Supply Chain

Free Cash Profiles: The Wholesalers

The industry suffers from “being squeezed in the middle” between manufacturers and retailers.
David KatzMarch 2, 2012

“It’s not a pretty sight,” says Chuck Mulford, musing over the inability of the wholesale industry to generate cash. Relative to other businesses, he adds, wholesalers suffer mightily from a lack of profitability and poor bill collection.

That’s a recipe for a negative Free Cash Profile (FCP), notes the Georgia Tech accounting professor and director of the Georgia Tech Financial Analysis Lab who developed the metric, which measures companies’ ability to generate free cash flow as they grow revenue. In fact, wholesale is the fifth worst of 44 nonfinancial industries the lab follows.

The industry’s poor FCP score, -6.94%, means that for the 12 months ending on September 30, 2011, the median wholesaler could be expected to consume 6.94% free cash flow per dollar of added revenue. In contrast, the median free cash profile at the end of 2010 for all nonfinancial companies was +4.95%. Based on data provided by Cash Flow Analytics LLC and developed by Mulford, the profiles provide snapshots of the ability of a company’s or industry’s ability to spawn free cash flow as it grows (see “How the Free Cash Profile Works,” below).

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Still, a company with a negative FCP might be able to generate free cash flow: it just better not try to grow. But in an indication of how tight on cash the industry is, about 42% of the 122 publicly traded wholesalers Mulford studied generated negative free cash flows even though they haven’t grown their revenues.

Where is the free cash flow they’re consuming coming from? “They’re doing it with debt financing,” says Mulford, who found that these companies have about 49% more debt relative to shareholders’ equity than the average nonfinancial company.

The prime culprits behind wholesalers’ cash poverty are significantly lower profits and the need to carry more working capital. Particularly striking is the contrast between the industry’s median operating cushion of 5.2% and the median of 15.3% recorded last year for all industries. (Operating cushion is operating profit divided by revenue from core operations.)

Almost as damning was the wholesale industry’s median operating working capital score of 10.6% of revenue. In contrast, the median for all industries studied last year was 2.8%. One reason wholesalers must carry so much working capital may be that “some of the improvements in managing trade channels haven’t accrued to wholesale” as they have to manufacturing and retail, says Mulford, referring to such developments as just-in-time manufacturing.

The industry suffers from “being squeezed in the middle,” he adds, “underperforming manufacturers on one end and retailers on the other.”

For his study, Mulford looked at six wholesale subindustries: computers and peripherals, petroleum, electrical equipment, drugs and sundries, groceries, and machinery and equipment. 

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