When preparing and reviewing financial projections for a retail business plan a useful technique is to analyse the financial statements of a similar business in the retail industry.
By reviewing a set of financial statements it is possible to check whether the assumptions used in the projection are appropriate, and whether the ratios generated are in line with actual results in the industry.
Key Characteristics of a Retail Business
Generally the financial projections of all businesses follow a similar format and are based on a set of key assumptions. These assumptions will vary depending on the type of business involved, and those for a retail business plan or online retail business plan will need to reflect the particular nature of that industry.
Although not a definitive list, some of the more important points to consider when reviewing the financial projections of a retail business are as follows.
A retailer purchases finished products from a supplier (manufacturer, distributor, wholesaler) and sells them direct to consumers and therefore might need to hold significant amounts of inventory. The level of inventory held will obviously depend among other things on the type of retailer, the variety of products sold, and on supplier lead times. In a retail business plan the level of inventory is reflected by the inventory days assumption.
Sales in a retail business are usually made direct to consumers rather than to other businesses. As such sales tend to be made on cash terms rather than extended credit terms resulting in low accounts receivable days.
Purchases are usually significant and on credit terms from suppliers often with long lead times, resulting in higher accounts payable days.
Generally gross margins in a retail business plan tend be between 25% and 45% (after deducting occupancy costs), but there can be significant variations depending on the type of products sold.
Which Financial Statements to Use
Ideally the financial statements used will be of a similar size to that anticipated by the financial projections, however this is not always possible in which case publicly available information for larger retail businesses can be used as a starting point.
Example Retail Business Plan Review
In order to demonstrate how to estimate the key assumptions to be used in the financial projections of a startup retail business plan, the financial statements of GAP Inc. a leading global clothing retailer, are used in the calculations below.
A copy of the GAP Inc. 2015 financial statements can be downloaded here.
In the financial projections template the key assumptions used are as follows.
- Gross margin %
- Depreciation rate
- Finance costs %
- Income tax rate
- Accounts receivable days
- Inventory days
- Accounts payable days
- Other liability days
The majority of the information used below is obtained from the balance sheet (page 34), income statement (page 35), and cash flow statement (page 38) of the GAP Inc. financial statements, and for ease of use, these three main statements are available for download here.
In the calculations references to the financial statements are shown in brackets as follows.
- Balance sheet statement (B)
- Income statement (I)
- Cash flow statement (C)
Gross margin %
Gross margin % = Gross profit (I) / Net sales (I) Gross margin % = 5,720 / 15,797 Gross margin % = 36.2%
It should be noted that in this example occupancy costs are deducted in arriving at gross margin.
To give an indication of the depreciation rate, it is useful to calculate the depreciation as a percentage of the net book value of long term assets.
Depreciation rate = Depreciation (C) / Property, Plant and Equipment (B) Depreciation rate = (592-65) / 2,850 = 18.5%
Full details of the depreciation rates used can be found on page 40 of the financial statements.
Finance Costs %
Finance costs % = Interest expense (I) / Debts (B) Finance costs % = 59 / (421 + 1,310) = 3.4%
Income tax rate
Income tax rate = Income tax (I) / Income before tax (I) Income tax rate = 551 / 1,471 = 37.5%
Accounts Receivable Days
Accounts receivable days = Accounts receivable (B) x 365 / Revenue (I) Accounts receivable days = 282 x 365 / 15,797 Accounts receivable days = 7 days *Accounts receivable (282) is shown in the note on page 47 of the financial statements
Inventory days = Inventory (B) x 365 / Cost of sales (I) Inventory days = 1,873 x 365 / 10,077 Inventory days = 68 days
Accounts Payable Days
Accounts payable days = Accounts payable (B) x 365 / Cost of sales (I) Accounts payable days = 1,112 x 365 / 10,077 Accounts payable days = 40 days
Other Liabilities Days
Other liabilities days = Other liabilities x 365 / (Operating expenses - Depreciation + Finance costs + Income tax) Other liabilities days = 1,002 x 365 / 4,273 Other liabilities days = 86 days *Other liabilities = 979 + 23 = 1,002 (B) *Expenses = 4,196 - (592-65) + (59-6) + 551 = 4,273 (I and C)
The values from this retail business should now be compared with the assumptions used in the financial projections template and adjustments made as appropriate.
In a similar manner the financial statements of GAP Inc. can be used to calculate ratios for comparison with those generated by the financial projections template.
The main ratios generated in the template are as follows.
- Profitability (Net income / Revenue)
- Efficiency (Revenue / Assets)
- Leverage (Assets / Equity)
- Return on assets (ROA)
- Return on equity (ROE)
- Liquidity (Current assets / Current liabilities)
Using information from the financial statements an estimate of each ratio can be calculated as follows.
Profitability = Net income (I) / Net sales (I) Profitability = 920 / 15,797 = 5.8%
Efficiency = Net sales (I) / Assets (B) Efficiency = 15,797 / 7,473 = 2.11
Leverage = Assets (B) / Equity (B) Leverage = 7,473 / 2,545 = 2.94
Return on assets (ROA)
Return on assets = Net income (I) / Assets (B) Return on assets = 920 / 7,473 = 12.3%
Return on equity (ROE)
Return on equity = Net income (I) / Equity (B) Return on equity = 920 / 2,545 = 36.1%
Liquidity = Current assets (B) / Current liabilities (B) Liquidity = 3,985 / 2,535 = 1.57
The next step is to see how these ratios compare to those generated by the financial projections for your business.
In summary, using the financial statements of an appropriate business in the same industry assumptions and ratios can be calculated using primarily information from the balance sheet, income statement, and cash flow statement.
In the example above, the financial statements of GAP inc. 2015 were used to represent a retail business revealing the following assumption and ratio values.
|Gross margin %||36.2%|
|Finance costs %||3.4%|
|Income tax rate||37.5%|
|Accounts receivable days||7 days|
|Inventory days||68 days|
|Accounts payable days||40 days|
|Other liability days||86 days|
|Return on assets||12.3%|
|Return on equity||36.1%|
Obviously the assumptions and ratios calculated from the financial statements of one business are not going to be the same as those of another business; even one in the same industry. Despite this, it is a worthwhile exercise to find a set of financial statements similar to your proposed retail business and, together with other information from trade statistics and benchmark reports, use these as the starting point for producing a set of financial projections for a startup retail business plan.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.