A Living, Breathing Thing; Cash Flow Management

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That’s actually the way he put it to me. Many years ago, the CEO of a company that had been in deep financial trouble and had clawed its way out said, apparently in frustration with my failure to understand his concept, “You don’t understand, the cash flow is a living, breathing thing.”

 Now I know he was right. You don’t just create a spread sheet and manage cash. Especially in conditions of seasonality or fast growth you massage, tweak, manipulate and coerce it. You plead with it and threaten it. You spend too much time trying to get the numbers just right even though you know they will be different the next day.
 
Like a complex computer program with some interesting bugs, cash flows sometimes seem to have personalities. Once you learn about the dynamics of that personality, you’ll be an effective cash manager.
 
In the beginning, most small business owners, be they retail or brands, manage their cash flow out of their back pocket. They know their bank balance and checks outstanding. They understand what bills have to be paid when and can estimate their cash receipts pretty closely. When the numbers are small, sales steady, and the business relatively simple, this works fine.
 
But things change with seasonality and growth. Other people are involved in decisions about receipts and disbursements. The sheer number of factors means keeping it in your head gradually, almost imperceptibly, becomes impossible. A business owner’s tendency not to share critical financial information with others can exacerbate the situation.
 
If you now recognize that you’ve gotten to the point where you have to take a little more formal and proactive approach to cash management, what should you do?
 
First, let’s talk about what we mean by cash flow. We don’t mean the traditional financial analyst’s definition of net income plus non cash expenses like depreciation. Regardless of adjustment for traditional non cash items, the accounting measurement of net income has very little to do with cash flow as I’ll explain below. You can have income and no cash. Not all that unusual a situation in the snowboard industry I’ve noticed.
 
Instead, look at your balance sheet. The assets are what you have and the liabilities are what you owe. The balance sheet is calculated at a particular point in time. Think of your balance sheet as a telephone pole on your street (bear with me on this analogy for a minute). Down the street is another telephone pole. It’s your balance in, say, two months. There’s a bunch of wires strung between them. Instead of electric current, the wires, in this analogy, carry the transactions that result in the changes from the balance of the first telephone pole to the second. Your cash flow is like a voltmeter. It measures the current and changes in the current in the wire.
 
How could you have lots of income and no cash? Let’s say that in the two months between telephone poles one and two you sell $300,000 dollars of merchandise. But the terms under which it is sold don’t require payment for 90 days. Two months later, your accounting based income statement will show sales of $300,000 and profit of whatever your margin after expenses is. But you won’t have a cent in a bank from those sales. Income, but no cash flow. Retailers, of course, are fortunate in not having to worry about that exact scenario since they don’t typically sell on terms, but it’s still important to understand the principal.
 
Now of course if you’ve sold $300,000 in the previous two months under the same terms with the same expense structure, then you could expect to collect that money in the current two month period. So you would have cash flow. And as long as your sales and expenses were the same from months to month, your net cash flow would basically equal your accounting income.
 
I guess everybody who has the same sales and expenses each month of the year can stop reading now. But in case your business isn’t quite so consistent, let’s talk about a simple way to begin to forecast your cash flow and develop good instincts about it.
 
First, let’s look at our two telephone poles. In the two months between one pole (balance sheet) and the other, the dollar amounts of what you own and what’s owed you will change. The net change in those amounts represents the result of all the transactions that occurred during that period of time. For example, let’s look at the inventory number on the two balance sheets. Say that at the first balance sheet date, inventory is $500,000 and at the second it’s $600,000.
 
It probably didn’t make that jump in one mighty leap. Product came and product went with the result being an inventory level of $600,000 at the date represented by the second telephone pole. At different times in the period, inventory may have been well over or under either of those numbers. But at the end of the day, you know you’ve got an extra $100,000 tied up in inventory. So you’ve used an additional $100,000 over that period to buy stuff. Had inventory gone down during that period, you would have a source of cash because less was tied up in inventory. That is, you would have converted inventory into cash.
 
Now, let’s look down at the bottom of the telephone poles in the what you owe section (liabilities) At the first telephone pole you owe the bank, say, $100,000 and at the second, $150,000. If you owe more, than you’ve taken in more money to work with. You’ve increased your cash by $50,000. If bank borrowings had gone down $50,000 instead of up, you would have decreased your cash position by $50,000, though you might be sleeping better at night because you owed the bank less.
 
