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A good net profit percent does not always equal cash in the bank.  Many store owners find themselves showing a profit but still being short on cash.  Owners tend to focus on sales as the single, most important number to track.  This is understandable since many managers and owners equate generating higher sales with bonuses as well as the achievement of a major goal.  But, have you ever talked to an owner who reported that their business was growing rapidly and to such an extent that they were having problems meeting payroll and vendor payments?  While sales growth can and should produce a positive cash flow, it does not always and it is imperative that you, the store owner/manager, exercise firm control over all aspects of cash flow.  After all, cash flow is the blood flow of your business.

What is cash flow?
Very simply put, cash flow is the cycle of money through the business.  It is called a positive cash flow if it has increased by the end of the month or a negative cash flow if it decreases.  A more technical definition is:  The difference between the available cash at the beginning of an accounting period and that at the end of the period. Available cash comes in from sales, short-term loan proceeds and lines of credit, investment interest paid to you and/or the sale of assets.  Cash outflows, or decreases in cash flow, includes cash paid for operating and direct expenses (like payroll and utilities), taxes, debts and mortgage payments (and interest payments), and the purchase of assets (such as new fixtures or a new PC) and inventory.  That is cash flow. 

Just consider transactions such as loan payments or any cash outlay that does not affect Net Profit.  The store may purchase new equipment or update by remodeling the store or dressing rooms.  The cash outlay (outflow) may be thousands or even tens of thousands of dollars, but the expense that shows on the income statement is minor in comparison (depreciation expense) and it can take many years to re-coup the cost (original cash outlay).  Note:  Depreciation, while it does reduce the value of an asset, does not directly affect cash flow. 

Cash Flow matters because without adequate cash, you cannot meet your obligations.  Many obligations cannot be put off without penalty (taxes, for example).  Obviously, penalties also hurt cash flow since your cash requirements increase.  And how many of you employ a sales staff who will work without receiving their paychecks on time?!  You may also find it difficult (or impossible) to get shipments from your vendors.  Most vendors work through factors and factors do not care if you have done business with this vendor for ten years.  If you are late with your payments, they will not release the shipment of merchandise for your store.

Why Plan for Cash Flow?
Cash flow is all about timing. If a business is not prepared for necessary large payment outlays (inventory, income taxes, new fixtures, etc.), it will affect the cash flow.  The objectives of cash flow planning are numerous:

  • To have enough cash available to pay your bills on time
  • To use excess cash funds wisely (and to have excess funds to use)
  • To know if you will need to borrow in the coming year, when and approximately how much, and when you will be able to pay it back (very important to lenders) 
  • To be able to plan cash outflows for expansion, hiring more personnel or trying a new line of merchandise

How can you improve your cash flow? 
These suggestions are not one-size-fits-all.  If you are experiencing problems with your cash flow; here are some suggestions to help the situation.  Some, like cutting expenses, should be a daily goal for any business but others, like borrowing against a line of credit, may not be an available choice.

1. Cut expenses where you can.  But, remember, you want your customers to have a positive shopping experience so keep the selling floor glittering, bright and cheerful.

2. Increase sales without increasing inventory.  Translated, that means have a lean inventory.  Buy only what you expect to sell this season.  Get a Open-To-Buy, keep it updated and use it.

3. Sell fixed assets or other company fixtures.  If you have equipment that you seldom or no longer use, sell it.  The extra funds could help you conquer a tight money situation.

4. Reduce the size of your inventory by increasing your stock turn rate.

5. Borrow against the store's line of credit; but be careful.  Both the interest and principle payments will decrease your cash flow in the coming months.

Note that 2 of these suggestions relate to inventory reduction.  Often buyers and owners seem to purchase under the theory that it is better to warehouse merchandise "just-in-case" or because "I-got-a-great-deal."  It is a common idea especially when the economy is good and growing; however, it brings havoc during times of economic struggle or recovery that could end with a GOB sale.  Use your Open-To-Buy correctly and purchase to support your Open-To-Buy. 

Negative Cash Flow Characteristics
A dwindling cash supply creates many other issues for an owner to contend with.  Store expansions may be postponed indefinitely.  The owner's time and attention is taken away from selling by phone calls from irate vendors demanding their payments.  Besides the effect on your employees morale (they are generally taking their lead from you) and your own stress levels from worry about paying the bills, the following is a list of common measurements that indicate poor cash flow. 

1. A current ratio of less than 1.0.  (The current ratio is current assets divided by current liabilities.)  Remember that the current ratio serves as an indicator of a business's solvency.

2. Operating at a net loss for several years.

3. A net sales to net worth ratio of less than 2.0. (Net Sales divided by Net Worth).  This serves to indicate how productively management is using the store's equity.

4. Annual sales growth rate less than 5%.

5.  Sales per square foot decreasing from one year to the next.

6. Total Liabilities to Net Worth ratio.  (Total Liabilities / Net Worth)  If it is more than 1.0, your creditors have more of an investment in the company than the store's owners!

The benefits of a cash flow budget are real.  It is a rare experience for a banker to see one and generally bankers are wary of borrowers who have to have money now. Bankers like the cash flow analysis because it shows them how the borrower expects to pay them back (remember, Cash is still King).  It shows foresight in how you truly plan to use the borrowed money and offers an explanation of the how and why you need money.  Enough emphasis cannot be placed on comparing planned with actual (historical) results.  Explanations for variances are essential!  When the reason you are caught short is that you failed to plan, a banker may not be very interested in helping you out.  After all, you may have not adequately planned repayment either.

Plus, while you are checking and writing out your explanation, you may learn that there was something you could have done to have prevented or reduced the problem.  Remember, any cash flow plan must include a contingency plan or "slush fund" to allow for potential new opportunities or unforeseen challenges that will come.

To sum it up:  "Profits cure a lot of ills, but cash flow pays the banker's bills."