Management Accounting

Free Cash Profiles: The Retailers

When it comes to free cash generation in the retail industry, size matters.
David KatzJanuary 6, 2012

The difference a quarter can make.

By the end of the third quarter of 2011, the retail industry had plowed much of its cash into inventory for the upcoming holiday season. Typically, retailers are the least liquid and the least profitable in the pre-yuletide quarter.

Drive Business Strategy and Growth

Drive Business Strategy and Growth

Learn how NetSuite Financial Management allows you to quickly and easily model what-if scenarios and generate reports.

Thus, a sample of the 195 public companies selling directly to consumers recorded a gloomy median free cash profile (FCP) of -0.78% at the end of the third quarter of 2011, the most recent numbers available. (See chart below.) That’s far less than the 4.95% median FCP for all industries as of the end of 2010.

On the surface, that means a retailer had, by the beginning of October, a good chance of eating up all its free cash if it chose to embark on an effort to grow. Based on data provided by Cash Flow Analytics LLC, CFO’s snapshot of the FCP of the retail industry shows its relatively narrow profit margins hinder free cash generation, according to Charles Mulford, a Georgia Tech accounting professor who developed the metric.

Thus, retailers’ median operating cushion — a profit component used in calculating the profile — was a relatively low 5.8%. In contrast, the transportation industry recorded a median 11.6% operating cushion for the 12-month period ended nearest to June 30, 2011. (To learn how FCPs are calculated, see “How the Free Cash Profile Works,” below.)

Weak as the retail industry’s free cash engines are, they’re bound to appear in better shape once the fourth quarter of 2011 is taken into account. “They do make a big part of their profits during the fourth quarter. That helps them end the year with a positive free cash profile,” says Mulford, predicting that “operating cushion will be higher in the fourth quarter.” Indeed, the retail industry showed a free cash profile at year-end 2010 of 1.13%.

The retailers studied were from eight subindustries: autos and auto parts, nonstore retailers, apparel, food, department stores, building materials (including garden supplies), home furnishings, and drugs. The top performers included such household names as Krispy Kreme Doughnuts, Autozone, Macy’s, and Home Depot.

As part of their study of FCPs across various industries, CFO and Mulford look at a particular target group, companies with annual revenues of $300 million to $800 million, as well as at the industry as a whole. (In this case, because of the broad nature of the retail industry, the study also looked at the highest FCPs within each subindustry.)

In many other industries, companies in that range fall under a middle-market rubric that tends to feature favorable free cash generation. Not so in the retail business, where companies tend to be much bigger in terms of sales and the targeted group is much smaller than the norm. Thus, the target firms have median revenues of $510 million, a fraction of the $1.491 billion median for the industry as a whole.

To be sure, bigger companies in any industry tend to yield brighter FCPs than smaller companies do. Because of the greater preponderance of large companies in retail, however, size may matter more. “Larger firms tend to be more profitable, have lower working capital needs, [and] tend to spend a smaller percentage of revenue on capital improvements,” says Mulford. “You put that all together, and larger firms tend to have a higher free cash profile than our target group.”


4 Powerful Communication Strategies for Your Next Board Meeting