How to keep your hardware store liquid

By Peter Cox May 01, 2015 Industry news

There is more to good financial management than simply keeping an eye on break-even performance. The list of key performance indicators you can monitor runs into the hundreds.

I do not expect you to know and use each and every one of them. I have however, to make life easier for you, isolated those few indicators which are so crucial to your business that you must take the time to understand and utilise them.

There are just no two ways about it: in today’s complex world, some things are absolutely necessary to the management of a successful hardware store.

These key performance indicators all relate to the concept of liquidity. Whether you understand this concept or not, this is a lesson you can never learn well enough.

Failure to prepare for adequate liquidity is a serious business blunder. After all, the real reason most hardware stores fail is that they run out of cash.

Put simply, liquidity is the ability to pay your bills. Liquidity answers the question “Does the store have enough cash plus assets that can be readily turned into cash, so that it can pay all debts on time?”

Failure to keep your store sufficiently liquid will result in an inability to pay the store’s obligations. This is the best way to bring on the crisis of insufficient funds, to back yourself into a corner and permanently damage your business.

 

TRY OUT THESE TWO LIQUIDITY TESTS

But you can work to avoid this dangerous predicament by testing the store’s liquidity on a regular basis by calculating two ratios.

1. The Current Ratio is one of the most highly regarded and often used measures of financial strength. It is calculated from the balance sheet by dividing the store’s current assets by its current liabilities.

For example if ABC Hardware has current assets of $1,000,000 and current liabilities of $400,000, it has a Current Ratio of 2.5 to 1 (calculated as current assets ÷ current liabilities or $1,000,000 ÷ $400,000 = 2.5: 1).

By most standards in use today, this ratio of 2.5 to 1 is considered good. Two to one or better is usually sufficient to keep the company solvent even in spite of minor setbacks or brief downturns.

To be cautious, I would suggest that you strive for an even greater margin of safety: a Current Ratio of 3 to 1 or better.

Giving your store an extra financial cushion to absorb unexpected shocks is, after all, one of the best ways to avoid the common mistakes which kill off so many hardware stores.

A more exacting measure of liquidity than the Current Ratio is the Acid Test Ratio. This is considered a highly precise measure because it excludes inventories and focuses on the really liquid assets.

2. The Acid Test Ratio is calculated as follows: cash + receivables (debtors) ÷ current liabilities. For ABC Hardware, cash + receivables is $700,000 and current liabilities $400,000.

So its Acid Test Ratio is $700,000 ÷ $400,000 = 1.75 to 1.

An Acid Rest Ratio of 1 to 1 is considered satisfactory provided the company is in a solid financial condition with little threat of receivables being a problem (i.e. accounts over 90 days owing). Hard to collect debtors can, of course, seriously impair a store’s liquidity.

Once again I suggest that you aim for an extra margin: an Acid Test Ratio of 2 to 1.

 

LIQUIDITY IS NOT AN ABSTRACT CONCEPT

Keep in mind that liquidity is not an idle measurement of abstract business performance. It is a central business indicator that reveals the store’s ability to pay its bills.

Failure to keep tabs on liquidity can bring on bankruptcy in a flash. Small businesses especially do not have the resources to sustain longstanding setbacks unless adequate provisions are made in advance.

So, learn from the mistakes of others – from the thousands of companies that go bankrupt every year. Do everything you can to keep your store liquid, for example by taking any or all of the following steps:

  • Increase your current assets with loans or other borrowing.
  • Increase your current assets by adding equity, preferably cash, to the business – there’s no better way to build in a good financial cushion than to maintain solid cash reserves in an interest paying account.
  • Put more of your profits back into the business – don’t be so quick to pay out earnings as dividends. First make sure you are covered by building in a solid base of liquid assets.

_________________________ 

Peter Cox is a senior consultant for Macquarie Advisory Partnership based in Sydney. He has over a decade of experience training and consulting in the retail hardware industry. He conducts key-note addresses, and management and sales workshops, which are aimed at improving profitability and liquidity in one of Australasia’s most competitive retail environments. Phone 0061 438 712 200 or visit www.petermcox.com.au 

share this