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FINANCIAL STATEMENT FRACTURES

A company's Financial Statements provide the tools you need to help run your business profitably. The information contained on the Financial Statements helps to analyze past performance and give the information needed to plan for a successful new year - but only if the information is accurate and presented in a meaningful way.
 
Financial Statements should be prepared in a manner consistent with industry standards. This eases communications between you and other retailers and makes possible the comparison of your results to published industry results.
 
It is essential that the independent accountant preparing your year-end Financial Statements be familiar with generally accepted standards of financial reporting in the retail industry. Most are not. I have an accounting degree and only 1 class session in all 4 years was devoted to retail - and it was just on inventory valuation methods. The NRF published a manual on Retail Accounting many years ago. I still have my copy. I checked on Amazon under "Retail Accounting Manual" published by the NRMA (National Retail Merchants Association - the predecessor of the NRF) and they list it for $39.00.  If you do not have a copy get one - and recommend that your CPA have one also.
 
I can usually tell if a retailer's CPA developed their chart of accounts and Income Statement since it is most likely that all expenses will be in alphabetical order. On the other hand, a properly presented retail Income Statement will show expenses based on their importance and how much direct effect the retailer can have on them. Therefore, you will see that after Cost of Goods Sold, Payroll is next with Advertising following it. Rent, although it is a significant expense is listed at the end because the only time the retailer has any control over that expense is when the lease is negotiated, usually every 5 years.
 
We see many Financial Statements each year and continue to be amazed at how many errors in financial reporting we see. Following are some of the more common errors we find on Financial Statements.

BALANCE SHEET

Life Insurance
Do not classify the cash value of life insurance policies with the company as beneficiary as a current asset since it is not expected to mature, or be cashed in within a twelve month period. It should be classified as a long-term investment.

Inventory
Do not overstate inventory based on some improper method. The inventory amount should reflect the lower of cost or market as determined by a generally accepted, recognized practice and technique such as the Retail Inventory Method.

PROFIT & LOSS STATEMENT

Sales
In a retail store, SALES is the income received from the sale of merchandise. It is the selling price of the merchandise, not the original retail. It should not include sales tax (which is a liability). It should not include Alterations income, tuxedo rental income, gift wrap income, miscellaneous income, finance charge income, sales of Gift Certificates or Gift Cards (which are a liabilities),etc.

If you charge customers for Gift Wrap the income should be netted against the Gift Wrap expense, not listed as an income item. The same with any fees charged for shipping and alterations. The retail store is not in the business of shipping or doing alterations so these fees are used to offset the store's expenses for these services.

Miscellaneous income and finance charge income should be listed on the Income Statement under the section at the bottom called "Other Income".

Also, remember that the Profit & Loss Statement (Income Statement) is a summary report. It should not be used to list the sales for every classification or department in your store. I looked at an Income Statement this past week that had one full page of sales by classification and another full page of Purchases by classification. This information is found on your merchandising reports and should not be cluttering your Income Statement. You would not list every individual utility under Utility Expense (water, gas, electric) so why would you list the sales and purchases for every merchandise classification?

Lease Departments and Tuxedo Rentals
Another error that we see occur is to include in Sales the lease department sales, and then subtract the amount paid to the lease department operator in the Cost of Goods Sold section. This gives misleading information since the Gross Profit on a lease department is much less than on the store's owned merchandise. As there is a need to show the whole picture, we recommend that lease department income and expense be shown as a separate item on the Profit & Loss statement, listed after the gross profit on owned sales. The same is true for Tuxedo Rental Income. It should also be listed separately following the Lease Department section.

Alterations
The income from alterations should not be listed in the Other Income section of the Profit & Loss Statement. Rather, it should be shown separately as a reduction of alteration expense. For stores that do a lot of alterations, we generally recommend that there be a separate section for Alterations showing Alterations Income, then all the Alterations expenses. Some stores may have an alterations department with payroll as well as paying for an outside service on occasion. By keeping all these expenses together it makes it easy to see exactly how much alterations are costing your company.

Freight
Freight on merchandise shipments (both inbound and returned to vendor) should never be shown as an operating expense. It should be reported as a separate item in the Cost of Goods Sold section. If you use UPS to ship out customer's merchandise, that cost should be included in Postage Expense, not included with the Freight on merchandise shipments.

