In today’s unprecedented times the only certainties are money, and the need for survival in supply and retail. Ignorance of your own company accounts and an understanding of how they relate to the customer’s financial performance needlessly adds personal risk to the other unprecedented uncertainties affecting a NAM’s survival in the marketplace. However, even a modicum of financial understanding can vastly improve the odds in your favour…
It all starts with downloading copies of the latest annual reports for your company and those of the customer from Companies House. These are of most relevance to you and the resulting spontaneous insight will encourage further study. These may seem a little out of date, but are the best available to outsiders at this stage, where insiders include the board and some key individuals in the finance department, all sworn to secrecy re: the contents. Thus your access to this open domain data is effectively equal with all others you encounter day-to-day. In fact in most cases you can be ahead of the game by simply accessing the reports.
At this stage avoid the ‘coloured brochures’ version of annual reports available from the PR department. These are selling-documents aimed at shareholders, suppliers and even customers and can obscure more than provide insight. The Companies House version is stripped down to the essentials and makes for easier like-with-like comparison. The introductory section can give some titbits, apart from providing some get-out clauses for the auditors…
The real action starts with the P&L or Profit and Loss Account, sometimes called the Income statement, a history of the company’s dealings throughout the year. Starting with the Annual Sales, ex. VAT the report compares these with the previous year, leaving you to calculate progress Year-on-Year.
Next comes Cost of Sales, literally what it costs in terms of ingredients and some labour/distribution outlay, that make it difficult to compare with competition, giving gross profit for the company. Here some ‘rules of thumb’ can help: essentially, most retailers buy in at 75 and sell out at 100, ex. tax, effectively making a gross margin of 25%, with which to run the shop. Ideally this costs 15% of net sales, leaving 10% to cover head office and profit. Suppliers meanwhile manufacture for 50% of their average selling price to the trade, giving them a 50% Gross Margin to cover brand building, trade management and profit.
Incidentally, the little numbers beside each P&L item are references to notes in the back of the accounts offering explanations of how they calculated each figure in the P&L.
Turning to the Balance Sheet, this gives a snapshot of where all company money was tied up on the last day of the financial year, and barring accidents, most of it will be still in place. Fixed Assets are things the company wants to keep, like buildings, plant and equipment. For a retailer the most expensive asset is space, hence the need for space management to ensure its effective utilisation.
Current or short term Assets are things the company wants to sell i.e. stocks, debtors (money owing to them) and cash, and the company’s objective is to turn each of these over as fast as possible i.e. stockturn and getting their money in as fast as possible. In practice, retailers are cash businesses, so they are in an enviable position of being paid in cash and getting up to 90 days free credit from the main risk-takers, the suppliers, nice. Incidentally, in accounting, short/current is less than a year, and long term is more than a year.
Further down come the Current Liabilities, what they owe to other people i.e. bank-overdraft and creditors i.e. all others. It is important to check the notes for this number at the back of the report to distinguish trade creditors (you) from other types of service-providers to whom they also owe money.
A quick comparison of Net Profit divided by a combination of Fixed Assets, Current Assets minus Current Liabilities, times 100 will give you Return On Capital Employed, (ROCE), the core ratio in financial analysis (about 15% for retailers). Sales/Stocks will give you annual Stockturn and Net Profit divided by sales, times 100, will give you % margin, ideally 5% in UK retail.
You are now in a position to study the ‘coloured brochure’. Your Companies House analysis will help you to get behind the pictures and propaganda, and accumulate some real insight, in readiness for your next encounter with the buyer…
