Currency, cost and liquidity risks in fashion

Assume a European brand orders fabric worth $2,000,000.

• At order date, EUR/USD = 1.10, so cost = 2,000,000 / 1.10 = EUR 1,818,182.
• At payment date (90 days later), EUR/USD = 1.04 (dollar stronger), so cost = 2,000,000 / 1.04 = EUR 1,923,077.

The FX move added EUR 104,895 to the same order, roughly a 5.8% cost increase, with zero change in the product. (Illustrative figures; rates fluctuate daily.)

How brands manage it

• Forward contract: lock a future exchange rate today. The brand agrees now to buy $2,000,000 at 1.08 in 90 days, removing uncertainty.
• Natural hedging: match dollar revenues (US store sales) against dollar costs.
• Currency clauses: share FX swings with the supplier via contract.

Large groups like Inditex (Zara) and LVMH run active hedging programs and disclose FX sensitivity in their annual reports. Smaller brands often carry the risk raw, which is exactly where due diligence should probe.

Commodity cost risk

The second squeeze comes from the raw material itself.

Cotton is the clearest case. It trades on the ICE Futures exchange and is famously volatile. Prices spiked sharply in 2010 to 2011 and again in 2022 on supply shocks and freight disruption. A brand with fixed retail prices cannot pass a sudden 30% cotton jump to shoppers mid-season.

Synthetics (polyester, nylon) are derived from oil, so they inherit energy price volatility. Wool and leather have their own cycles.

You can track live cotton pricing and background via the USDA cotton market data, a free public resource.

Why it hits margins hard

Fashion sets prices early. The tag on a summer dress is often decided 6 to 9 months before it hits the floor. If input costs rise after pricing is locked, the gross margingross marginGross margin is the share of revenue left after subtracting the direct cost of producing goods or services, expressed as a percentage of revenue.Voir la définition complète → (revenue minus cost of goods sold, divided by revenue) compresses directly.

Simple illustration:

• Retail price: EUR 60
• Original cost of goods: EUR 24, so gross margingross marginGross margin is the share of revenue left after subtracting the direct cost of producing goods or services, expressed as a percentage of revenue.Voir la définition complète → = (60, 24) / 60 = 60%
• Cotton spike lifts cost to EUR 30, so gross margingross marginGross margin is the share of revenue left after subtracting the direct cost of producing goods or services, expressed as a percentage of revenue.Voir la définition complète → = (60, 30) / 60 = 50%

Ten margin points vanish with no ability to reprice a printed catalog or a season already in stores.

Liquidity risk: the cash trap

Liquidity risk is the risk of not having cash available when you need it, even if the business is profitable on paper.

Fashion is a cash-conversion nightmare because of two clashing forces: supplier payment terms and unsold inventory.

Supplier payment terms

Suppliers, especially fabric mills and factories, increasingly demand deposits upfront and short terms. A brand may pay a 30% deposit at order and the balance on shipment, long before the product sells.

Meanwhile powerful retailers and department stores push the other way, paying brands on 60 to 90 day terms. The brand is squeezed from both ends: pay early, get paid late.

The cash conversion cycle

The key metric is the Cash Conversion Cycle (CCC), the number of days cash is tied up:

CCC = DIO + DSO, DPO

• DIO (Days Inventory Outstanding): how long stock sits before selling.
• DSO (Days Sales Outstanding): how long customers take to pay.
• DPO (Days Payable Outstanding): how long you take to pay suppliers.

A worked example for a mid-size brand (illustrative):

• DIO = 120 days (inventory sits four months)
• DSO = 45 days (wholesale customers pay in 45)
• DPO = 30 days (suppliers demand fast payment)

CCC = 120 + 45, 30 = 135 days.

That means the brand funds itself for 135 days out of pocket on every cycle. High DIO is the fashion killer: seasonal stock that misses its window becomes markdown fodder.

Unsold inventory: the silent leak

Inventory is cash frozen in physical form. When product does not sell:

• It ties up cash that could pay suppliers.
• It forces markdowns, cutting margin further.
• It may require write-downs, hitting the P&L.

This is why off-price channels (TK Maxx / TJ Maxx, outlet villages) exist: they absorb overstock, at a steep discount. Burberry drew public criticism in 2018 for burning unsold goods to protect brand valuebrand valueThe commercial value your brand adds beyond functional product attributes: the price premium, preference and loyalty it generates.Voir la définition complète →, and later pledged to stop, a vivid reminder that inventory risk is both financial and reputational.

Regulation and the due-diligence checks

These risks intersect with real financial regulation and disclosure duties.

Relevant regulation

• IFRS 9 (International Financial Reporting Standards) governs how companies account for financial instruments including FX hedges. Brands using forward contracts must apply hedge accounting rules.
• IAS 2 governs inventory valuation: stock must be carried at the lower of cost or net realizable value (what it can actually sell for). This forces write-downs on aging fashion stock.
• In the US, the SEC (Securities and Exchange Commission) requires listed companies to disclose market risk, including FX and commodity exposure, in the 10-KKThe average number of new users each existing user generates through referrals. Above 1.0, growth compounds on itself and becomes exponential.Voir la définition complète → annual filing.
• In Europe, listed brands report under IFRS with market-risk disclosures required by the relevant EU transparency rules.

Practical financial due-diligence checks

When assessing a fashion brand (as an investor, lender, or acquirer), run these checks:

1. FX exposure: What share of costs is dollar-denominated versus revenue currency? Is any of it hedged, and how far forward?

2. Cash conversion cycle: Calculate DIO, DSO, DPO. A CCC creeping upward year over year signals a cash squeeze.

3. Inventory ageing: What percentage of stock is older than one season? Rising aged inventory foreshadows markdowns and write-downs.

4. Markdown and full-price sell-through: What proportion sells at full price versus discount? Falling full-price sell-through erodes margin quietly.

5. Supplier terms: Are deposits rising? Are terms shortening? Both drain cash.

6. Working capital financing: Is the brand relying on short-term factoring or supply chain finance to plug the gap? Heavy reliance is a warning sign.

A brand can look profitable on the income statement while quietly starving for cash. The balance sheet and cash flow statement tell the truer story.

Key takeaways

• Fashion's timing gap (order and pay early, sell later) makes it structurally exposed to FX, commodity, and liquidity risk simultaneously.
• A 5 to 6% currency move on a dollar-priced fabric order can wipe out a collection's margin; hedging with forward contracts is the standard defense.
• Commodity spikes in cotton or synthetics compress gross margingross marginGross margin is the share of revenue left after subtracting the direct cost of producing goods or services, expressed as a percentage of revenue.Voir la définition complète → directly, because retail prices are locked months ahead and cannot be repriced mid-season.
• The Cash Conversion Cycle (DIO + DSO, DPO) is the single most useful liquidity lens; high inventory days are the classic fashion trap.
• In due diligence, read the balance sheet and cash flow, not just profit: aged inventory, falling full-price sell-through, and heavy working capitalworking capital financing reveal the real risk.