Cash Flow: Common But Lethal Mistakes Retailers Make

In simplest terms, cash flow refers to the amount of available cash a retailer has at any point of time as a result of cash inflows (e.g. sales) versus cash outflows (e.g. inventory payables).

Cash flow is a distinctly different dynamic from profitability, which measures profits or losses from operations including both cash and non-cash expenses. Rent is a cash expense while depreciation is a non-cash expense.

In the case of profitability, you can lose money for a year or two but not go out of business. A loss year only reduces the net worth of a company (the difference between total assets and total liabilities). On the other hand, if you run out of cash and can’t make the payroll or your bank loan payment, then you will have to close your business or obtain additional paid in capital (cash).

Having a positive cash flow allows the retailer to stay in business and meet all of their cash expenditures such as payroll, payables and debt obligations. Profit on the other hand, is the profit or loss report card for that retailer for a defined period of time such as a month or a year.

The typical sources of cash are paid in capital, profits and asset liquidation such as inventory. If there is insufficient cash to meet liquidity needs and if additional paid in capital is not available then the retailer must borrow the needed cash from a bank or other lending institution or person.

In order for a retailer to keep the business liquid and healthy, a cash flow analysis (aka cash budget) is needed much like an open-to-buy (OTB) budget is needed relative to inventory purchases. In the case of cash however, the budget becomes an open-to spend versus an open-to-buy.

As a side note, retailers need a variety of plans or budgets such as a profit plan for sales, margins and expenses, an OTB for inventory and a cash flow budget (open-tospend) to insure the company’s liquidity.

The cash flow analysis is relatively straightforward. Usually the plan is done in thirty-day increments and simply compares likely cash inputs such as sales and receivables versus likely cash outflows such as payroll, payables and scheduled payments such as bank loans or car payments. If planned cash inputs equal or exceed anticipated cash outflows, then the retailer remains liquid, viable and out of danger. Again, this pertains only to cash flow and not to profits.

Of all the challenging problems retailers face, cash flow is fraught with danger. As mentioned above, you can operate without profits for a year or two, but you cannot operate without sufficient cash.

To guard against cash shortfalls, I recommend that retailers do the following:

  • Create all budgets including cash flow as mentioned above.
  • Have your comptroller, accountant or bookkeeper weekly post anticipated cash requirements versus cash inflows to a spreadsheet for a cash forecast. Automate the process preferably.
  • Have in place a plan to energize cash inflows whenever it becomes evident that there is a cash shortfall looming.
  • Create a good banking relationship such that if and when you run short of cash, you can borrow on a short term basis to meet your cash needs.
  • Strive to increase your inventory turns to four (4) turns. This is doable but challenging. Many retailers get up to 6 or 7 turns.
  • Wherever possible order less on large dated orders in favor of ordering as needed with 30 days terms. This will increase your turn rate and therefore your cash flow.
  • Concentrate your purchases in the “A” item group (the 20% of items that produce 80% of the sales) and greatly reduce or drop the “C” items.
  • Don’t use short term liquidity (cash) for long term capital purchases such as a new store, autos, computer systems, store renovation, etc. Take out a term loan for capital purchases.
  • Set up a progressive markdown plan for all items that are selling below expectations and whose “weeks of supply” (current on-hand inventory divided by average weekly unit sales) is unduly elevated.
  • Wherever possible increase your margins through vendor consolidations, use of more off price purchases, closer vendor relationships, shared markdowns with vendors and modification of your merchandise mix to include items with richer margins. Greater maintained margins will increase profits and therefore cash flow.

Just remember that in the world of business, profits are great but cash is king. Moreover, being liquid will allow you the flexibility to take advantage of opportunistic purchases and opportunities.