One of the biggest challenges of running a successful retail store is managing cash flow. Much of your capital will be invested in your inventory. When that inventory sells, the profits must be invested in new stock to make sure your floor and shelves are full for customers. But, what happens if you run low on funds? Slow periods occur. When they do, cash flow becomes precious (in reality, it always is even if robust sales obscure that fact). The problem is, you lose your ability to invest in new products to replenish your store.
The solution that a lot of independent retailers turn to are loans. However, even though they offer a quick infusion of needed funds, they can become problematic. Below, I ll explain how these collateralized loans work in the context of specialty retailing. You may be surprised to discover that this ready source of capital may lead to more harm than good.
The Need To Offer Collateral
Unless you have a longtime relationship with your commercial banker, a lender will require collateral. As a small retailer, the only collateral that your lender is likely to consider is your inventory. It s usually the only thing that represents value and can be liquidated in the event that you default on the loan.
Before making the loan, the lender will hire an appraiser who will evaluate the worth of your stock. The appraiser will take into account the quality of the merchandise and the volume in your possession. Then, once an appraisal is made, the lender will offer the amount they are willing to finance.
Why Inventory Appraisals Are So Low
Many independent retailers are stunned (not to mention irritated) when they hear the appraisal figure of their merchandise. The figure is usually very low. They re further shocked to hear that the financing offered by the lender is based on an even lower amount. It s worth clarifying the process by which this amount is calculated.
First, if you default on the loan, and the lender is forced to take possession, they will liquidate your merchandise. For that reason, the appraisal of your inventory is based on its liquidation value, not the value you expect to receive from selling it within your retail store. That is why it is low.
Second, lenders use a figure called an advance rate to determine the amount they re willing to lend. The advance rate is a percentage of your collateral s value. For example, if your inventory is appraised with a liquidation value of $700,000, and the advance rate is 83 , the highest amount of the loan will be $581,000 (83 of $700,000).
You may have already identified a major disadvantage (from the retailer s perspective) inherent with this arrangement.
The Disadvantage For Small Retailers
Independent store owners can use this method of financing to receive a fast infusion of desperately needed cash flow. However, because the financing is based on the value of the retailer s stock, the arrangement encourages high inventory levels. In effect, the more merchandise you have, the higher your line of credit. If your inventory levels plummet, your loan can be called in.
For example, suppose you receive financing from a lender and you invest the cash flow into merchandise for your store. When the merchandise sells, you will not be able to use all of your profits to replenish your stock. The liquidation value of your inventory has changed. As a result, the lender will require you to pay down a portion of the financing.
Collateralized loans can be valuable for specialty retailers who are dealing with severe cash flow issues. However, they should not be considered a panacea. They are not without risk or potential consequences.
Author Resource:
G.A. Wright specializes in high-impact sales promotions that produce big increases in sales volume and attract big audiences. Check them out online at: http://www.gawrightsales.com
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