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Two, three, or seven challenging words

The secrets of making inventory control work

In today’s retail world, there is nothing that brings up a lively discussion more than the topic of the Internet. Participating in the discussions, this writer finds that most retailers seem to think the Internet retailers live in a very different world than the brick and mortar retailers.

While we could easily create a list of the differences between the two worlds of selling, all forms of retailing must confront the challenge of inventory control. (The first challenging two words.)

And while Internet retailing has changed the way all of retailing works, far too many retailers think that dealing with inventory must be done the same way it has for years. The lone change that has occurred has been the advent of the point of sale system allowing a machine to do what the buyer used to do.

The POS works only if the point of sale system has the correct amounts of inventory; a count of all inventory is taken on a regular schedule, be it on one day or inventoried in sections on a rolling basis throughout the year. It also only works if the parameters are properly established for the reordering of merchandise and the buyer knows how to read the information the point of sale system provides.

The oddity of that statement about dealing with inventory in the same way we have for years is that the proper and most profitable way of dealing with inventory has been around for decades. It is the unfortunate situation that many retailers do not utilize the correct methodology.

Some retailers use a concept of, “stock replenishment”. (Another two-word combination but not the one we intended.) Stock replenishment is the idea of your taking the dollar amount of sales in any category; let’s use a fabric. You then look at the margin; our example will be 55%. You multiply the amount of sales by the 55% and that is amount of money you spend to replenish what you sold. It is a great concept but with one sizable fallacy. Stock replenishment makes an incorrect assumption that you need the inventory sold to all be replaced.

The error? No consideration for the four seasons of the year or products niched to a holiday. Who wants a fabric with Easter eggs on it to arrive in their store in May?

The three-word combination is what we do want to use; “open to buy”. While this method takes more into consideration in determining how much to buy, we anticipate you will quickly see this is the correct, best and most accurate method for having inventory in your business.
We start with the fabric. Not all vendors are the same!

How much inventory do you have to order? Vendors have minimum quantities, weight, or dollar amount. We need to know if you are buying for the sales you anticipate in the next month or the next six months?

How long does it take for the inventory to arrive? Can you reorder this fabric or will this be a one time order for the season? These answers will determine if you are ordering for just your immediate needs or for a longer period.

Is this a fabric that you stock year-round or one that you want a diminished amount, or none on hand after its primary selling season? Some shops want to start with all new Easter materials; others want to keep some Easter oriented fabrics on hand throughout the year.
Once these questions are answered, you get a feel for which months you are now ordering. It could be for the next month, one month six months from now, or for the next six months.

Just as determining how much inventory to order is a guess, you make a similar guess (let’s call it an estimate) of what your sales will be. This will tell you how much of this fabric you are going to need to produce these sales for the month, or months, you determined with the questions about the fabrics.

Got all this information put together? Now we can begin to put together the “open to buy”. (And there is the three-word phrase.) Understandably at this point, you would rightfully ask, “Doesn’t my point of sale do this work?”

Good question. To which we would respond that we expect it should. But are you willing to gamble the future of your store without knowing if the POS knows all of this. And surely, if it is in the first couple of years of your having a POS, the computer cannot know which items are which; it only knows numbers. And would you want to call the POS support line to speak with someone that may have never worked a day of retail in their life, to determine if they understand this?

We will make it easy to do by sharing an Excel file that will help you understand how “open to buy” works. As you see the answers produced in the Excel file, you can compare the answers to what your POS says to see if it is learning how to properly order for your store.

When you confirm your point of sale is making the proper calculations, you will not have further need of the Excel chart, as well as no need to hire any of the many individuals in retailing who offer to track your inventory for you or teach you how “open to buy” works. It makes no sense to us to pay for a POS that can perform “open to buy” calculations and then hire someone and their service to use their computer to make the same calculations.

Let’s take a moment and answer one more question about the “open to buy” format. Your store will need to have multiple “open to buys”. How many? We leave that for you to determine, but we will give some guidelines.

Most retailers divide their store into departments, fine lines, or categories. Similar products are in each category. We suggest that as you look at your store, that no category should have more than 10% of your overall sales. As an example, if you sell sewing machines and they constitute half of your sales, it is very challenging to know which machines to order.

