Expert Column: Indicators of Retailers' Financial Health

Retail is a difficult business, and it gets more difficult all the time. The Internet, innovation in business models, increased competition, and a challenging economy have produced changes both seismic and subtle. Across industries, shortsightedness and inflexibility have compromised the foundations of seemingly strong competitors and the grocery business has not been immune. Companies that do not focus on positioning themselves strategically are vulnerable to losing ground. How can grocers avoid financial peril in this rapidly evolving industry?

With a business to run and razor-thin margins, grocers can profit by paying attention to levels and trends of a few simple measurements, indicators that can mean the difference between a thriving business and bankruptcy. The National Grocers Association (NGA) estimates there were 21,000 independent stores nationwide last year, down from 25,000 just five years ago. In order to position a business for success, whether as a consolidator, a potential target or a successful stand-alone brand, identifying and responding to early signals across the business is essential. Key indicators and their trends can tell important stories.

Grocers must be laser-focused on inventory and product management. Successful grocers maintain a keen eye on sales data to measure the effectiveness of promotions. Sales related ratios such as inventory turnover (cost of goods sold/inventory) and sales growth (year-over-year, same-store, etc.) indicate more than the freshness of products. They act as a telltale, measuring whether or not grocers understand their customers. In addition, a negative trend in turnover has the potential to expand logarithmically as consumers hesitate to purchase products that are dated - they become frustrated and shop elsewhere. Grocers must be aware of the market profile and the vastly divergent needs of each consumer segment. Low turnover ratios are likely to run parallel to declining sales volume. Further, grocers should be aware of, and continuously measure the cost of, acquiring new shoppers and households (both brick-and-mortar and online). An increase in cost of acquisition can signal market saturation or that the channel has reached the point of diminishing returns.

'Drilling down on product pricing'

Gross profit margin (gross profits/revenue) and overhead ratios (overhead/revenue) are important indicators of profitability, and can be used to identify pricing and expense issues. Narrow or negative gross profit margins on targeted products might be used to drive foot traffic, but the loss has to be compensated for by the sale of higher margin-goods. Today’s technology provides tools that let management drill down to understand the dynamics of product pricing. Based on data available from Risk Management Associates (“RMA”), the median gross margin as a percent of sales has been in the 26 over range over the last five years.

Management can also track the ratio of net change in property, plant and equipment to net change in revenue, in order to measure if an investment in PP&E is providing a return, or to indicate if a lack of investment is costing sales.

On the finance side, it's critical to keep an eye on liquidity and the ability to pay debts as they come due. The current ratio (current assets to current liabilities) and the quick ratio (current assets excluding inventory divided by current liabilities) provide a snapshot of a company’s ability to pay its short-term liabilities. A ratio close to or less than 1 means a company has $1 or less in hand for every dollar owed. RMA reported a median current ratio for grocery stores and supermarkets from 2010 through 2014 of between 1.4 and 1.7.

Negative shifts in the cost of capital and debt coverage ratios might indicate and exacerbate faltering financial health. Banks and vendors are wary of being caught off guard, and sudden changes in vendor payment terms often magnify financial distress. Wholesale suppliers monitor their clients and will tighten terms or require cash on delivery/cash in advance if they sense a customer is financially stretched. Use debt wisely and be cognizant of trends in the cost of capital and debt coverage ratios and where they stack up in relation to that of competitors.

Paying attention to operational details is key. Management that takes advantage of today’s technology (integrated POS systems, availability of market data and financial management tools) to monitor the health of their business and react quickly and creatively should be able to successfully navigate today’s competitive environment.