Cash-The Most Important Word in Retail
What is the single most important word in retail?
If you answered… CASH you were correct! But do you really understand what the difference is between cash margin and gross profit? We’ll take a closer look at the difference between the two.
Cash flow is the money left over (or not) after all the costs needed to operate the business have been paid. Cash margin is the difference between sales and purchases. Cash margin dollars are the funds available to pay expenses and build up reserves. Ideally the cash margin should neither be too high nor too low. A cash margin that is too high could indicate that not enough money is being spent on new inventory to support potential future sales. A cash margin too low may mean that too much is being invested on inventory leaving a potential shortage to cover operating expenses.
Consider a store with my keyword000000 in sales. Assume that purchases are $550000 (55%) and operating expenses total $400000 (40%). The purchases and expenses added together equal $950000 leaving a positive cash flow of $50000. If the percentage of purchases and expenses totals a number greater than 100% of sales the retailer is experiencing negative cash flow which over time is not sustainable.
Ways to Improve Cash Flow
- Buying less
- Reducing expenses
- Taking fewer markdowns
- Improving inventory turnover
Remember that a 2X turn in simple terms means that the entire inventory is replaced twice in a year. This means that there is a six month’s supply of merchandise (think stock-to-sales ratio). Another way to look at turn is by the number of weeks of stock. In this example that equals 26 weeks of supply.
If however turnover is increased to 2.5X
Through inventory planning quicker markdowns better-timed deliveries and more attention paid to assortments the weeks of stock would be reduced to about 21. Each week of supply of stock that can be reduced increases cash flow by approximately 1% of sales. So going from 26 WOS to 21 WOS is equal to about a 5% improvement in cash flow. On a million dollars in sales this improvement in cash flow is significant. 5% = $50000!
Cash Vs. Profit
Profit is based on the inventory that was sold and does NOT consider the total spending on merchandise that is still unsold. As previously discussed the cash flow calculation does take into account spending on merchandise purchased but not yet sold. Experienced merchants keep their focus on cash and cash flow.
[YOU PAY YOUR BILLS WITH CASH NOT PROFITS!]
Have you ever been told by your accountant that you have made a profit only to discover that you don’t have enough cash to pay the taxes?
Remember that cost of goods sold (COGS) is not the same as cost of goods purchased and unsold merchandise has no impact on COGS.
Note in the table above that the cash flow is negative ($50000) while the profit is a positive $50000.
Keep in mind that financial reports are based on COGS and paper profit not on purchases and cash flow. It is incumbent on you to monitor the cash margin and cash flow. With proper inventory planning profit and cash flow should be close to the same number. Overbuying will cause the profit to be larger than the cash flow resulting in obvious problems.
Having a Good Cash Flow
Having a good cash flow means you have cash available to pay bills make payroll purchase fresh inventory take a salary and have funds available to reinvest in the business. Optimizing cash flow and ultimately profits requires managing your inventory investment as well as timing merchandise deliveries markdowns reorders vendors pricing and expenses.
Understanding GMROI
GMROI is the metric that ties everything discussed here all together. Understanding this simple calculation is vital. It basically shows for every dollar invested @ cost how many dollars of gross margin are being returned. The formula is gross margin $/Ave. inventory @ cost.
Planning and Forecasting
As you review your planning for the remainder of this year and build your forecast for the next remember to keep cash a priority.
Ritchie Sayner
(Management-One contributed to this article. Links to the cash flow tool (and others!) are available here!)
Article Summary
The article emphasizes the importance of cash flow over profit in retail highlighting the need to understand cash margin which is the difference between sales and purchases. It discusses strategies to improve cash flow such as reducing expenses and improving inventory turnover and explains that cash flow rather than profit is crucial for covering operational costs and reinvesting in the business.
You pay your bills with cash not profits!
Real-World Examples of Cash Flow and Cash Margin in Retail
Understanding the concepts of cash flow and cash margin is crucial for successful retail management. Here are some real-world examples that illustrate these principles in action.
- A boutique clothing store regularly reviews its inventory turnover rates. By increasing its turnover from 2X to 2.5X through better inventory management and timely markdowns the store improves its cash flow by 5% translating to an additional $50000 in available cash on a million dollars in sales.
- A grocery chain focuses on reducing its operating expenses by negotiating better terms with suppliers and optimizing delivery schedules. This strategic reduction in expenses results in a positive cash flow allowing the chain to reinvest in fresh inventory and expand its product offerings without financial strain.
- An electronics retailer closely monitors its cash margin to ensure it is not too high or too low. By maintaining a balanced cash margin the retailer avoids over-investing in unsold inventory ensuring sufficient cash is available to cover operational costs and enhance customer service.
