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Creating an Open to Buy
Spending Wiser with Inventory Control
Perhaps you are starting to think about getting ready to go to the show in Denver, Atlanta, or Billings early next year. Has this situation ever happened to you? You are going to look for merchandise for the spring season. As with many businesses, the spring months can be some of the busiest days of your year, especially if you are selling to a lot of folks that are farmers or working outside. Likewise, these months should be the time of year when you receive a larger amount of inventory as compared to the amount of inventory you are likely to need for later in the summer when sales are traditionally slow.
However, here in the fall, you are concerned as you are examining the material that the merchandise mart and various vendors are sending to you. As you look about your store, you can see that your shelves are already getting full for the holiday season. And then you are probably going to go into a part of the year with lesser sales for January through March. Taking a quick calculation of what your sales should be for the next 90 to 120 days, you see that if you receive absolutely no inventory in that time, you will still have a substantial amount of inventory on April 1.
If you take a look at your checking account balance, and do the math for sales and expenses for these same 90 to 120 days, you find that you are not going to have enough money available to spend when you do go to market.
There are a couple of options available to you. The first is to go to the bank and borrow the necessary money so that you can order and pay for the incoming spring inventory. The second option is to go to the mart and ask, maybe beg, for extended terms. Unfortunately as the extended terms is a requirement of your spring purchasing this year, you may find yourself walking away from vendors that you would want to order from. You may also find yourself placing orders with lines that are your second choice as they are the only ones who would give extended dating.
The third option is to hastily create a clearance sale to free up as much money and shelf space as possible in early January so that you will have the money and room for the spring inventory that will arrive as a result of your trip to the market.
If you have ever found yourself in this situation, you have probably asked if there isn't a better way of solving it. Unfortunately, the only better way is to develop a way of not getting into this position in the first place. And the best way of preventing this situation from reoccurring is to learn how to create, buy from, and manage your inventory from an "open to buy".
If you already understand and utilize an "open to buy", read on as we will have several new ideas to share with you in an effort to help you have your open to buy become a better management tool. However, if you have heard the phrase, but have never known how or why to have an "open to buy", then we can go a long way today towards making sure you never have to experience the situation we described at the beginning of this article.
We will make the assumption that your business receives monthly financial statements in a timely manner. In this context, as an example we mean you have completed financials for November so early in December that you are able to use the information to make decisions affecting December's financials. When you are looking at the December financials you are probably making a point to look at the line which indicates the amount of inventory you have on hand. As we would expect you to have December as one of your best sales months, your inventory for November 30 will probably be the largest amount of inventory you will have for the last day of business in any month in the year.
But what if your business follows the model which shows you January and February sales to be the two slowest selling months of the year? Then the inventory you would want to have on hand for December 31, and for January 31, would stand to reason to be the lowest two end of the month inventories you should have. And yet, we will want to build up inventory again in March for the better months of April and May.
The logic is that higher sales require additional inventory levels. And if you can get by with lesser inventory, as with our two example months, you will want to make sure you are getting your money out of your inventory and into your checking account during the higher sales of December. Unfortunately, if you do not utilize an open to buy plan, the ending inventory for each month will be a surprise to you as you first look at your financials. And without a plan, as you go to market to buy the next season of merchandise, you will find the necessary money might not be in your checking account but is sitting on the shelves in the form of winter inventory.
How do you create an open to buy? You begin by establishing goals for your total sales for each of the next twelve months. If you track your sales by departments and fine lines you will want to establish a goal for each department for each of the twelve months.
Let's take a quick moment to define each of these. Within your store, you sell many types of products. As an example, you sell men's and women's clothing and accessories which could each be a department of your business. Within the department of men's clothing, you probably sell shirts, pants, boots, hats and accessories. Some businesses will track their inventory and sales of each of these groups of products within the men's department. These groups are called fine line categories. With the more defined information, you gain more knowledge about the inventory and sales within your business.
The second step is to know the maintained gross margin for your store overall. And again, if you are tracking sales by departments and fine lines, you will want to know the maintained gross margin for each of them. Taking each month's sales goal and multiplying it by the margin, the answer will tell you how much inventory at cost you are expecting to sell for that particular month.
For example, if you sell pants and for the months of November and December you expect to sell $3,000 and $5,000 respectively, in pants with a maintained margin of 45%, you will be selling $1,650 at cost in November, and $2,750 at cost in December. Now perform this same task for each department and fine line for each month.
With this number in hand for our example, we are going to pretend you will have $5,000 in inventory on October 31. As November and December are your best months for selling pants, you will not want the same amount of inventory on hand on December 31.
You need some inventory for those who are making purchases with their "Christmas cash" in January, but you know that you want less inventory. Again in our example, you have decided you need $2,000 in inventory at year end. Here is the math:
With these figures, for you to have the desired $2,000 in inventory for December 31, you need to have $1,400 in inventory, at cost, to arrive in November or early December. If you fail to have this much inventory arrive, you will have a very poor selection for those after Christmas shoppers, and if you have too much inventory, your cash to pay year end bills will be sitting on the shelf in the form of inventory and you will be struggling to figure out what to do.
What if sales are not what you expected them to be? Then you will have to decrease your open to buy for the following month. If sales are greater than anticipated, you have additional open to buy and you will be calling the vendor to get an order placed for immediate delivery.
If sales are less than expected, you will be starting the new year with more inventory than you want. You will then take your open to buy for the first part of the next year and decrease it by a like amount.
There are a couple of questions that probably still remain. How often should you calculate open to buy? While monthly is the traditional time frame, you may find that this is too overwhelming and want to use bi-monthly or quarterly.
How should you calculate an open to buy? You can get buy with something as simple as a columnar pad, pencil, and calculator to create a chart as we have just described. If you are comfortable working on your computer with a software program such as Microsoft Excel, you can create an open to buy chart which is updated with the pressing of a couple of digits and the 'enter' key.
We have created an "open to buy" calculator and put it on our website at www.profitsplus.org where you are welcome to download it for free.
Should an open to buy be such an important part of your business? Consider the statistic that indicates 54% of the businesses that fail, do so with a financial statement that shows they are making a profit. Their problem is that they have no cash available to pay bills. The answer is yes! You need an open to buy if you want to be open for business.
This article is copyrighted by Tom Shay and Profits Plus Solutions, who can be reached at: PO Box 1577, St. Petersburg, Fl. 33731. Phone 727-464-2182. It may be printed for an individual to read, but not duplicated or distributed without expressed written consent of the copyright owner.
Profits Plus Solutions, Inc.