Instead, you would categorize the sewing machines into groups. The same could be said for fabrics. If you had only one “open to buy” for fabrics, it would make it very difficult to know which fabrics to order and when.

On the other end, as you create categories, we suggest each have a minimum of 3% of your overall sales. Going smaller than this suggestion and you could find yourself with a lot of “open to buys”. The record we have seen to date was 287 categories in one store! Think how much time you are going to be spending at the desk managing all these categories.

Using our guidelines, your store will have somewhere between 10 and 34 “open to buys” to manage your store.

Here is the math for a sample category using the Excel file you can download.

In row three for the first month, you insert the amount of inventory, at cost, on hand as you start the exercise. After the first month, the Excel file will be able to calculate the inventory on hand at the beginning and end of each month.

Row four is where you enter your anticipated sales for each of the next 12 months. An “open to buy” should be a calculation that is performed on a rolling 12-month basis, meaning you always have 12 months in front of where you are today.

Row 43 is where you will enter your “maintained gross margin:”. The word “maintained” is key as this represents what actually happened in your store as compared to what your initial gross margin was. Ever put merchandise on sale? Of course; we all have. The margin when the merchandise first arrived is different from the day you sold the merchandise; that is maintained gross margin. Most definitely, it will not be the same number for each of the 12 months.

Row 48 is the key component to your having an accurate open to buy. It is where you determine how much inventory, at cost, you want on hand at the end of the month. From that series of questions we asked initially, you are determining how much inventory you will need; be it for the next month, two or three months or for an entire season.
Now the calculator is ready to work. Rows 6 through 38 are where you put each of the purchase orders you write for this category. You put the dollar amount, at cost, in the month where you expect the inventory to arrive.

All of this works together to give you a very important answer on row 50; how much money do you have left to spend this month for inventory. It could however be, how much you have overspent your budget.

Never expect that you are going to get the number in row 50 to be a zero, meaning you have perfectly performed the exercise. You could never guess the exact sales for a month; you will have inventory that arrives earlier or later than the month you expected; your gross margin will surely vary; and you will definitely have a vendor that does not ship the order in its entirety. There will be variations.

And with the completion of each month, you will look ahead to what you have put in rows 4, 43 and 48 to make the adjustments as you learn from each month. Inventory control is an ongoing project.
However, whatever amount of variance you have as shown on row 50, will carry forth to each of the succeeding months. This becomes an exercise of an ongoing effort to get row 50 to be as small of a number as possible; be it positive or negative.

Looking back at all this information, it could be easy to take this as an overwhelming task. As a retailer who grew up in a store that utilized this system, I can attest it is not that time consuming. Once a month, you look at rows 4, 43, and 48 to make appropriate adjustments. You make an entry with each purchase order you write. And, once a year, you should be inventorying that category to make sure your information entry process is correct as well as watching for internal or external theft of inventory.

There is one last item to be considered; the last part of the title which is the six challenging words. They are, “We are sold out for the season”.

Few retailers realize that always having enough inventory on hand is a very costly proposition. Using an Easter themed fabric as an example, when do people stop buying to sew something for Easter? How many of those customers wait for a store to put the fabric on sale and then make a purchase? How many are just buying fabric on sale this year to be used next year?

While you would understandably say, “They will go somewhere else to get their fabric”, you have to ask yourself if this “always a price shopper” is a customer you want to cultivate.

Just as all the calculations above are a calculated “guess”, you now must consider another business is going to be discounting their merchandise at the end of a season. It is challenging to try to sell at full margin when someone has already began discounting to get rid of certain inventory for the season.

Instead, what if you were selling at full margin and then ran out? Granted you would miss some sales, but how many of those sales would be at full margin and how many would be at discounted prices? And when discounting any low margin items, you can quickly find yourself selling items at below cost. This means you are eating away the margin you earned on the same item sold at full price.

You have to decide for your own store if “We are sold out for the season” is an acceptable answer to a customer’s inquiry. This answer can also be saying to the customer, “I had better get here earlier before they run out”.

Two, three, or seven words; they all deal with what is the biggest asset for most retailers. Using these twelve words properly can mean you get a lot more of one word: profit.

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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.
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St. Petersburg, Fl 33731
(727) 464-2182
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