Inventory Control: BACK TO THE BASICS
by Patricia M. Johnson, CMC and Richard F. Outcalt, CMC
Sound merchandise management is crucial for the survival and prosperity of your retail business.
It’s not just another “paper exercise”.
For example, if you’re currently keeping about $150,000 tied up in inventory, and you discover that a carefully-monitored merchandise management (or “Open-to-Buy”) plan can cut that by 10 percent, you’ve just freed up $15,000 in cash for more prudent investment!
Chances are you have slack of at least 10% in your inventory right now!
Are you ready to bring that inventory into line? Let’s begin with a quiz.
The Merchandise Management Quiz
You know that six customers will walk into your store next week and buy a particular item.
You have two of those items presently in stock.
How many more should you purchase to cover your needs?
Well, what’s the right answer?
You should have said,"We don’t know!"
You cannot know how many to buy without knowing how many you want to have left at the end of next week.
Inventory management is based on a four-part equation.
If you only know two of the parts (how many items you have on hand and how many you will need), you cannot complete the equation.
If you try it, you’ll either end up buying too few—or more often, too many.
Here’s the equation:
Sales + Ending Inventory – Beginning Inventory = Purchases
(Experienced retailers recognize this as the basic formula for Open-to-Buy, which can be worked in units, at cost, or at retail, depending upon which is easiest and most useful to you.)
In order to figure out how many items to buy, you first must decide how many you want to have remaining.
If you decide three is a good number to have on hand after the week’s sales, plug that into the equation: 6 + 3 – 2 = 7. In this case, you would purchase seven items.
finding the missing number
If you keep up-to-date sales projections (and you should!), then you probably have an idea of how many of these items you’re likely to sell during a week, a month, or season.
But how do you arrive at that missing number, the one representing ending inventory?
Base your ending inventory projection on the number of inventory turns you want to achieve for that merchandise classification.
The higher the turnover rate, the smaller the ending inventory.
Inventory turnover represents the number of times you sell out your entire inventory in one year.
It’s a theoretical rather than an actual number because you never totally sell out your entire inventory, and different parts of your inventory sell at different rates.
But it works because it averages out.
Industry averages, experimentation, and your own business goals will help you set a good turnover rate for your store.
Determine your present inventory turnover rate by dividing your Cost of Goods Sold by your average inventory @cost. Here’s an example:
Cost of Goods Sold
for the year
Average Inventory @ Cost
Annual Turnover Rate
(You also can calculate turnover this way: Annual Sales divided by Average Inventory @Retail.)
Applying the Formula
Let’s work through an example to illustrate how this formula works.
Suppose you specialize in widgets and you need to know how many widgets you should buy for next month. You expect your beginning inventory for next month to be 200 widgets. Your sales plan projects sales of 150 widgets for next month. How many do you buy?
As we’ve learned, that depends! What do you want next month’s ending inventory to be?
Your ending inventory depends on the turnover rate you’re trying to achieve.
If you’re aiming at six turns per year for widgets, you need to have no more than two months’ supply of inventory on hand at any time (12 months divided by six turns equals two months).
You check your sales plan and find you expect to sell a total of 500 widgets in the two months following the month you are currently planning.
+ Ending Inventory
– Beginning Inventory
Based on six turns in your widget inventory, if you buy 450 widgets for delivery next month, you should end that month with 500 widgets on hand, which is enough for the next two months of planned sales.
Suppose your sales plan for the gizmos department looks like this:
On October 1, you expect to have 50 gizmos in your inventory. How many more should you buy for delivery in October?
Again, that depends on your planned turnover rate!
If you want to turn your gizmo inventory four times a year, you’ll need to have no more on hand at any time than you expect to sell in the next three months (12 months divided by four turns equals three months).
So at the end of October, you will need 80 gizmos on hand. You can now work your equation:
This is all wonderful, you may be thinking, as long as your sales projections are on target.
But what if they aren’t? Or, what if your supplier runs out of gizmos? Can unforeseeable factors throw your merchandise plan into a tailspin? Not any more!
In fact, with a good merchandise plan, you’ll be much better prepared for the unexpected.
And, by monitoring your sales week to week, you can easily adjust your merchandise management plan as necessary.
Suppose for example, that you have an unexpected rush of sales next week and your stock of gizmos is reduced by 15. What does that do to your inventory management?
If you’re working from a plan, simply adjust your equation for the unexpected increase in sales. Your purchase plan then becomes:
= 60 75
On the other hand, if your gizmo sales suddenly go flat, and you can tell by mid-month that you are only going to sell ten, you can adjust the other way. You either can run a promotion to try to hit your original sales target, or cut your order by ten gizmos, or a combination of both.
Either way, you’re controlling your inventory rather than letting it control you.
All of the examples above have been worked in units. That’s a very good way to approach a merchandise management plan, but your results will be just as good if you use either retail dollars or cost dollars in the equation. Just make sure the figures you use are either all @retail or all @cost!
Your Merchandise Plan Can Be a Money-Maker!
Though making a plan takes time and effort, it pays off when you begin seeing your merchandise inflow closely matching your sales patterns.
A good merchandise plan improves your inventory turnover, cuts your inventory carrying costs, and helps you keep your inventory fresh—thereby cutting markdowns and closeouts.
In short, it will help you make more money!
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This retail financial how-to article is by Pat Johnson and Dick Outcalt, Co-Founders of The Retail Owners Institute® and CannabisRetailBiz.com.
Much more self-help, how-to information on retail profits, inventory control, and cash flow management can be found at The ROI. See "Who's Behind This?"
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