You can see that the “what you own” (asset) accounts at the top of the telephone pole work exactly the reverse of the “what you owe” (liability) accounts at the bottom. Increase the asset accounts and you tie up cash. Increase a liability and you create cash to work with.
 
Decrease an asset and you free up cash. Decreasing a liability is a use of cash.
 
Probably, I’ve been doing this too long because otherwise I wouldn’t say that there’s a certain elegance in how the various accounts all work together, each related but at the same time independent of the other. Study a couple of balance sheets and think about how the accounts changed. When you begin to have some intuitive comfort with these relationships, you’re well on your way to good cash measurement and management.
 
To be really on top of things, you still need your voltmeter to measure the flow of current across the wires and the changes. Do it on a computer or a piece of paper. Here’s the format I recommend and use myself in various business situations. There’s no magic to the categories. Change them to reflect your business situation.
 
                                                            Jan.      Feb.     Mar       Etc.
Beginning Cash Balance
 
Sources of Cash
            Cash sales
            Collection of receivables
            Line of credit borrowing
            Interest income
            Other
Total Sources of Cash
 
Total Cash Available
 
Uses of Cash
            Product purchases
            Repayment of bank line
            Payroll
            Taxes  
            Rent
            Utilities
            Phone/fax
            etc.
Total Uses of Cash
 
Ending Cash Balance
 
The beginning cash balance is whatever is in your checking account plus (if you’re a larger company) any liquid investments you may have. The ending cash balance each month becomes the beginning cash balance for the next period. Depending on how quickly your situation is changing, your estimate of expenses can usually be based on your historical experience. But remember that just because you get your phone bill in July doesn’t mean you pay it that month. Typical many of your operating expenses will be paid in the month following receipts, and your cash flow has to take this into account.
 
If you’re a retailer, a lot of your product purchases are paid for well after the product is received, and the cash flow has to reflect that.
 
If you already have a budget and are creating and tracking it on a spreadsheet, use the program to adjust your budget to manage the differences between the budget and cash. If you don’t have to pay for your product for 90 days, reflect product costs from August as a cash expense in November.
 
Don’t get too caught up in the process of creating a perfect model. Get it done and work with it. Modify it as you learn more. Look at your projections versus what actually happens. Creating the model isn’t really where you get the benefit. Using it and watching the variables change with each other is. It’s a lot like learning a language. You only get better with practice and as soon as you stop speaking it, you start to lose it.
 
Print it out and hang it on your wall. As changes occur, use a pencil to change entries. Consider the impact of each change on future months. When there are so many pencil marks that you no longer can have a feeling for the cumulative result of all the changes, make those changes on a clean version, print it out and start over again.
 
You’ll quickly find that it is a living, breathing thing that responds to your attentions by surprising you less and less.

 

 

Self Help for Core Retailers; The Coastline Model

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Hi, I’m back. This was just too interesting not to inflict myself on. And I imagine O’Brien couldn’t find anybody else willing to touch it. 

From the last issue of TransWorld Biz, you may remember that our hero, Sean Kennedy of New Zealand, had started a company called Coastline owned by, so far, 42 core surf shops in New Zealand. The purpose of Coastline, as reported earlier, was to provide small retailers with the scale and collective resources to allow them to create and sell, just like the larger chains, their own store brand (Coastline) which they could control and earn a higher margin on. Seems simple, but I imagine that organizing a group of independent retailers and getting them to cooperate is a lot like herding black cats in the dark. But you know what? I like it.
 
I like it because it’s retailers taking the bull by the horns and helping themselves to deal with the issues we know exist for specialty retailers. I like it because it represents a realistic evaluation of how the retail market is evolving. I like it because it may be the difference between success and failure for some of the specialty surf retailers we all seem to believe are critical to the industry.  I like it because it can evolve to be much more than it is right now. I like it because after talking with Sean, I’m convinced it’s being done in a professional and businesslike way.
 
And I like it, truth be told, because I love anything that stirs up the pot like this. This is not “more of the same” to quote me.
 
Why Now?
 
This ought to be a really short section. Being a specialty shop in surf, or in any action sport has become a really tough business. People who aren’t either growing, or increasing their gross margins, or both, are going out of business. Growth happens, and if the market is growing I guess you can expect to get your share if you do things right. If it’s not, or if you want to grow faster then it’s hard work and costs money.
 
