According to our data, retail bankruptcies increased by 64.75% in the first half of 2023 (January to June 2023), compared to the same period last year. To put this into context, the agriculture industry fared much better, with bankruptcies dropping by 26.32%. Meanwhile, the wholesale industry has faced its own financial struggles, with bankruptcies rising 54.05% in the first half of 2023, compared to last year.
But what’s really startling about these figures is that a lot of retailers have been flush with cash. Yet they’ve still worked up a massive amount of debt.
Here are some examples of this happening recently:
So, why does this happen? There are several reasons that we’ll explore in this blog, both bad and good. Because taking on debt isn’t necessarily a bad thing if there’s a purpose to it.
Bill James, Enterprise Director for Creditsafe, says: “There’s always good and bad debt. Savvy credit managers can tell the difference. Good debt is debt leveraged to grow the business and invest back into it. One way to do this is through accounts receivable. As long as the company has strong annual turnover and good debt collection strategy, that’s good debt.
Bad debt, however, would be if you see a business has maxed out multiple lines of credit. Put another way, it’s the variable types of credit that could potentially be abused by a company that is in a cash current situation.”
Retailers can take on debt to be entitled to tax reductions and lower interest rates. So, when you’re making interest payments, your borrowing funds may be tax-deductible. In this situation, you’re writing off bad debt. This could be loans you make to a supplier or credit sales.
To be able to write off the debt and be eligible for the tax deduction, you must have made a reasonable attempt to recover what’s been owed. Think about context too. Following up with a letter to collect a sum of a few thousand dollars would be considered reasonable. For a debt that covers tens of thousands – or even millions of dollars – legal action would need to be taken.
You can also deduct interest paid on certain kinds of business loans (i.e. purchasing equipment or borrowing money to buy another business). The advantage here is that you can use any capital that comes from this debt to be able to continue to finance business operations.
Debt financing is an option for retailers who want to maintain control of a company, while also not having to rely on physical assets to offset repayments. This can be a better option than equity financing for a couple of reasons.
Firstly, if you give someone equity in the business, that means they will have a say in the direction of the company and it may not be the direction you want to go in. Secondly, you might have decided to give equity to some of your employees in the early stages of the company and you now want to buy them out.
There are also times when having excess cash is beneficial for company growth. The first advantage is providing more flexibility for retailers in a competitive environment, particularly with all the uncertainty plaguing the 2020s. For example, a sudden labor shortage can cripple a company and shut down operations in key locations. But a retailer with excess cash can still afford to pay workers and not lay anyone off.
Another advantage is using leftover cash to invest in key growth areas. This could be in marketing to ramp up holiday sales or carry out detailed supply chain audits to make sure you aren’t going to be hit with cash flow losses in the near future.
Of course, there are times when having excess cash and being millions of dollars in debt are a bad combination. And one of the greatest disadvantages is when it becomes clear to investors, lenders and customers that you’re on a path towards bankruptcy.
Lenders will certainly run a credit check on your business and look at a combination of data points to see how strong your financials are, how you’re keeping up to date with payments, if your credit score has dropped drastically and suddenly in recent months, among other data points. Don’t assume that just because one particular data point might look better than others, it’ll make lenders feel confident in your finances. They will look at everything and make an informed decision based on a holistic approach.
Red flags that they’ll look out for include:
Another risk of having a huge amount of cash on your balance sheet and high debt is the presence of activist investors. You could be perceived as not putting cash to work and not investing in profitable situations that can help you offset the debt.
From the investor’s point of view, that’s unacceptable. So, they may start pressuring you to spend the money or increase shareholder dividends. The next thing you know, you’re suddenly in a battle with that investor for control of the company and you’re on the downward slope towards more debt and bankruptcy.
An overlooked part of excessive cash is how it can change team dynamics. When a business is flush with money, it’s easy for managers to fall into ego traps. We can’t do anything wrong. We’ve got all this money to make our problems disappear. These thoughts may lead to complacency and have a negative impact on the future success of the organization.
Rather than using that money to fix problems, managers start using it to cover up their mistakes and protect themselves against a detailed investigation. Expenses are hidden. Unethical behaviors start to fester. Management becomes reactive instead of proactive. So then, what happens? The company’s market value is destroyed, cash flow takes a hit through overpaying for acquisitions and staff morale is dismantled.