looking store in town!”
Andrea was a bit more cautious by nature than Joe. “Sounds great,” she said, “but I can’t give you a firm answer yet. Let me go over my books.”
That night Andrea analyzed her ability to raise some cash and called Joe with the good news. “Let’s go for it, Joe,” she said. “We have plenty of Working Capital!”
Working Capital: Current Assets (Cash plus Accounts Receivable plus Inventory) minus Current Liabilities (all debts owed within one year). The amount of money which may be readily available to meet current debt obligations.
Now we’ve covered all the basic terminology you’re likely to need in conversation with your banker. You should be able to use “conversational banker-ese” with the best of them!