Furniture supply disruption boosts special orders, but retailers need to reserve that extra cash
ENFIELD, Conn. — The great sales increases furniture stores are seeing post lockdown may seem like one big boon, but Tom Liddell says retailers are digging themselves into “a monstrous hole.” And if they don’t take steps to protect themselves soon, a severe cash-flow crisis could be in the cards.
The senior vice president at sales and liquidation firm Planned Furniture Promotions told Home News Now high consumer demand combined with the current furniture supply shortages have led to a dramatic influx in special-order business. That’s welcomed found money, but if retailers aren’t smart about setting aside that deposit cash now and keeping their hands off it until the product comes in, they’ll be in for a rude awakening a few months down the road, one that could cripple their operations.
“It’s a very serious problem that’s going to come back to bite a lot of dealers,” Liddell said. “It has the potential to affect everybody.”
Here’s what led to the potential crisis, the problems that could arise, and what retailers need to do to ensure they don’t fall victim.
More demand than supply
COVID-19 and the resulting store closures created a cash-flow challenge for just about everybody, Liddell said. Many retailers countered this by selling off a good portion of their inventory (because supply was scarce) when they were finally able to reopen. What they didn’t sell-off, they nailed down as the foundation for special orders.
Typically a retailer will require a minimum deposit of 50% of the order, Liddell said, and a lot of consumers wind up paying even more — often 100% — while their wallets are out. What’s more, retailers who were doing, say, 10% or 20% in special order business pre-COVID are now enjoying 50% or more as a result of the supply disruption and the need to pivot.
This has done wonders for retailers’ top line, but that’s not necessarily the good news it sounds like.
“What’s happening is it’s artificially inflating retailers’ cash flow to a level they’ve never seen before,” Liddell said.
Where the cash is going
And what are retailers doing with this extra cash? A lot of them are using it to pay today’s bills and past-due bills that came in during the shutdown. They’re paying salespeople and using it for other immediate costs of doing business.
The problem will crop up when these special order goods start flowing in and when consumers start canceling because it’s taking too long to get delivery, Liddell said. He’s concerned too many retailers are spending that deposit money now and won’t have what they need available to pay off their expenses later. He lists seven of the pending expenses in a cautionary letter to dealers:
Cost of goods
Incoming freight (which typically is higher for special orders)
Allowance for freight damage, touch-ups and other handling issues
Sales commissions (often paid after the goods are delivered)
Cost of related warranty and product protection plans
And commissions on those protection plans.
The difference between the remaining payment a retailer receives from the customer upon delivery and these other expenses is what Liddell called the “backlog deficit,” and it can be a huge difference. “This is often a major shock to retailers that write a high percentage of special orders,” he said.
And right now a lot of retailers writing a lot of special orders.
“So if they receive 50% down, the could be upside down (come delivery time),” he said. “It’s going to cost them a ridiculous amount of money to deliver those goods, and they’ve already gone through the cash flow.”
Now, here’s how retailers can protect themselves from this looming cash-flow nightmare if they haven’t done so already.
Hold onto the money
First, Liddell said they can go ahead and assume a certain net profit on the special orders; it depends on the dealer, but a typical net profit after expenses is about 10% of the sale price. That’s the portion of the deposit that the dealer should consider theirs to co-mingle with the rest of the business’s operating cash. Everything collected beyond that, however, needs to be considered a loan that’s ultimately going to have to be paid back.
Liddell and PFP aren’t suggesting retailers start taking smaller deposits to avoid any problem. But whatever they are collecting above that net profit estimate needs to be set aside. PFP suggests opening a separate bank account — not a checking account but one solely for special order deposits, in effect, an escrow account for customer prepayments.
“This not only gives retailers a more realistic snapshot of their cash flow, but it will enable them to fill their backlog with no financial challenges when the time comes to do so,” he said. Most states have laws that require companies to set aside this money anyway. Indeed, some retailers, who have intentionally dipped into the pot with no intention of delivering the goods, have wound up in jail.
That’s not what Liddell is suggesting is happening here, but he said many retailers just aren’t familiar with these laws because this kind of situation has never come up before. Again, in normal times, a retailer’s special order business may account for 10% to 20% of total sales, and the final cost associated with it is easily absorbed by their normal business model, he said.
But these are not normal times. “Whatever the normal percentage of their special order business is, you can bet its a least double, if not more, now,” Liddell said. “So the end result is their cash flow is going to be artificially increased 400% to 500%, and it’s going to seem like they’re in high cotton.”
Another consideration: cancellations.
Liddell and others at PFP believe they’re likely to be compounded in the months ahead for a few reasons. Right now many consumers are cash-rich, thanks in part to the enhanced unemployment benefits of $600 a week they’ve been receiving. But that program recently has expired, and while President Trump just signed an executive order to extend the program with $400-a-week payments, there’s no guarantee the order will be executed, and those cash-rich consumers could start feeling less so and will have second thoughts about special order product that’s still weeks away from delivery.
In addition, Liddell believes the delivery dates retailers have been quoting aren’t likely to hold up as manufacturers continue to play catchup to the surge in demand. So those eight- 10- and 12-week delivery quotes could soon turn into 12, 14 and 16 weeks — and more cancellations.
And there’s one more related looming problem that has to do with a retailer’s credit lines with vendors and factors.
“With most, when a dealer places a new order, it ties up their credit line, even though the product hasn’t shipped,” he said. “In the past, their $67,000 in special orders had little impact on their credit. But the new blast of business will certainly impact their open to buy.”
This is yet another reason why retailers should open that escrow account. “It will give retailers the ability to pay down credit balances or even prepay if necessary,” he said.
Liddell conceded this is a lot to consider. If retailers are struggling to wrap their minds around all the potential pitfalls surrounding this special-order surge, he urged them to speak to their accountants for assistance in developing the best course of action.
Check out the follow-up to this story, which features a link to a cash-flow calculator in the form of an Excel spreadsheet that PFP offers for free.