ChalkCreek Consulting

Adversity Test for Retailers

The Adversity Test enables you to evaluate the strength of your retail business: how well might you withstand unexpected adversity? The information gained from this test can help you in at least two ways: you can identify your business’ weaknesses; you can prepare to gain your banker’s support, perhaps before you need it.
Step 1.  Calculate Your Business’ Ratios
The Adversity Test compiles ratings of the trends of five key financial ratios in your business and your retail segment. Bankers watch these five ratios closely, and so should you.
Here are the ratios you must calculate: Current Ratio; Debt-to-Worth Ratio; Inventory Turnover; Gross Margin Percent; Profit Before Taxes Percent.  (See column to the right for a refresher on these.)  Locate the financial statements for your store for the past three years, and calculate the five ratios for those years. (ROI Members can use The ROI's Key Ratios Calculator.)
Using a form like the one below, list your business' key ratios for the past three years.  It is the trends that are most telling!
Step 2. Score the Trends of Your Ratios
In the column marked “SCORE”, assign a score to each ratio, using this standard:

1 = substantially down
2 = slightly down (1 to 2 tenths)
3 = no change
4 = slightly up (1 to 2 tenths)
5 = substantially up

Step 3. Calculate Your Adversity Score
Then, using the five “Score” figures, calculate your final Adversity Score with this formula: 

Current Ratio score minus Debt-To-Worth Ratio score plus Inventory Turnover score plus Gross Margin Percentage score plus Profit Before Taxes score = Adversity Score 

Ratio	Year 1	Year 2	Year 3	SCORE
Current Ratio					+
Debt-to-Worth Ratio					–
Turnover					+
Gross Margin %					+
Pre-Tax Profit %					+

Step 4. "Well...Is That Good?!?"

A score of 0 or below may indicate a precarious position and you can probably wave good-bye to that hoped-for loan! You may have just had record sales, but if these ratios are out of line your banker will not be pleased, nor should you be.

If you scored 1 - 15, you are not quite in a position of safety. You can, however, pinpoint your “losers” and make significant improvements toward strength.

If you scored 15 - 24, congratulations on doing a good job of juggling the many concerns of your business.  Continue looking for improvements and keep watching trends within your business and your industry.

This Is Just the Start
Of course, the Adversity Test scores are not to be considered by themselves. Many other factors go into evaluating a business!
ANALYZE Your Ratios
Look at your five ratios individually. Pinpoint the improvement or decline of each one. For instance, if turnover is slowing, that indicates a build-up of inventory levels. An increasing debt-to-worth ratio would suggest a growing reliance on debt.  It’s possible that cash is tied up in inventory, and the business needs to borrow money to finance its operations. More debt can mean higher interest costs, resulting in a lower profit before taxes.

COMPARE Your Ratios with Your Industry Averages
Industry “benchmark” figures for more than 50 retail segments are posted here on The ROI site.  (Use the drop down menu in the next column to find your segment.) With this data, you will be able to compare your business’ performance and financial condition to others in your industry. Note: The ROI provides these benchmarks only as a guide for teaching how to use these ratios. Your ratios will vary due to numerous factors including location, inventory, etc.
When you place your ratios beside those from your industry, what differences do you notice?  Are you "stronger" or "weaker" than other retailers in your segment?
This perspective is very important.  (In fact, many retailers have the pleasant discovery that they are doing better than their peers!)  You can be certain that your banker will be aware of the industry trends.  You need to be able to explain why your ratios are different.
Look to the Future: "Turn On Your Financial Headlights!!"
The Adversity Test examines the past and the present.  But, what about the future?
History is of limited value unless we apply those lessons to the future. Use the information generated in the previous steps to determine your target ratios for the next one to three years. Incorporate industry standards, company policy, your personal comfort level – everything that helps you arrive at a positive, realistic goal.

Use the Adversity Test to quickly assess the past, present and future trends of your business. By revealing your business’ weaknesses (if any), this test can help you deal with unexpected difficulties ahead. Those difficulties may not drag you down with them, but remember—luck is a flimsy rope to rely on! With the insights gained from the Adversity Test, you will have a much better chance of holding on in the face of difficulties.