Cash Flow is an important measurement of whether your business is doing well, or poorly, but it can sometimes be hard to measure since cash flow fluctuates. That’s why at Blacks we do a calculation that we call the “Acid Test.” It’s a simple formula, but since it looks at cash flow in a different light—and relates it to your margin goals— it can take some getting used to.
Let’s break it down since this is one of the most useful tools for looking at the health of your business. The Acid Test compares sales with purchases at cost over a defined period of time. Think of it as cash coming in versus cash going out.
The Acid Test compares sales with purchases at cost over a defined period of time. Think of it as cash coming in versus cash going out.
Let’s look at an example of a women’s wear business over a 12-month period.
Let’s say that from January 2022 until December 2022 this store purchased $450,000 worth of inventory at cost, and their total retail sales over the same period were $1,000,000. Their planned margin goal is 60%.
We are going to divide the purchases by the sales with the goal of getting a number that is the inverse of the planned margin.
Example:
Purchases at Cost: $450,000 /
Total Sales at Retail: $1,000,000
Acid Number: 45%
So, this Acid Test gave a result of 45%. This is good – it means that the store’s sales over the last year generated gross profit dollars at a rate of 55% (the inverse of the Acid Test.)
Reading the Results
Here’s how you should interpret this number:
– If the inverse (Acid number) is higher than your margin goal, you are building inventory, turn rates are slowing, and cash is being squeezed.
-If the inverse (Acid number) is lower than your margin goal, you are driving down inventory and freeing up cash
Acid Planning
One of the key exercises that we do with our clients is to establish an Acid Plan, which is essentially a margin plan. We set specific goals based on the type of business it is, and then we check in to see the progress of our goals by regularly performing the Acid Test. This is just one tool in our toolbox, but a very effective one.
You can perform a quick Acid Test right now by using the simple formula above, or you can contact us if you want us to help walk you through it, as well as set 2023 goals for your business.
