As a retailer, what is more important to you, profits or cash flow? The initial response from most merchants posed that question is: “Profits, of course!”
On the surface, that answer makes sense; who wouldn’t want more profits? The mere word “profitable” itself evokes a sense of financial well-being.
In today’s retail environment, though, profits alone are not enough; cash flow is the new financial reality.
I have reviewed countless profit and loss statements that showed extremely strong gross margin figures, only to find out that the store had no cash. Since accounting does not factor in the element of time, turnover does not appear on a profit and loss statement. Therefore, the financial picture created by a “profitable” business with poor cash flow can be a false reality.
Recently, a client came to us for a strategy to deal with a bank request. The bank wanted the retailer to produce an additional $200,000 in cash, not profits – cash. If you were given a similar mandate, what would you do? Well, hope is not a strategy and crying is not an option. To paraphrase Tom Hanks’ famous line about baseball from the film, “A League of Their Own,” There is no crying in retail. Three more practical solutions quickly come to mind: Cut expenses, increase sales or cut inventory. Let’s examine all three.
Option: Cutting Expenses
Putting excess expenses on the chopping block is an obvious first step to save some cash. The problem here is that most retailers feel they have already trimmed expenses to the bone. If you have recently renegotiated your leases, reviewed payroll costs, and scrutinized the remaining administrative costs, there may not be much left to cut.
Slashing costs too deeply can actually have a negative effect on business. Several “big box” retailers have experienced this recently as sales have been undermined by deep cuts in staffing and training. Prudence and caution are priorities when examining expenses.
Option: Increase Sales
Increasing sales sounds like a viable option, but how? You can promote more, but you might experience a margin hit which will most certainly raise a banker’s eyebrows. You could buy more inventory, which mightdrive volume, but the risk is that the cash problem could worsen if the additional stock does not perform as it should. You could advertise more, but that would only increase expenses if the ad campaign didn’t pull enough customers in.
Option: Cut Inventory
The third option is to cut inventory. Cleaning out excess stock will generate more cash in the short term. The dilemma, however, is how to consistently build cash over the long term. I prefer the scalpel approach as opposed to the meat cleaver method. Anybody can slash and burn inventory and generate quick cash, but the aftermath of kneejerk business decisions can haunt you for months to come. This is the very reason that I object so strongly to the marketing strategy of 20% off everything in the store, or what is often referred to as “the lazy man’s markdown.”
This promotional approach does little to solve merchandising problems, since the desirable items that couldhave sold at full price are the first to sell at discounted prices. Aside from a momentary bump in cash, the downside is reduced margins and broken size runs. Worst of all, the problem inventory is still a problem.
A Better Answer
Strategic planning is the answer. This means bottom up dollar merchandise planning at the store and class level. Most often a retailer’s line of credit (LoC) is tied to inventory. A banker’s valuation of inventory is what he thinks he can liquidate it for given the outside chance that the bank ends up with the keys to the store.
Because of the way bankers perceive the value of inventory, they get nervous whenever the word “cutting” is mentioned. Understand that to a banker, goods that are a year or two old have the same value as merchandise that was received yesterday. In most cases (although not all), what the banker sees with regard to your inventory is only numbers on a financial statement. Given their reference point, it is understandable, though not always justifiable, why a lending institution might require more collateral when stock levels are reduced. For that reason, it is paramount that you keep the communication channels wide open with the bank if you depend on them for your LoC. Demonstrate to bankers, using sales and inventory reports, that fresh, “balanced” inventory has a better chance of increasing sales than simply having more inventory. It is also a good idea to have your banker visit your store and even attend a management or buying meeting. Treat the banker as part of your management team.
Anyone working in the retail business longer than a week knows the positive effect that new products can have on sales when received at the proper time. Customers don’t visit your store to see what came in last year. It is the constant flow of fresh inventory that drives profitable sales. A strategic merchandise plan that blends inventory balance with properly scheduled deliveries, and timely markdowns, is the pathway to faster turnover, which drives sales volume.
There are few problems in retail that can’t be remedied by increasing sales and cash flow. Hence, my new retail math formula: Cash Flow + Sales Increases = No Problems!