Retail Apocalypse Due to Covid-19

Why orders are canceled, and some brands about to go bust?

It is reported that less than two months into the current Covid-19 crisis, some of the prominent apparel retailers and brands are canceling orders and refusing to pay for the finished goods, which they placed before the Corona crisis.

Naturally, many manufacturers are very concerned and voice their disapproval 

and disgust. In the outset, it appears these brands are not practicing what they were preaching all these years, in terms of ethics, sustainable buying and wellbeing of sewing operators and other employees who were working in the manufacturing plants. Some analysts and industry experts even started naming and shaming retailers and brands who were opting out honoring their commitments. Some of the brands already reported canceling orders are C&A, Primark, GAP, ASOS, NEXT, New Look, Urban Outfitters, and even NIKE. However, it is noted that brands such as H&M, VF Corp, PVH Corp, and Target actively working with their respective manufactures to ensure all their pre-booked orders are paid in full which gives some comfort to those manufacturers who made products for them.

The purpose of this article is to discuss how the apparel brands operate in the marketplace and why most brands have to take the difficult decision of canceling orders. In order to understand, it is important to learn how the brands were performing financially prior to Covid-19. Learning to read annual reports and identify relevant financial terms help on this matter. Few financial terms worth knowing are,

1. Revenue
2. Operating cost
3. Net profit
4. Cash flow statement

Revenue is the total income a business generates from its business activities. Brands and retailer's primary revenue generation activity is the sale of goods

Operating costs are expenses associated with the maintenance and administration of a business on a day-to-day basis. This is the most substantial cost associated with running a business. For apparel brands, this cost includes, buying the goods from manufacturers, operating local offices in manufacturing countries, traveling, hiring employees, consultants as well as the cost associated with selling. This includes renting retail locations, hiring employees to run the retail operation, all relevant bills and so on 

Net profit is what left with the company after paying off all the costs associated with the business activities and all related taxes, which generally referred to as corporate taxes. 

Cash flow is the money moving in and out of business in a given period of time. This is a very important financial gage to ensure the company has sufficient liquidity in any given time to ensure the smooth operation of the business activities. The cash flow statement is a forecast prepared by the CFO looking at the historical data and the company goals set out for the coming financial year. 

It’s a common practice that businesses agree on terms and conditions, giving greater importance to payment terms. This is done for a reason and, it is something do with the cash flow of the business. Most buyers request from 30 days to 90 days payment terms, so they have the flexibility to ensure required liquidity is there to pay the bills. 

All businesses operate as a going concern. The going concern concept is a fundamental principle of accounting. It assumes that during and beyond the next fiscal period, a company will complete its current plans, use its existing assets, and continue to meet its financial obligations. What happened with the Covid-19 was, abruptly, all business activities ceased to exist, and all the revenue expected to generate through sales stopped. This wasn't planned and factored into the cash flow. Evidently, this had a major impact on most of the apparel retailers. Without having clear visibility, it is near impossible to make decisions on the future revenue generation activities. However, most retailers still have to pay for the retail employees and other related staff, pay rent for the retail locations and all other related payments. 

The below chart gives a basic understanding of how the money generated and then spent on a few brands. The idea was to highlight the vast majority of the money spent on buying goods and then trying to sell them.

Company	Revenue (US$ Billions)	Operating cost (US$ Billions)	Gross profit (US$ Billions)	Net Profit (US$ Billions)
Walmart	514.00	492.00	21.00	14.00
M&S	12.00	0.40	0.60	0.37
NEXT	4.10	3.40	0.76	0.59
NIKE	34.50	29.00	4.40	1.10
GAP	16.60	15.60	1.40	0.85
ASOS	2.50	2.46	0.33	0.24
H&M	25.30	23.00	2.70	2.10

Source – quandl.com (2018 data)

While it's awful, frustrating, and simply unacceptable to hear buyers are pushing back on their commitments, it is crucial to understand what is prompting them to make those difficult decisions. As the above chart shows, they were spending most of the money to keep the supply chain going and keep suppliers and manufacturers up and running. Net profit is a fraction of the revenue. 

With the current market conditions, If the situation persists, and stores stay closed; some of these beloved brands might even disappear from the highstreets. Even after re-opening the economy, it would take a good amount of time to get the customers back to the shops and websites. The best strategy is to discuss case by case scenario with the buyers and give them options. If the buyers go bust, so as manufacturers.