Six Warning Signs that a Retailer is Heading to Financial Distress

The success of the retail industry is closely intertwined with the state of the economy.  Certain economic factors that are outside of a retailer’s control can negatively impact business—factors like unemployment and increases in costs of living or gasoline, among others. These factors have a significant effect on consumer discretionary spending, and ultimately on retail sales.

If the current tenuous economic conditions begin to deteriorate, certain retailers may fall prey to the negative impacts of the economy.  The following are some key warning signs that a retailer is heading towards financial distress:

 1.      Decline in Customer Traffic:  If consumers are concerned about the economy, their job security or have to spend more of their disposable income on gasoline or other costs of living, consumer discretionary spending usually decline, ultimately resulting in a decrease in customer traffic and sales at retail stores.

2.      Shortage of Inventory: A sudden decrease in a retailer’s usual inventory levels can indicate a lack of sufficient cash flow and difficulties in purchasing replacement goods. Another indicator of potential distress is having an improper mix of inventory on hand.

3.      Storewide Sales/Discounts: If a retailer is conducting storewide sales or starting to drastically discount price—ostensibly in an attempt to generate quick sales to increase short-term liquidity—it is usually a warning sign of potential financial distress.

4.      Delay in Paying Vendors, Landlords or Lenders:  If a retailer is experiencing tightening liquidity, the retailer may attempt to manage its cash flow by deferring payments to its vendors, landlords or lenders.  Many retailers utilize revolving credit facilities for daily operating liquidity, generally with borrowing limits based on inventory values.  If a retailer reaches its borrowing limit and is unable to borrow, it will likely be experiencing cash flow problems.

5.      Aggressive Cost Cutting:  Reductions in workforce are one of the first things a retailer may try to quickly reduce expenses. To further save on payroll costs, a retailer may shift from full-time to part-time employees, and try to reduce overtime costs and employee benefit costs.  Retailers that are aggressively cutting capital expenditures, advertising, remodeling and other similar expenditures run the risk of alienating customers and negatively impacting sales.

6.      Store Closures: Retailers often close stores as a means to “stop the bleeding” at unprofitable locations. The closing of multiple store locations in a short time span is often a key indicator of financial distress.
Unless the retailer can find alternative sources of capital, the above indicators of financial distress may lead the retailer down the path toward either an out-of-court financial restructuring or ultimately to bankruptcy court.

Have you seen other key warning signs of a retailer in financial distress?