October 5, 2016
By Ben T. Nicholson
President, Fortis Business Advisors
C-Suite Wednesday — Maximizing Recoveries in a Wind Up
Early in the Going-Out-of-Business sales at Sports Chalet, customers reported disappointment in not getting a “great deal.” This is not surprising. To generate a significant enough return to pay off creditors and vendors, it would have been both fiscally imprudent and unnecessary for Sports Chalet to sell high-demand merchandise for pennies on the dollar early in the sale process.
It is not uncommon for an orderly liquidation to yield average sales-to-inventory cost recovery rates ranging from 90-110 cents on the cost dollar, but to do so, a complicated but effective strategy must be employed that involves the systematic execution of a chain of planned events. This process is pure market economics. When the sale event is managed strategically, the new pricing strategy employed will lead to high-demand merchandise selling for the highest prices early in the sale process, gradually evolving into lower demand merchandise selling at lower prices and in volume through the end.
A 3 Phase Approach
Going-Out-of-Business sales transition through 3 phases which, when effectively marketed, elicits a psychological effect that can lead to buying frenzies and lines of customers. Results are often never before seen during the normal course of business operations. The phases include:
- Cost Recovery
- Liquidation/Forced Reductions
Beginning with the Profit Phase, the firm is effectively set-up to execute a typical storewide sale event. Because the mix of markdowns are varied and relatively low, less volume of merchandise is sold; however, average sales transaction rates are expectedly higher. When time permits, to set the stage for a high overall-recovery rate and minimize the volume of available merchandise through the proceeding phases, it is prudent to plan around and remain in the Profit Phase for as long as possible, executing deeper markdowns only as demand subsides.
When transitioning into the Cost Recovery Phase, the markdown strategy sets prices at or around the original cost of the merchandise. While gross profit diminishes, the firm should expect a spike in customer traffic and sales volume along with a significant increase in the volume of the merchandise sold. In a Turnaround scenario, following a successful execution of the Cost Recovery Phase, strategy shifts to rebuilding stores of new and updated merchandise for ongoing operations.
Prior to the Liquidation or Forced Reduction Phase, if the previous phases have been successfully executed, the remaining merchandise should be lower-demand items or merchandise in bulk. If large quantities of merchandise remain, it is an indication that the condition of the merchandise is compromised, the merchandise value has depreciated, or the marketing efforts in Phases 1 and 2 have been ineffective. If time constraints exist, this can lead to leftover merchandise upon completion of the event. During the Liquidation Phase, the focus and the markdown strategy shift to “moving merchandise” to effectively empty out the store.
If each phase has been successfully executed, when gross sales from the three phases are combined the result will be a high sales-to-inventory cost ratio often averaging 90-110 cents on the cost dollar. It is not uncommon to discover that the sell-off of inventory will not only help significantly increase cash flow but will raise more capital than selling the firm as an ongoing concern.