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Before planning to close your retail business, consider fixing your cash flow and managing your inventory better.

 

Q: My business is currently in dire straits, financially speaking, and I am already thinking of closing the business (a bookstore/gift shop) if by the next quarter it does not make a profit. Is there any last-ditch measure that you could suggest in order to prevent the shutdown?

 

A: There are many ways to approach this problem, but the one thing you should look at before considering closing down is the level of cash flow the business generates.

 

If your monthly cash flow collections from sales are able to cover your expenses and payables, there is a high probability of saving the business by implementing some marketing efforts. It is possible that accounting shows you are experiencing losses, but it doesn’t mean that you are running out of cash, yet. You could look into the causes of the losses: how you price your merchandise, how you control your inventory, or simply mismanagement resulting in frequent theft. As long as there is cash flowing into the business, there is a strong chance that it would survive.

 

If you are in this situation, first look at your pricing policy. Maybe your pricing does not provide sufficient margins that support your operating expenses. This normally happens when you price your merchandise too competitively in order to boost your sales. Do you mark down your merchandise too often? This can lower the average selling price of your merchandise, thus lowering your total gross margins.

 

Budget your pricing by determining the minimum gross margin you should attain at any period, and use this to calculate your breakeven sales. Let’s say your monthly operating expenses amount to P75,000. Use this figure to equal your gross margins in order to break even. If your gross margins is P75,000 and your average gross profit rate is 20 percent, derive your break-even sales by dividing P75,000 with 0.20, which gives you P375,000. If your actual monthly sales does not reach P375,000, then it means that you are losing.

 

To get out of negative territory, adjust your gross profit rate to lower the breakeven sales requirement. When you adjust your gross profit rate, you will have to adjust your pricing higher. Using the same example, raising your gross profit rate to 30 percent would give you a more manageable break-even sales target of P250,000 (that is, P75,000/0.30).

 

The next item to look at is your inventory policy. As a retailer, you may have the tendency to stock up a lot on merchandise, and you might overbuy certain items that you could not unload properly. When you carry too many items in your shelves that remain unsold for many months, you incur costs indirectly by not being able to use the money that is tied up to the inventory, along with the sales that were lost owing to your inability to put new merchandise on your shelves.

 

Manage your inventory by determining your average inventory turnover. How many days, on average, does it take for you to sell your inventory from the time you purchase it from your supplier? You can compute your inventory days by dividing your cost of sales by your inventory costs, the result of which is called the turnover rate. Divide this figure by 365 days, if your figures are on a per-year basis.

 

For example, your cost of sales is P175,000 and your inventory at end of year is P50,000. Your turnover rate is 3.5x (computed by dividing P250,000, from our previous breakeven sales target example above, with P75,000). Your inventory days should be 104 days, which is 365 divided by 3.5.

 

When you know your inventory days, compare this with your industry practice. Use this as a benchmark for you to improve. Try to see which merchandise in your inventory is slowing you down, and try to get rid of it as soon as possible. Your objective is to shorten the inventory days so you could convert as much inventory as possible into cash, and thus become more efficient.

 

As a retail shop, you are prone to cash and inventory thefts, which could be prevented by implementing internal controls. This will not only protect you from embezzlement, but also reduce the number of honest errors made, helping your merchandisers operate efficiently. Make sure that every transaction is authorized by specific persons in the company, and that their duties must be properly segregated to ensure accountability and an audit trail. It is also essential to conduct monthly bank reconciliations and inventory audit, to minimize the risk of losses. 

 

You can undertake these measures, while extending your operations despite the losses. Your cash is the lifeblood of the business. Do anything to sustain your cash flow while you restructure the business. 

 

Henry C. Ong, CMA, RFP, is president and COO of Business Sense Inc., a financial advisory and consulting firm that helps small and medium businesses. Business Sense is affiliated with INPACT International Network of Certified Public Accountants. He may reached at hong@businesssense.com.ph or www.businesssense.com.ph.

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