Purchase Discounts
Purchase Discounts should not be shown as Other Income. Purchase Discounts should be reported as a separate item in the Cost of Goods Sold section.

Interest Expense
Interest Expense should be treated as an Other Expense, not an Operating Expense. This facilitates the comparison of stores that are adequately capitalized, with those that are not and must continually borrow. 

Miscellaneous Income
A retail store receives miscellaneous income, other than from the sale of goods, such as for gift wrapping, or repairs. These items should be deducted from the most nearly related expense. For example, the income from gift wrapping should be posted to the expense account to which gift wrapping supplies are charged, most commonly Store Supplies. This will reduce the amount of that particular expense.

Finance Charge Income
Finance Charge Income should be handled as a separate item listed in the Other Income section of the Profit & Loss Statement. Since so many expenses are involved in producing this income (payroll, postage, supplies etc.) it would be very difficult to separate these items or to deduct the finance charge income from all the associated expenses.

Cash Value of Life Insurance
When reporting the increase in Cash Value of Life Insurance on the Profit & Loss Statement, it should be deducted from Insurance expense, not listed as a separate item in the Other Income section.

Occupancy Costs
In a situation where a retailer's store is in a mall, I advocate including all occupancy costs in Rent. This can include taxes, insurance, repairs and maintenance. By handling the expense in this manner rather than charging each of these items to the appropriate natural expense category, you will easily be able to see the true cost of leasing space in a particular location and be able to make comparisons between one location and another.

In conclusion, your company's report card is it's Financial Statements. By educating yourself and your accountant you can make sure that the information on the Financial Statements is accurate and meaningful so you can avoid basing management decisions and future planning on misleading information.

To give you a better idea of what a retail Income Statement (P&L) should look like, below is a sample:

SALES
Sales
Less: Employee Discounts
Less: Sales Discounts
NET MERCHANDISE SALES

COST OF GOODS SOLD
Purchases
Purchase Discounts
Freight
Inventory Adjustment
TOTAL COST OF GOODS SOLD

GROSS PROFIT ON MERCHANDISE SALES


Leased Dept Sales
Leased Dept Expense
Net Lease Dept Income

Tux Rental Income
Tux Rental Expense
Net Tux Rental Income


TOTAL GROSS PROFIT


OPERATING EXPENSES
Payroll-Alterations
Services Purchased-Alterations
Supplies-Alterations
Merchandise Cleaning/Repair
Less: Alterations Income
Total Alterations

Payroll-Management
Payroll-Selling
Payroll-Shipping/Receiving
Payroll-Buyers
Payroll-Office
Total Payroll

Advertising-Newspapers
Advertising-TV/Radio
Advertising-Direct Mail
Advertising-Electronic Media (email)
Advertising-Other
Advertising-Display
Advertising-Web page
Special Events (Trunk Shows, etc)
Advertising Agency Fees
Co-op Advertising Credit
Total Advertising

Taxes-Property
Taxes-Personnel
Taxes-Other
Total Taxes

Supplies-Office
Supplies-Utilities
Supplies-Shipping/Receiving
Supplies-Store
Supplies-Selling
Supplies-Gift Wrap
Total Supplies

Data Processing
Software Support
Credit/Collection Service
Credit Card Discounts (Fees)
Alarm System
Buying Office
Total Services Purchased

Misc Store Expense
Donations
Dues & Subscriptions
Employee Training/Education
Cash (Over)/Short
Total Unclassified

Travel-Local
Travel-Buying
Total Travel

Postage/Shipping
Telephone
Total Communication

Ins-Property/Business
Ins-Personnel
Total Insurance

Depreciation
Amortization
Total Depreciation & Amortization

Professional Services-Accounting
Professional Services-Consulting
Professional Services-Legal
Total Professional Services

Bad Debts/Checks
Recovery of Bad Debts
Total Bad Debts

Maintenance & Repair
Rent (including CAM)
Total Equipment & Property

Total Operating Expense

NET OPERATING INCOME

OTHER INCOME
Finance Charge Income
Interest Income
Misc. Income
Total Other Income

OTHER EXPENSE
Interest Expense
Misc. Expense
Corp Income Tax
Total Other Exp.


NET INCOME (LOSS)




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