Audio

Uncertain consumer spending trends create accounting challenges

Retailers plagued by uncertain forecasting, excess inventory

Oct 20, 2023

Key takeaways

Uncertainty about changing consumer trends is affecting company forecasting and modeling.

Thinking ahead about quantitative analyses may preclude the need for third-party specialists.

Retailers that truly understand their evolving consumers will be positioned to grow profitably.

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Financial reporting Audit Economics Retail

Changes in consumer behaviors and preferences are creating accounting challenges for retailers and other consumer products companies.

“Uncertainty in where consumers are going to be spending their money, and what money they have to spend going forward, that creates challenges for forecasting for companies and modeling, which impacts company compliance,” says Kevin Brady, RSM’s consumer products industry audit leader.

Brady joined A.J. DeLuca, RSM’s retail sector industry audit leader; Peter Cadigan, RSM consumer products senior analyst; and Mike Lundberg, RSM’s industry audit policy leader, for a 10-minute discussion about the latest business issues and accounting implications facing retailers and consumer products companies. Below is a transcript of the discussion, edited for clarity and length. Please find the transcript of the video below.

They covered the following topics, with the corresponding timestamp noted for your convenience:

  • Uncertainty plaguing consumer spending trends, including inflation, savings, and debt levels (1:29)
  • Accounting risks resulting from uncertainty about sales and consumer trends (5:28)
  • Accounting implications of built-up inventories (6:38)
  • Accounting implications of how elevated interest rates are influencing mergers and acquisitions activity (7:32)

Mike Lundberg: Pete, what's new in the retail space?

Peter Cadigan: It’s not only what's new, but it's really what has stayed the same. And one of the big things that is important for retailers is the health of the consumer. So far, the consumer has been strong. It has been resilient.

Consumer spending makes up over two-thirds of U.S. GDP, so it's an important component of the economy. While consumer spending is very strong right now, we are starting to see some cracks.

If you look at where that strength has come from, it's been the labor market. But the wage growth for those employees is starting to cool, especially when you look at real spending, the spending that's adjusted for inflation. That's negative year-over-year, and jobless claims are continuing to kind of creep higher in 2023.

Consumer debt is also continuing to rise relative to income. Now, let me be clear. It's nowhere near the crisis levels we were at in 2008, but it's an important signal to monitor as we're looking at growing consumer spending that's growing faster than income growth—and that's just not sustainable.

And, finally, excess savings. The savings is what got consumers through the pandemic. It allowed them to deal with inflation, especially those energy prices and the food price shocks in March of last year. And there was still about $500 billion left as of the end of the first quarter of 2023.

However, that was largely concentrated in the upper-income quintiles. For lower-income earners—consumers that have been most impacted by things like energy prices, food prices, and shelter prices—that’s pretty much gone.

So for businesses in this industry, it's really important for them to understand how their consumers are going to adjust their spending as these tailwinds erode.

We've already seen how some businesses didn't really anticipate that shift back to experiential spending the last holiday season, and they were stuck with excess inventory coming out of the holiday season last year. And that, of course, will continue to be a theme in 2023 with the added complexity of tighter wallet shares. Inflation is slowing down, but it's still well above that 2% target.

And the shelter, service, and food inflation are particularly sticky. So even though the consumer is still in a position of strength, that's not to say that they're not going to be making difficult choices going into the end of '23, particularly with the expiration of added SNAP benefits impacting those lower-income consumers and impacting their purchase power.

Also, the resumption of student loan payments is going to impact middle-income earners and even some upper-income earners, which have been very resilient so far.

Last year, we may have been talking to a furniture or apparel retailer falling short of their sales expectations in the fourth quarter. This year, it may be some of those CPG (consumer packaged goods) companies—those premium food companies, those premium beauty companies—that are going to give back some of that market share they've picked up during the pandemic to those lower-cost national brands or store brands.