It would sure be easier to make money if fifteen or even a higher percentage of your sales were from a product that made you a 60% gross margin instead of 38%. It would be even nicer if some of those sales were incremental because this product represented a great value for your customers.
 
Let’s see, 15% of sales of one million is one hundred fifty thousand. Twenty points on that is $30,000. But if, let’s say, $50,000 of those sales are new, then you get $20,000 on the incremental gross margin plus 60 percent of those $50K in new sales, so the bottom improvement, more or less, is a total of $50,000 in additional gross margin. Granted, I just pulled those numbers out of my posterior parts (or “arse” as they call it in Dublin). But it’s kind of an interesting calculation, don’t you agree? 
 
So that pretty much deals with “Why Now?”. Hey look, I did keep it short.
 
How Do They Do This?
 
A few years ago, I had car insurance with what was called a mutual insurance company. That meant I paid my premiums, based on how much insurance I wanted and how many little old ladies I’d run over while intoxicated, and at the end of the year, depending on how the company did, I got some money back. It could be more or less depending, for the company as a whole, how many of those little old ladies were unhappy about being crushed.
 
Sean wasn’t all that forthcoming about details, but said my insurance analogy wasn’t too bad. Basically, the stores that are owners put up capital each year based on how much product they want. The company designs, gets made, and delivers the product. Coastllines also has to pay its people and own expenses. But it isn’t trying to show a big profit- it’s goal is to help its owners/members make more money. 
 
Coastlines is a bit cautious about what kinds of shops they allow to join the company. For now, they have to be surf shops, but equally important, they have to have a certain level of financial strength. Coastlines is no more interested than any brands in customers, even if they are owners, who can’t pay their bills. Makes sense to me.
 
Of course, that means that the shops who most need this kind of help are less likely to get it, but I’d hate to see the whole concept endangered because of the problems of a few owners, so I guess that comes under the heading of “oh well.”
 
The design work is all done by Coastlines, but they aren’t looking, in Sean’s words, “To create the image for 16 year olds. That’s Quiksilver’s and Billabong’s job. We just want to make an attractive product that sells well and gives the retailer a good margin.”
 
So they are going to be a bit behind the curve and look for what they consider to be the best and safest ideas they see. I suppose that might annoy some people but I can’t say that I see that as being different from what major retail chains do when they do private lable.
 
Sean was, as I would have been, tight with his numbers. That is, he didn’t give me any. But let’s generously assume that his 42 stores average $1,000,000 each annually in sales. Let’s say 20% of their business so far is Coastlines. If those numbers were anywhere near accurate, total retail sales of Coastlines would be (42 x 1,000,000) x 0.20 or $8.4 million New Zealand dollars. I want to emphasize again that I have no idea what the real numbers are, but I’m working towards making a point here.
 
Of course, Coastlines is selling the product to its owner shops at its cost plus some mark up. You pick the markup you think is appropriate and decide for yourself what Coastlines’ sales as a company are.
 
My point is that Coastlines needs to get bigger before it can really take advantage of economies of scale and have buying power with factories. Still, it’s way beyond what a single shop could hope to do already, and that’s why Sean thought it was so necessary.  How might they get bigger?
 
Future Plans
 
This is the intriguing part isn’t it? Sean was closed mouth about how Coastlines might evolve, but that was fine with me. I’ll have a lot more fun envisioning possible futures for Coastline without being encumbered by facts. He did let a few things slip. He allowed as he’d had some calls from different people in different part of the world and in different sports. And when I asked about having other action sports shops as owners, he said, “Not yet.” So he’s thinking about it and, I’m expecting, will be pulled toward growth and other avenues of expansion besides surf. It will be fun to watch.
 
One thought I had was that there wasn’t any reason that Coastlines couldn’t easily function as a trade association as well and offer benefits and services similar to the Board Retailers Association in the US (Join BRA if you haven’t already). And many months before I ever talked to Sean or heard of Coastlines, I had heard rumblings of some form of retailer cooperation from some pretty solid US retailers. If it works in New Zealand, I can’t see any reason it shouldn’t also work in the States. 
 
