Hardware and trade stores are retailers – you get a product in, mark it up and sell it hopefully for cash but, for trade stores, generally on account.

From a liquidity point of view, the generation of cash in the trade industry in particular is a lot harder than other retail stores. I will explain why later in this article.

Cash is king in retail and the cash crisis in Dick Smith’s stores earlier this year shows what can go wrong when retailers allow inventory levels to explode and working capital (current assets less current liabilities) gets out of control.

A good measure to check your liquidity position in a hardware /trade store is the Cash Cycle. The calculation towards establishing your Cash Cycle involves three key components:

Days stock on hand + Days debtors outstanding – Days creditors outstanding = Cash Cycle

Take this case study from a typical hardware or trade store:

	2014	2015
Sales	$6,000,000	$6,500,000
Cost of sales	$4,000,000	$4,550,000
Purchases	$3,900,000	$4,400,000
Average Stock	$1,000,000	$1,300,000
Average Debtors	$450,000	$540,000
Average Creditors	$520,000	$600,000

First we calculate Stockturn:

	2014	2015
Cost of sales	$4,000,000	$4,550,000
÷	÷	÷
Average Stock	$1,000,000	$1,300,000
Stockturn	4 xpa	3.5 xpa

Now we move on to calculate the three components needed to establish this store’s Cash Cycle.

 

COMPONENT #1: DAYS STOCK ON HAND

	2014	2015
365 days per year	365 days	365 days
÷	÷	÷
Stockturn	4 xpa	3.5 xpa
Days Stock on Hand	91 days	104 days

 

COMPONENT #2: DAYS DEBTOR OUTSTANDING 

	2014	2015
Average Debtors	$450,000	$540,000
÷	÷	÷
Account Sales* (*50% of total sales)	$3,000,000	$3,250,000
x 365	x 365	x 365
Days Debtor Outstanding	55 days	61 days

 

COMPONENT #3: DAYS CREDITOR OUTSTANDING 

	2014	2015
Average Creditors	$520,000	$600,000
÷	÷	÷
Purchases	$3,900,000	$4,400,000
x 365	x 365	x 365
Days Creditor Outstanding	49 days	50 days

 

THE FINAL CALCULATION

Now to calculate the Cash Cycle for this hardware / trade store:

	2014	2015
Days Stock on Hand	91 days	104 days
+	+	+
Days Debtor Outstanding	55 days	61 days
Operational Cycle	146 days	165 days
–	–	–
Days Creditor Outstanding	49 days	50 days
Cash Cycle	97 days	115 days

 

What this shows is that in 12 months the cash cycle of this store deteriorated by 18 days.

For me, the Cash Cycle is the best indication of the underlying health of a store because it shows how well management is managing cash flow on a day by day basis.

For a hardware or trade store I would aim for less than 90 days, so obviously, using this rule of thumb, our example store has problems.

An accountant can always tell you where the problems are, based on past results. But a good business advisor or owner/manager should have the strategies to look ahead and improve into the future.

Hardware and trade stores get into trouble because they run out of cash. There have been many companies who report profits but have cash flow problems, because they have an issue with working capital.

If you do not manage this sort of problem (which will be the subject of my article in future issues), you will have liquidity problems and in this respect we can all be thankful of the low interest rates at present.

Businesses that are making sales and profit probably think that everything is OK.

But, if these sales and profits are not being converted to cash, then any business may well need to borrow to pay suppliers and overheads.

Remember – working capital is not directly linked to profitability and “cash is king”.

 

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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