Root Causes of Inadequate Cash Flow in the Retail Sector

In the previous articles, we have already seen how important cash flow is for the retail sector.

We have also explained how the lack of adequate cash flow can be a cause of concern and even causes many retail businesses to shut down. However, the fact that retail businesses have cash flow issues is an oxymoron within itself.

Ideally, retail is supposed to be a cash flow positive business since customers tend to pay upfront whereas suppliers are generally willing to extend credit.

In this article, we will have a look at some of the common reasons which lead to retailers having inadequate cash flows. The reasons have been explained in detail below:

1. Low Gross Profits: The first and most obvious reason why retail companies tend to face cash flows is because of incorrect pricing. Incorrect pricing means that the retailers are not able to accurately take their overheads into account and raise the markup accordingly. The end result is that the markup is insufficient to generate enough gross profit.

   Now, gross profit is the manner in which retailers earn money which can then be paid off to meet their expenses. When the financial statements of retailers with cash flow issues are analysed, lower than industry gross profits seem to be a common factor amongst all of them.

2. Low Stock Turnover: Stock turnover is a very important factor for a retail company. This is because a large number of their expenses such as rent, salaries etc are fixed. This means that these expenses are driven by time and are not driven by the number of units sold. As such, if a large number of units are sold within a short frame of time, then the cost is apportioned between these large number of units. Hence, the per unit cost is reduced and this helps improve the profitability as well.

   The bottom line is that when a retailer has a high turnover, they are able to generate far more cash than required in order to pay their bills in a timely manner whereas retailers with low stock turnover generally struggle to pay their bills.

3. Excessive Investments: There are some retailers who have a decent stock turnover rate and also have a high gross profit percentage. Hence, ideally, they should not have any cash flow issues. However, these retailers also tend to face cash flow shortages, if they start investing in expansion very aggressively.

   It is common for certain new retailers who are in their growth stage to stretch themselves too thin and use all their cash flow to finance growth in the short run. This may become unsustainable and could lead to money being tied up in growth which could further create a cash flow crisis for the firm.

4. Excessive Debt: A lot of the times, retailers finance their growth or even their day-to-day operations by taking on excessive debt and that too at exorbitant rates of interest. Hence, even if such retailers make generate enough gross profits, they end up paying a lot of that money towards repayment of principal as well as interest on loans which were taken in the past. Also, debt payments tend to be fixed. This means that they need to be paid regardless of the cash flow situation of a business in any given month. It is for this reason that companies which have a lot of debt tend to face adverse cash flow situations.

5. Incorrect Projections: A lot of the times retailers tend to extrapolate their growth while making projections. This means that if they have received a certain amount of success in their current stores, they assume that they will be able to replicate the same in the next stores that they open. A lot of the times, these projections turn out to be overly optimistic. This means that the retailers are not able to generate as much sales or their costs go out of control. As a result, they face a difficult cash flow situation.

6. Crisis Events: Retailers often face seasonal variations and industry cycles. This leads to their cash flow being impacted during that period.

   Retailers who do not maintain healthy emergency funds or do not have access to organized financing from where they can borrow money at a reasonable cost tend to end up in cash flow problems as a result of these crises. It is important for retailers to plan for such situations beforehand.

7. Low Bargaining Power: There are many small retailers who do not have enough bargaining power to negotiate with suppliers. The same suppliers may offer a deeply discounted rate to a bigger retailer. However, they may not offer a discounted rate to a smaller retailer. As a result, along with having a higher cost of capital, the retailer will also have a higher cost of operations i.e. a higher purchase price.

From the above points, it is clear that there are certain parameters which retailers need to be aware of while planning their cash flow. It is also evident that even though retail is generally a business which can be considered to be cash flow positive, it is possible for a retail company to run into cash flow issues.