Right now, Coastlines’ product line consists of wet suits, some simple mens’ and women’s apparel, and a couple of pairs of shoes and sandals. The point is that it’s soft goods and, with the exception of wet suits and maybe sandals, the design and sourcing translates from surf to skate and maybe to some other places with little difficulty. Most retailer, even core surf shops, are selling lifestyle street wear to non participants. I can’t see any reason why Coastlines couldn’t move in that direction and find an attractive source of growth that would be consistent with its core mission. If surf shops, in the midst of unprecedented growth in surfing, need this kind of support, how much more must other kinds of sports specialty shops need it?
 
And the Brands?
 
Well, hell, I assume they would prefer that everybody buy their stuff and that there was no private label business from anybody. And they are probably still watching BRA out of the corner of their eye to see if Roy Turner is going to turn it into a buying group, which he keeps saying is not his goal. They’d also like it if all shops always paid their bills before their due dates and never returned any warranty product. And myself, I’d like to win the lottery, but I’m not holding my breath.
 
Sean and I, and maybe even most of you, agree that it’s too bad that distribution has become as wide as it has. And we wish the specialty retail environment hadn’t gotten quite so tough and competitive. And we’re not quite sure we’re thrilled with all the company stores being opened.
 
And then we shrug our shoulders and go, “If I was a brand, I’d be doing the same things.” We hope it turns out to be good for the industry. We know it’s the nature of competition and will be good for the brands who do it best.
 
But unlike some other people, Sean isn’t hoping brands won’t open stores. He isn’t bitching and moaning to his supplier when it open a shop down the street from him. He’s said, “Okay, this is how it is. How can we respond in a positive way that supports the shops that everybody in the industry thinks are critical to our industry’s future?”
 
If the shops aren’t incubators for new ideas and brands, if they aren’t aware of trends, if they and the brands don’t keep the lifestyle alive, then it’s just a sport and is less of a priority to the participants. And then it’s price that matters.  Let’s hope Coastlines continues to succeed.

 

 

“Hey Look! Real Retailer Numbers!” What’s to Learn From Them?

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For a while now, I’ve been carrying around in my back pocket the National Sporting Goods Association’s 2004-2005 Cost of Doing Business Survey.

I have no idea why they call it that since it obviously doesn’t contain any numbers from either 2004 or 2005.
 
Well, never mind. They do it every other year and collect actual financial date from sporting goods retailers of various types and sizes. They got 314 responses to their survey. 226 of these responses were from what they called “specialty” stores. 217 (not all “specialty”) were from retailers with only one storefront. Now, these aren’t skate shops. They are bike, ski, camping, and exercise/fitness stores. Look, I’m sorry and if any of you know of a detailed survey of the financial performance of skate shops you should by all means write an article about it.
 
But as I’ve argued on a number of occasions in, uhh, well, another magazine…….. Ohhhh, I feel pangs of guilt.  I’ll get over it.
 
Anyway, I’ve argued that the problems of specialty retailers in sporting goods are more the same than they are different at this point so deal or do your own survey. Based on the survey, here are some things you might want to think about as you manage your shop.
 
Earn 4% With No Risk!
 
That’s the current pretax yield on 10 year U.S. Government treasury securities. Generally that’s considered to be a risk free investment. Junk bond funds, according to one source, typically yield about 8% higher than Treasuries, or around 12% currently.
 
For all 314 of the surveyed retailers, not all of which are specialty, the before tax return on net worth  (which is a lot like yield) was reported to have declined from 15.8% in the 1993-94 survey to 9.2% in this survey. That’s a decline of 42% and brings us well under the junk bond fund yield I’ve included for comparison purposes.
 
For non financial people, the word “junk” can have a negative, almost personal, connotation. But it’s just a low rated bond that has a greater chance of default than an investment grade security. Those of you have had to borrow money to run your shops and could only do it with a personal guarantee know that however your risk compares with a junk bond fund, the lender didn’t consider the risk low.
 
The survey also shows that, over the same period, the before tax return on assets for all 314 respondents fell from 5.7 to 3.9 percent. In the intervening surveys it fluctuated at higher levels of from 6.4 to 9.9 percent, but 3.9% is where we are in the latest one. The return on asset number is not necessarily comparable to a yield, but you can see that the trend is the same.
 
Net profit before tax as a percent of total revenue fell during the same period from 3.0 to 1.8 percent, though it was higher in the intervening surveys.
 
On the positive side, gross margin rose from 36.4 to 40.8%. That’s an indication, I think, of increased sales of shoes, apparel and other soft goods. I’m not prepared to believe that hard goods margins have increased. Inventory turnover improved from 2.4 to 2.7 times.
 