We're expecting that the companies that can really understand their consumers are going to be the best suited to excel going forward. Understanding the right volume price trade-off, elasticity, and the value of acquiring a new customer—will be imperative to navigating some of this uncertainty going forward. And I think uncertainty is really going to be the key theme for the rest of 2023.

ML: A.J. and Kevin, how are companies reacting to this changing economic environment?

A.J. DeLuca: That's a great question. We're hearing and seeing many different operational changes in our clients, all trying to address the state of the consumer and the unpredictability of what's to come over the next 12 months, especially with the Fed acting slowly in the interest rate easing.

There's definitely concern out there about the state of the consumer and the risk associated with sales and retail sales, which ripples through accounting consequences.

A lot of times, these middle market companies don't have the people in-house to do these analyses, so they have to engage a third party, which can back things up at the end of the year if we're not thinking about it ahead of time.
Kevin Brady, Senior manager, consumer products audit policy leader, RSM US LLP

Kevin, maybe you could touch on some of the forecasting risks we're seeing out there as companies try to navigate the state of the consumer going forward.

Kevin Brady: Uncertainty about where consumers are going to be spending their money and what money they have to spend going forward creates challenges for forecasting for companies and modeling, which impacts company compliance.

From an accounting perspective, whenever we think about forecasting, we think about goodwill and long-lived asset assessments. So, these companies that historically have been profitable and have had good margins, with their shrinking margins, they're starting to think about, well, what do our forecasts look like? Do we have to do a quantitative analysis on some of our assets to see if we have an impairment at this point?

And when this comes up at the end of the year, specialists have to get involved if we're not thinking about it ahead of time. A lot of times, these middle market companies don't have the people in-house to do these analyses, so they have to engage a third party, which can back things up at the end of the year if we're not thinking about it ahead of time.

ML: Pete mentioned inventory earlier. There’s a lot of risk with the supply chain challenges and inventory building up. What are some accounting risks and issues we see with our clients?

KB: If we don't have the right inventory, we're going to have excess inventory sitting on the shelves, which means you have to do lower or cost of market analyses. You might have some obsolescence concerns, or you might have decreased revenues if you don't have the right inventory and you're not meeting the demands.

We saw a lot of the larger Fortune 500 companies navigate this pretty well, with their in-house resources, analysts, and economists knowing where things were going. But, some of the middle market companies did struggle. They weren't as nimble, and we just need to make sure that we have a plan and know where things are going to avoid some of these concerns.

ML: What about the M&A activity for middle market companies? We’ve seen a lot of activity over the last 12 months, but it seems like it’s starting to slow down. Kevin, what are you seeing?

KB: We did see activities start to pick up in '22. It slowed down in '23 with the rising interest rates, so it's hard to get the capital needed to make some of these investments.

What we are seeing in the acquisitions that are happening are some different deal structures that we may not have seen in the past few years. It's not just a straight debt and equity acquisition anymore.

We might see different structures, contingent considerations, warrants, and different equity instruments being used, which, from an acquisition perspective—and when you're thinking about your private equity groups, too—have their complexities. But from an accounting perspective, just at the company, some of these instruments cause issues in the accounting. Make sure that you have the right people in place.

Again, it may require the use of a third-party valuation specialist. It may require some technical accounting expertise, as well, for some of these things, like warrants. Where on the balance sheet they go may not be intuitive. So you just need to make sure you have the right people in place.

These companies are talking to the right people. And, again, as these deals are getting done or being negotiated, just thinking about the accounting is an important step in the process.

ML: So, Pete, any final thoughts on the state of the consumer?

PC: I think, again, that uncertainty is going to be the prevailing theme for the rest of 2023 and potentially into 2024. The businesses that really understand their customers, really understand the consumer and how they're going to be impacted by some of these changes, are going to be able not only to grow but grow profitably.

RSM contributors

  • Mike Lundberg
    Mike Lundberg
    Partner
  • Peter Cadigan
    Peter Cadigan
    Partner
  • AJ Deluca
    Partner
  • Kevin Brady
    Senior Manager

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