ASK THE EXPERT: HOW CAN I BE SURE I’M NOT OVERSPENDING?

Q: My sales are starting to flatten out. Which indicator should I monitor this year to ensure I am not overspending?

A: It’s great that you are looking ahead so you do not get overbought in a slower cycle. Here at Blacks, we like to look at purchases at cost versus sales at retail as an indicator that can help you determine if you are out of balance.

We use a simple formula to determine the health of your business, and we call it the “Acid Test.”

You simply take your purchases at cost over the last 12 months and divide them by your total sales at retail over the same period. The result is your Acid percent. The ideal Acid percent you seek is the inverse of your planned margin.

For example, if your margin goal is 60%, your perfect Acid number is 40%. 

If your actual Acid % is higher than the inverse of your margin % goal, you are building inventory, and your cash is being squeezed. 

If your actual Acid % is lower than the inverse of your margin % goal, you are driving down inventory and freeing up cash flow.

So, I suggest you do this exercise to reveal the health of your business. In a flat or slightly down trend cycle, it’s more important than ever to ensure that your purchases are not outpacing your sales.

This is also a great way to see the difference between your transactional margin —which can be relatively high — and your cash margin, or cash flow, which may be squeezed. If you are just looking at your transactional margin, you may be misled.

If you have any questions, please let me know. Here is the formula again for reference:

Acid = Actual 12 months of purchases at cost/Actual 12 months of sales at retail.

 

Photo above by Micheile Henderson.