Retailers’ Quick Ratios Hold Up

NEW YORK — The quick ratio is also called, somewhat ominously, the “acid test,” and with good reason, as it is considered to be the most stringent measure of a company’s liquidity and balance-sheet strength.

By that metric, the retail apparel business is in good health. A WWD survey of the sectors’ quick ratios showed that the majority of the retailers have enough, or more than enough, immediate liquidity in relation to current liabilities to meet any obligations in a matter of days or even hours.

That is critically good news, because when analysts, investors and, especially, creditors want to know how quickly a company can pay its immediate debts under the most apocalyptic conditions, they use the quick ratio. What this acid test indicates is how many current assets — that is, how much cash and things it can sell quickly for cash — a company has on hand, exclusive of inventories, to pay the bills.

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Quick ratios are especially relevant these days, now that all eyes are on the Federal Reserve, waiting to see if it will raise interest rates in response to last month’s spike in both retail sales and consumer prices.

When interest rates rise, the cost of short-term debt, and therefore a company’s current liabilities, can rise, too. As a result, retailers holding a lot of short-term debt will feel their immediate liquidity pressured.

To calculate quick ratios, WWD took companies’ current assets, subtracted their inventories and divided the results by current liabilities. As a general rule of thumb, an acid test ratio of more than 1 raises the comfort level of potential creditors.

Of course, there are always exceptions. If a company has an exceedingly high quick ratio, sure, it’s good news that the company is so liquid, but it’s bad news if it’s sitting on too much cash. Investors prefer retailers to find a way to squeeze more profits out of cash, or get interest on it as an investment, rather than just have it sit idle in the company coffers.

Then there’s Wal-Mart Stores Inc. At first glance, the world’s largest company’s acid test ratio of 0.2 looks a lot like its prices — improbably low. It’s not. Wal-Mart is among a handful of companies whose inventories are so liquid, it’s like having cash. Indeed, Wal-Mart’s logistics are so superefficient, it can actually sell much of its inventory before it has to pay for it. MBAs call this “negative inventory,” and by making money on the backs of its suppliers, Wal-Mart frees up cash that otherwise would be held in idle reserve.

As for Kmart Holding Corp., having emerged from bankruptcy less than a year ago, the company is flush with cash and largely debt-free, which explains that healthy ratio of 1.45.

The most liquid companies were specialty retailers with average and median quick ratios of 1.9 and 1.8, respectively. Bebe Stores Inc., which surpassed retailers in all channels with an acid test ratio of 6.03, may be hoarding too much cash, while Loehmann’s Holdings Inc., at 0.33, probably needs to shore up its balance sheet.

Taken as a whole, however, most apparel retailers are in the welcome position of having their short-term liquidity buttressed against any apocalyptic events, or even Alan Greenspan.