Retail Metrics: Cash Crunch 2023?

Given current and expected business conditions, nothing is more important for home furnishings retailers right now than being aware of the five important sources of cash.

This year is shaping up to be another highly profitable year for many furniture retailers. This is in part due to the resolution of supply chain issues. As inventory comes in faster, the backlog of open sales is being delivered and recognized as revenue. Even though profitability has been decent for most, faster-flowing inventory caused inventories to rise which has had negative impacts on cash positions. At the same time, written sales have declined for many in the industry. Eventually, written sales, delivered sales, and inventory flow will stabilize. As we move towards this stability, possibly during a recessionary period, a complete understanding of how to measure and preserve cash flow will be essential.

Understanding the Five Sources of Cash

Without considering loans, shareholder draws or taxes, cash is affected by five key source drivers: profitability, inventory, customer deposits, receivables, and payables.

Source #1: Profitability

Delivered Sales – Delivered Cost of Goods = Margin – Operating Costs = Pre-tax Profit.

Inventory is not an official expense until it is sold. However, it is the most consistently purchased asset in a retail business and one that fluctuates the most. That’s why keeping inventory at an optimal dollar level and an ideal proportion to sales can have significant benefits to cash flow. When receipt and delivery of inventory are balanced, there is little direct cash impact. This has not been the case recently in most retail operations because purchases received have accumulated faster than delivered sales. Additionally, there are hidden carrying costs associated with excess inventory, extra people, facilities, movement and damages.

Source #2: Inventory

Starting inventory + purchases received – merchandise delivered and picked up = ending inventory.

As retailers’ backlogs of open sales get delivered, the cost of merchandise and freight will be decreased to produce margin. With freight costs being uncertain over the past couple of years, realized margins have been a moving target. Those retailers who achieved solid margins had the foresight to plan for higher freight costs. Operating costs include all the other expenses it takes to run a business. Many operations consistently achieved a ratio of 40 percent operating costs to sales over the past couple of years. However, should delivered business slow down substantially, fixed expenses will put pressure on operating costs and profitability. In the long run, profit has the largest impact on cash available for businesses, since other factors like inventory will eventually normalize.

Source #3: Customer Deposits

Starting deposits + deposits on written sales + COD balances collected – delivered sale deposits = ending customer deposits.

Customer deposits are a massive source of funds for most furniture retailers due to the time lag between written and delivered business. Even operations with few custom orders experience this effect as product must be temporarily warehoused prior to delivery. Deposits are, in effect, a loan from customers until their merchandise is delivered. The more written sales a retailer has and the higher its deposit requirements, the greater its total deposit amounts will be. If deposits coming in equals deposits on delivered sales, there is little impact on cash. If, however, written sales fall, fewer deposits will come in, resulting in cash decreases.

Source #4: Receivables

Starting receivables + new receivables on delivered sales – receivables on delivered business collected = ending receivables.

Most businesses now carry receivables via financing companies so sales are often fully collected when merchandise is delivered or picked up by customers. Even so, there can be huge impacts on cash flow due to the volume of financing a retailer does. This is due to the collection process on finance sales, the expense of those sales and the proportion of finance sales. For example, if a business shifts a sizable portion of its sales to finance sales without increasing volume, a cash decrease will likely result. This is because fewer deposits are realized, greater expenses are incurred, and the collection of receivables is typically not received until days after delivery.

Source #5: Payables

Starting payables + new payables – payables paid = ending payables.

Accounts payable can be another substantial liability on a furniture retailer’s balance sheet. If payables are paid down at a faster dollar level than the dollar level of those coming in, cash will fall. As is the case for inventory and deposits, balancing incoming payables with outgoing payables produces fewer cash swings. Taking discounts for paying earlier will produce a lower cost of goods but the associated effect this has on lowering cash should also be considered. Paying with credit cards to extend payables further and possibly provide some cash-back incentives should also be considered in the mix.

Measurements Related to Cash

There are five additional measurements related to cash position that can help retailers understand cash flow. Each of these should be reviewed on your cash flow statement at least monthly.

“Categories such as rugs, accessories and lighting may have a dollar-displayed target inventory, for example. For other categories a percent of sales might be used.”

Inventory-to-Written Sales Metric:

Inventory to written sales = Average Inventory / Projected Written Sales.

This metric can help determine the “sweet spot” for your business model. Every furniture retailer has its own sales, marketing and merchandising strategy. There is a wide variety of ways individual operations warehouse inventory. That’s why the optimal percentage of inventory-to-sales can differ.

The inventory-to-written sales metric will likely be under 15 percent for fast-turning, low-cost basis retailers. For higher-end operations, it may be above 25 percent. For a stocking only model, it may be somewhere in between. Whatever your merchandise mix is, it’s a solid strategy to stay within a comfortable percentage range to avoid problematic cash positions. For example, an increase of only one percent in inventory-to-sales ratio for a retailer doing $20 million in sales has a cash impact of plus or minus $200,000, or a $400,000 possible swing.

