Cash flow is the amount of money flowing through your business each month. In its simplest terms, if you have more money coming in (sales) each month than you have outgoing (expenses), then you have a positive cash flow. But if the opposite is true and you have more expenses going out than sales coming in, you have negative cash flow. The concept is not hard to understand since it is the same for your personal checking account. But know this, the number one reason a retail business fails today is its inability to manage cash flow.
Managing Cash Flow
Often, retailers need working capital, in the form of a loan or line of credit, to cover shortages in cash flow – especially during the slow seasons each year. But, if you manage your cash flow correctly, then you will not need this.
The biggest drain on your cash flow is inventory. Since your rent and utilities are fixed costs, it’s easy to predict or plan for these. But when it comes to inventory, it’s much harder to predict what will sell and what will not sell when you buy for your store. The fact is, most retail stores have a turnover in its inventory that is slower than the due date of the bill. In other words, if you buy 12 hammers today and only sell 4 per month, you will have to pay for 8 of the hammers before you have even sold them. It takes cash out of your bank account even before the sales go in. This bad management will result in markdowns on the hammers just to get the revenue coming in.
It is why being smart in your buying and using tools like an open to buy system can make a huge difference for you. Also, negotiating great terms for the dating of your invoices can also help. Dating is the term for the amount of time you have to pay an invoice. For example, if you have terms of Net 30, this means the invoice is due within 30 days. The best retailers try to match their inventory turn with their dating. It is the exact strategy Wal-Mart employed to grow into the dominant retailer in the world. Most of the merchandise sold in Wal-Mart stores has dating well beyond the sale date. In fact, many times Wal-Mart sells out of the inventory months before the due date of the bill. This positive cash flow position allows them to invest in other tools to grow like marketing and software.
While you will never have the buying power of Wal-Mart, you can borrow a chapter from their playbook. First, control your buying. Resist the temptation to buy 12 of an item if you only need 6 just because you get an extra 20% off the cost. The problem is that while you save 20% in margin, you negatively impact your cash flow. Try to stock items that will ship "at once" from your vendors meaning that they are available in the vendor's warehouse at all times. If you stock items that are at once, then you can keep less inventory on hand and sell through that inventory before the bill comes due. It will put you in a positive cash flow position.
Profit and Loss
The mistake most people make is they track their P&L (profit and loss statement) each month and use that to run the business. Here is the issue with that. The P&L is a look at the past, and you need to plan for the future. If you have a great month in sales (and thus a great P&L), you may be tempted to buy a bunch of inventory. However, if sales slow down, the bill still has the same due date, and suddenly you do not have as much money to pay bills as you thought.
High levels of cash flow do not mean high levels of profit (or any profit at all). Just the way high levels of profit do not mean high levels (positive) cash flow. Make sure you are using an accounting system that can show you a cash flow analysis. Being able to track the months of cash you have on hand (meaning the number of months you can continue at the current sales and expenses rate) is paramount to surviving in retail today.