Source: Instrumental “Drops of H2O ( The Filtered Water Treatment )" by J.Lang (feat. Airtone),” Creative Commons, http://ccmixter.org/files/djlang59/37792
Hey, everyone, and welcome to our video today-- A Case Study on Merchandising Financial Statement Analysis. So what's today's video about?
Well, we're going to discuss the subject company, Legacy Clothing, and then we're going to look at financial statement analysis and how it relates to our subject company, Legacy Clothing. And then we're going to finish up with a case study where we're going to be performing financial statement analysis for our merchandising company, Legacy Clothing.
So let's learn a little bit about this company. What type of company is it? Well, it's a sole proprietorship. That's a type of company that is owned by a single individual and where the individual and the business are legally treated as the same.
So what's the business's purpose? Well, Legacy Clothing owns and operates its own clothing stores, so it has clothing and merchandise stores similar to a department store. They sell men's, women's, children's clothing and other related items.
Where's the business located? It's located in Washington DC, and they have a staff of 50 people.
So now let's discuss our company and financial statement analysis. So does our company need financial statement analysis? Yes, of course they do. Well, why? Well, there's two types of financial statement analysis. There's income statement analysis. And why do we need that? Well, that helps us with trend analysis, so we can identify trends, and it's helpful for assessing both past and future performance. So we can assess past performance and predict future performance.
It also provides a more complete picture for our financial statements. It helps us understand the relationship between expenses and revenues, the changing composition of our expenses over time, and it helps measure the results of expense management.
And the other type of financial statement analysis is balance sheet analysis. So why is that important? Well, it helps with inventory management, and it helps us to understand the flow of our merchandise, so how the inventory is flowing in the business. We don't want to have too much inventory, because there's going to be an increased cost associated with storing, protecting, and managing that inventory, and if we have too little inventory, we might not be able to make our sales, because we don't have the items in stock.
So that's why our company needs to have financial statement analysis.
Now let's look at performing financial statement analysis for our subject company, Legacy Clothing. So let's go ahead and jump into performing income statement and balance sheet analysis.
OK. So what we're starting with here is our income statement analysis for our subject company, Legacy Clothing. And the starting point for our income statement analysis is going to be our income statement, so you'll see that we've prepared an income statement for our subject company. And now we're going to perform our analysis. And the first thing that we're going to do is express our expenses as a percentage of our total sales. So you'll see here that our total sales represents 100%.
So now we're going to express our expenses as a percentage of that total sales number. So you'll see here, for example, our sales returns and allowances are 3% of our total sales, sales discounts are 2% of our total sales, and you'll see here, salaries expense. Well, that makes up 36% of our total sales.
So this analysis is great for understanding the different relationships between the specific expenses and the total sales. So it helps us to understand the composition of our expenses and how those expenses change over time, any trends that we can identify. So that's our first piece of our income statement analysis.
Now let's look at calculating the gross margin ratio. OK. So here we're still performing our income statement analysis, but now we're going to look at our gross margin ratio, which you can see here. It's our net sales minus cost of goods sold, divided by net sales. So we can take that information, net sales minus cost of goods sold, divided by net sales from our income statement. So if we populate that information, we'll see here that our gross margin ratio is 76%. So our gross profit from our total sales is 76%. That's what the gross margin ratio tells us.
OK. So what we're looking at here is our balance sheet analysis that we're going to perform for our subject company, Legacy Clothing. And what we're going to focus on is calculating our inventory turnover as well as our days inventory on hand or days in inventory. So let's focus on the inventory turnover first. So this can be calculated one of two ways.
First, we're going to look at net sales divided by inventory. So if we take our net sales and divide it by our ending inventory, this tells us that our inventory is sold 7.6 times during the period. However, a more accurate way to calculate our inventory turnover is to look at our cost of goods sold and divide it by our average inventory. These speak more to activity during a period. So if we take our cost of goods sold, take the average of our beginning and ending inventory balance, we'll see that our inventory turnover is more accurately reflected as 1.7 times.
So that's the number of times inventory is sold during a period. So now if we go down to this days inventory on hand or days in inventory calculation, this will tell us how many days our inventory is actually held. So if we take the number of days in the period, and in this case, we're looking at an annual period, so we're taking 365, and divide it by our inventory turnover ratio, which we just calculated. We'll take this 1.7. So if we divide that by 1.7, we'll see that the number of days that we hold our inventory is 220 days. So that's our balance sheet analysis.
Great. So now that we've performed our financial statement analysis for our subject merchandising company, Legacy Clothing, let's summarize what we talked about today. In a nutshell, we discussed our case study company, Legacy Clothing, and then we looked at performing financial statement analysis for the company. We looked at performing income statement analysis, and we looked at balance sheet analysis, specifically inventory turnover analysis.
I hope everybody enjoyed this video, and I hope to see you next time.