Customer Deposit Change Metric:

Customer deposit change = (Customer deposits at start of period – Customer deposits at end of period) / Customer deposits at start of period x 100.

Measuring the change in customer deposits from month to month is a good way to track deposit trends. Provided that deliveries are being consistently pushed out to customers, increases in deposits over time usually reflect expanding business. If deposits were $1.1 million at the beginning of a month and $1.2 million at the end, deposits will have increased by 9 percent over the month. Watch out for multiple months of decreases in this metric.

Cash Ratio Metric:

Cash ratio = Cash / Current Liabilities.

The cash ratio metric is a measure of how much cash a business carries versus its current liabilities. Current liabilities are typically customer deposits, accounts payable, and any other debt due in under a year. As you take action to preserve and maximize cash, you should see this number stabilize. In my experience, a comfortable level would be above half of one percent.

Burn Rate Metric:

Months of operating cash = Cash / Monthly operating expenses.

This ratio shows how many months of operating expenses the current supply of cash will cover. It measures how long it will take for the current cash supply to be depleted if operations cease and expenses remain the same. Burn rate is most often used for start-up businesses, but can also be helpful for ongoing operations. Typically, any number above three is a solid target for retailers in our industry. Like cash rate, if there are successive periods of decline, right-sizing the operation will become necessary.

Changes in Cash Flow Statement:

Changes in Cash flow = Starting Cash + Net Income + Increases in non-cash assets + Increases in liabilities +/- Owner Draws = Ending Cash.

The Changes in Cash Flow statement is one of the three critical financial reports. The other two are the Balance Sheet and the Profit and Loss Statement. The Statement of Cash Flow is the most important of the three. This is because it combines all the important elements affecting cash, including sales, margins, operating costs, net income, swings in inventory, customer deposits, payables, debt and equity. Review it weekly if cash is a concern.

Preserving & Maximizing Cash

There are several strategies retailers can use to leverage the five source drivers of cash to maximize cash flow. If you successfully execute these as appropriate, you will see improvements in your cash flow position over time.

Profitability Strategies:

• Implement practices to maximize the speed of delivered sales and reduce inventory in the warehouse.
• Faster delivery scheduling with text automation.
• Customer self-scheduling of delivery.
• Pick-up notifications.
• Over-schedule outgoing trucks to hit capacity limits rather than under- scheduling.
• Maximize margins by factoring in possible cost increases and higher freight rates than anticipated.
• Maximize the sales of intangibles such as protection plans, service and delivery income.
• Merchandise for higher margins. Focus on best sellers. Buy deep in hot-stocking items and upcharge for customization.
• Keep operating costs within the targeted budget. Compare budgeted written sales and delivered sales to get ahead of any downturns.

Inventory Strategies:

• Set standards for buying by product category. These standards can be set on inventory to sales by category or by GMROI (Margin dollars / inventory).
• Limit purchases of new un-tested goods if under target inventory levels. Consider incoming stock as well.
• Categories such as rugs, accessories and lighting may have a dollar-displayed target inventory, for example. For other categories a percent of sales might be used.
• Have an avenue for reducing despised and non-selling merchandise. Bigger operations ($30+ Million) often need an outlet or clearance center. Smaller operations need to set aside a selling area in the store or warehouse for these blowouts.
• Re-buy best-sellers based on current or “real” lead times, stock levels and personal judgment. Be skeptical of computer-generated historical numbers in today’s environment.

Customer Deposits Strategies:

• Require payment in full at the time of the written sale if merchandise is in stock or incoming on order.
• Eliminate CODs.
• Establish a custom order payment policy. This can be 50 to100 percent of written sales. I recommend asking for full payment in advance, as in most cases these orders are usually non refundable. If there is an issue later, a store credit may be issued.
• Drive written business! Focus on sales productivity, follow-up, close rate, and return customers.

Receivables Strategies:

• Seek to reduce receivables with finance promotions. Offer a reduced-price tier as an incentive for customers to pay with 12-month financing or to get points by using a credit card. Just because they are shopping while you are doing a financial promotion does not mean they want to make monthly payments.
• Have a certain dollar amount down payment required for finance sales.
• Explore options with buying groups and finance companies for pre-funding opportunities.
• Use automatic collection technology to process any after-delivered sale collections.

Payables Strategies:

• Take the discount if your cash is at a desirable level.
• Extend payables to the due date and use checks to pay if an increase is desired.
• Use credit cards provided there are no extra fees. Pay off the full amount at the due date so no interest charges are incurred. You can gain extra time and non-taxable rewards.
• Go beyond your due date only when there is little risk of harming your relationship with vendors delaying shipments.
• Submit vendor credits and take chargebacks with efficient service techniques.

Conclusion:

Keep track of all the source factors that affect cash flow as a first step towards stabilizing and improving it. Then, put in place appropriate strategies to help your operation emerge in great shape from what is likely to be a tough period ahead. The past couple years have been full of challenges and opportunities for retailers in our industry. If you stay vigilant and proactive you will adapt and persevere no matter what may come your way.