Wait a minute- if gross margin is up and inventory turns improved, how come profitability is shot to shit? You don’t have to be Sherlock Holmes to deduce that the cost of running a retail store has gone through the roof. But you already know that, don’t you?
 
The survey only supplies these kinds of time series numbers for the complete sample- and they don’t supply balance sheet numbers across time. But I will tell you that the risk associated with running a shop has grown. You’ve watched as people open fewer shops and more close and you know the same thing.
 
So, higher risk and lower returns. That risk free 4% return is starting to look sort of interesting. What can you do about this?
 
Grow, Damn It.
 
Just to get right to the heart of the matter, below is a chart you should look at with data taken from the analysis of the 226 specialty shops in the survey.
 
Store Revenue
Owner Comp. & Profit to Revenue
Total Debt to Total Assets
Less Than
$500,000
7.6%
79.7%
Greater Than
$2,000,000
8.8%
56.2%
 
 
In percentage terms, bigger stores earn more and take less financial risk. Their profit margin is almost 16% higher and their leverage is 29% lower. Be bigger. And recognize that it’s hard to see a financial model that makes sense for very small stores. For those of you who are small and are making it, I’d love to hear from you to find out how. That would be worth an article.
 
Be Important to Suppliers
 
I suspect most shops get a big chunk of their sales from a relatively small number of brands. Those brands are critical to your shop’s success. Bluntly speaking, you can’t survive without most of them. But as they grow, and as their distribution widens, the financial importance of your sales to their success inevitably declines. You can’t differentiate yourself with your numbers, but you can with your input.
 
Tell them what’s selling or not selling and why. Give them insights into trends. Send them a list of comments kids have made about their brand- or about other brands. Don’t just wait for the rep to come in. Go right to the sales manager, or higher in the organization, and tell them. Don’t do just what they expect or what they ask for. Do more. Surprise them. I bet it’s not really much work because not that many retailers do it.
 
Oh, and pay your bills on time. If you don’t, your credibility is shot to hell no matter what you do and you’re just another problem. By the way, my definition of “on time” is that the check arrives at the supplier on the due date.
 
Tell the brand what you’re doing to support it. Be perceived by the brand to be important to its success in your local area. Become the shop the senior managers want to visit when they are in town. In turn you can expect?  Well, what would you like? Ask for it. Now, you have the credibility to get it.
 
Not for a moment am I suggesting that this can, by itself, overcome the apparent financial disadvantage of being a small retailer. Indeed, it probably only helps once you are well established.
 
Live the Numbers
 
I recognize it’s inconvenient when some pencil pushing, number crunching, calculator carrying, green eyeshaded SOB like me comes along to present you with inconvenient facts. If you feel like it, shoot the messenger. Lord knows, I’ve been shot often enough. I await your slings and arrows.
 
It’s difficult, I suppose, to deal with some of this stuff because we didn’t get into this industry as a clever shortcut to becoming accountants. Still you need to be one now more than ever. Look dispassionately at your numbers. How does your business compare to the NSGA numbers? If the industry, and the retail environment, continues to evolve as it is now, and the financial trends in the NSGA report continue, how, to put it bluntly, will you survive and prosper? You can, you know. And the industry needs you to. But you have to plan for it.
 
The NSGA can help you. So can the Board Retailers’ Association and the Retail Owners Institute. Don’t sit on your ass and wait to be swallowed by the whale (hell of an accidental analogy) like Queequeg in Moby Dick.
 
About the Numbers
 
It’s my personal belief that it’s the retailers who are doing fairly well, and who have the systems to provide the requested numbers without too much work, who are likely to respond to surveys. If so, it skews the numbers towards showing better performance. Also remember that in small businesses, the owner’s financial position and the business’s are synonymous. Return on investment may look lousy only because the owner is taking a bunch of money out. That’s why I used owner’s compensation plus profit to revenue in the table above. Finally, beware of small sample size. 314 retailers may sound like a big sample, but once you start dividing them up into full line and specialty, by store size, by revenue, by type of store, some of the group sizes can begin to get a bit small. That’s why the NSGA has used the median, rather than the mean in its calculations. The mean can be distorted by a couple of extreme values- especially as sample sizes get smaller. The median doesn’t have this problem.