$ & Sense

$ & Sense

Retail Asia’s financial guru, Brian Moore shares tricks and tips with retailers on strategic procurement, branding, communications, finance … to run their business more efficiently and save money. Read his column to get the info you can use.

Making money on money

If we accept that retailing operates one of the few business models where customers pay cash, whilst suppliers and vendors give retailers up to 90 days of free credit (See $&Sense, January 2014 edition of RETAIL ASIA), retailers themselves often fail to optimise the resulting ‘cashflow advantage’.

This month we shall focus on how a retailer in Asia can make money from the cashflow circulating in the supplier-retailer relationship.

Key sources of funding in the supplier-retailer relationship

Essentially, a supplier contributes to retailer profitability via a combination of the following:

  • Faster sales i.e. more traffic, brand pulling-power, opportunity for switch-sell to private label;
  • Margin on sales to shoppers;
  • Space efficiency (sales psf driven via media and merchandising);
  • Gross Margin and lower stock levels via logistics efficiency (GMROII);
  • Trade investment by the supplier;
  • Free credit, when it is difficult to borrow money;
  • Settlement discounts for earlier payment.

Specifically, a supplier’s financial contribution to a retailer can be quantified as follows:

  • Margin (average gross margin is 25% of retail sales, but can be 3% on fast-moving basic foodstuffs and up to 75% on high-end cosmetics);
  • Credit (interest-free money, 45 days credit may be equivalent to 1.25% of retailer purchases);
  • Trade & Marketing Investment + Cost management (up to 20% of retailer purchases);
  • Stock rotation (UK average 20 turns per annum driven by delivery frequency);
  • Deductions off invoice i.e. for lapses in contract agreements (up to 7% of retail purchases).

The retailer can make money on money in two ways. One, the retailer can make better use of supplier credit to invest in business opportunities without having to take loans and incur the cost of borrowing. Two, the retailer can negotiate with suppliers to secure off-invoice discounts in exchange for early invoice payment.

Cash on deposit

Given the difference between instant receipt of money from shoppers and paying suppliers at anything up to 90 days later means that the cash can be placed on deposit, a combination of overnight money such as the day’s takings, and longer term deposits to capitalise on supplier credit.

However, given the low interest rates currently available on deposits, retailers may choose instead to use this spare cash to build stores, or take over competitors, all without increasing their bank borrowing.

The slide below shows the major global retailers’ use of supplier credit.
Screen Shot 2014-07-24 at 10.37.04 pm

These figures derived from retailer’s latest annual reports show that the five retailers owe their suppliers a total of US$81.4 billion on an ongoing basis, with their free credit representing an average of 10.3% of their sales!

However, when individual retailers are examined, it can be seen that the retailers differ significantly in their use of supplier credit. For instance, this reveals that Metro are over double the average, taking credit from their suppliers that represents 21.2% of their sales, with Carrefour coming in a close second at 17.2% of sales.
In the long term, with flat-line demand in global markets, it remains to be seen whether suppliers will force a reduction to an average of 10%, or strong retailers will take the average out to something like the Metro average of 21.2%.

Meanwhile, it is obvious that free credit from suppliers can be a source of cash for investment.

Early settlement of supplier invoices

Most finished-goods suppliers need to fund the free credit of 45+ days given to retailers from their cashflow.

However, because of the high added-value of their manufacturing process – i.e. the value of their purchases of ingredients can be as low as 10% of the resale value of their output – they are unable to pass the cost of credit back to their suppliers by taking even longer to pay their ingredients’ invoices.

In other words, a supplier would need to delay payment to an ingredients supplier for 450 days in order to ‘neutralise’ the 45 days credit given to the retailer.

This pressure on cashflow means that finished goods suppliers can be willing to negotiate off-invoice discounts for early payment by retailers.

It can be seen that because of the time value of money, even a small discount off invoice for a small reduction in payment period can have a significant impact on a retailer’s profitability.

The following example illustrates the benefits of settlement discounts to a retailer.

Gaining from settlement discounts

Say a supplier’s Annual Invoiced sales to the retail customer = $95m
Retailer currently pays in 20 days; supplier wants payment in 15 days, i.e. a 5-day reduction in payment period
Retailer currently pays 18.25 times per year i.e. 365/20
Supplier wants payment 24.33 times per year i.e. 365/15
Amount the retailer owes when paying in 20 days = $95m/18.25 = $5.2m
Amount the retailer owes when paying in 15 days = $95m/24.33 = $3.9m
Therefore the cashflow saving = $5.2m – $3.9m = $1.3m
Say the cost of borrowing is 9% interest per year
Therefore the cost of borrowing $1.3m for a year = $0.117m
Which is equivalent to 0.123% of sales i.e. $0.117m/$95.0m  x 100%
Therefore, any extra discount above 0.123% is more beneficial to the retailer than investing the money at 9%!

That is, because of a discount of 0.123% for a 5 day earlier payment period, the discount on an annual basis is equal to 9%, allowing a cash-rich retailer to capitalise on their unique cashflow position in the current economic climate.

In other words, using the same calculation, a supplier selling $95m per annum to the retailer and willing to give 0.5% off invoice for a reduction from 45 days credit to payment on delivery is in fact paying at the rate of 40.5% per annum for the privilege.

Thus cash-savvy retailers are in a strong position to make their cashflow work for them. They can make money on money by a combination of longer trade credit and early payment discounts, without selling an extra box.

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