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The do’s and don’ts of inventory

You don't need a consultant to do this for you

Only if you own the building your business is in can there be the possibility that inventory is not the biggest asset. And only with the exception of that building being in a location where property values are increasing at an extremely fast rate, can it be that properly controlled inventory is not the fastest way to make money in your business.
That being said, I remember a conversation with a retailer about the inventory in their store in January. They sold seasonal merchandise, so at this time there would be plenty of Valentine cards, candy, and gifts of red, pink and white. My comment to the retailer was that they would do well to sell out of all this merchandise by the first few days of February.

“Oh, no! That would not work in my store. There are all those people who come in at the last minute to make a purchase”, said the retailer. My response was to point out that chain stores ranging from mass merchants to pharmacies would be his competition for these sales. Think about what their stores looked like at that time. The Valentine merchandise is marked down, and the staff is setting the store for Easter sales.

“You will be trying to sell your merchandise at full price, competing against stores that have all their Valentine merchandise at half price. How do you expect to compete against that?” was my question and the point I was trying to make.

There is a second key inventory teaching situation I remember. It was a class of individuals who were going to be the next generation to manage their family business. All of these businesses sold sporting goods. In the class we were using shoes as an example. The students agreed that 30% was the initial gross margin on this product category. They also recognized that with the many manufacturers, there was a constant parade of new shoes being introduced. Each retailer needed to have the newest shoe to remain relevant to their customers. And the shoe that was so popular only a few months ago has now lost its appeal.

These retailers told of how they make their decisions regarding inventory control with each new shoe. There was a period of a month or so in which they could get full price for that shoe. Then they would have to begin the process of markdowns as new products arrived and as they began to have holes in the range of sizes and colors in that shoe.

With each of these young retailers there was a markdown after that first month, followed by a second and third markdown to finally clear that inventory from their shelves and free up the dollars necessary to purchase the next great shoe.
As they told the story of their markdown plan, we asked each to use this planned markdown calculator to see the results of their plans. Follow this link to the free online calculator so that you can perform the same exercise in your business.

Planned markdown calculator

When each was asked to share what their maintained gross margin was, there was a look of astonishment on their faces when they found that on average, they had a 16% gross margin.

“Can you have a profitable store with a 16% gross margin?”, was the rhetorical question asked because we all know that you can’t.

Let’s take a moment and clarify that gross margin reflects the price of an item when it first appears on your sales floor and maintained gross margin reflects the actual price you received for the item. With this scenario, and many that occur every day in stores, there can be a substantial difference.

At this point, the students are looking for a solution as they don’t want to return to their parents to find they have failed as buyers. The solution in the situation of the shoes, as well as the Valentine merchandise, comes in inventory control.

Too many retailers are wanting to get every possible sale they can get. What they failed to remember is that we are looking for profit first and sales second. While it will be more complex than just this simple statement, the answer begins with the retailer being comfortable in saying to a customer, “We are sold out for the season”, or “We have sold out of those items and will not be getting any more in”.

In one sense you are working to create a sense of urgency in the customer’s shopping. You are also working to create a feeling that your business is one that is on the cutting edge of having what customers want and need. More importantly, you are demonstrating to yourself that you have a solid understanding of how inventory control and profit are interrelated.
Let’s go back to that initial series of comments about inventory likely being your biggest asset as well as being what can make you the most money in the fastest way. Perhaps we could put the perspective of proper inventory control in this example.

Imagine selling your business. After paying taxes, you would likely look at the money you have received and speak with a financial planner. One of the questions you are surely to ask is, “what is the rate of return I can expect on my money?”

And while you may like the answer you receive, unless you study a lot and become fluent in knowing trends in the market, there is nothing you can do to make the rate of return to be any better.

Now, let’s look at your business again. Do you know what the rate of return is that your business is producing for you? Do you know what to do to make it improve?
We have long heard there are three ways to create an improvement. They are (1) sell more products (2) increase your margin and (3) decrease operating expenses. Today, I am going to show you there is a fourth way. And the good news is that this fourth method can easily outperform the other three.

Let’s start by answering that question about the rate of return. Using this free online calculator, fill in the yellow squares and in the bottom right corner you will see your current rate of return. With each change you make, take a look at the return on investment (ROI) to see how this has changed your business.
Return on investment calculator

Now I will ask the question about your inventory. Having asked it many times, we are pretty confident of the answer.

How much inventory do you have that is not moving? You know, things where you ordered a dozen and after six months in your store you still have 11 sitting on the shelf. I often ask if you have 15% of your inventory that fits in that category and the usual answer is, “I wish it were only 15%”.

So, let’s get rid of that inventory immediately. When I was very young and thinking about being a retailer, I remember my Dad telling me one of the benefits of a retailer is when you make a mistake in your buying, if you act quick enough, you can get your money back and try something else. It is when we let that non-moving inventory sit on the shelf (waiting for that right customer to come in or order online) that we get in trouble by having that investment sitting on a shelf.

When you sell off that dead inventory, you can put that money in your checking account. That might make you feel better, but when you put these changes into the ROI calculator, what does it do to improve the ROI for your business?

I can tell you in advance the answer is that it does nothing to improve the ROI! That is because you can’t get an ROI from money sitting in a checking account. However, you will see one change in the ROI calculator.

That change will be with the inventory turn rate. With that dead inventory, (with a turn rate of zero) converted to cash, your inventory turn rate is going to show an improvement. Now think about that dead inventory that you converted to cash. (It is still doing nothing for your ROI.) What if you put that money into inventory that would move at the same rate as the rest of your store is now turning inventory?

And that is where you are going to see the most phenomenal change in your business. We have seen businesses that have gone from the high teens as a ROI to the low forties because they moved dead inventory into cash and then into inventory that moves.

I think when you see the change, you have received as much inspiration as possible to address the dead inventory that your business has. However, there are guidelines to not only duplicate what has been described, but to also exceed that improvement.

The first guideline deals with what inventory you decide to buy. Only if you have items that you are constantly sold out of can you use any of this money to buy more of those items. Having depth in your inventory is not going to do you any good. In fact, having deeper inventory is only going to decrease your inventory turn rate and in turn that is going to lower your ROI.

The suggestion is that you find complimentary items to what you already are stocking. Consider not adding lines in which the products are similar or the same as what you already carry. As an example, adding another line of threads will only bring you customers that are loyal to that specific brand. Otherwise, you are just diluting the spending of money on thread between what you currently stock and what you are adding. It is definitely not a way to increase sales or inventory turn.

As you order this new inventory, consider balancing all the components of ordering. This includes what is the minimum quantity or dollar amount for an order; What size of order qualifies for free freight; What size of order qualifies for any special extended dating terms the vendor might offer.

Yes, ordering in a larger quantity may make it easier on you by requiring less monitoring of inventory needs, but unless there is some special when it comes to cost, freight, or dating, your buying in quantity is only going to tie up your money and diminish your inventory turn rate.

Here is one more free online calculator that will help you in making the decision as to how you are going to make your purchases.
Cost of inventory calculator

Controlling dead inventory is more than just recognizing that there is merchandise that is not going anywhere anytime soon. And as we have shown, just moving that dead inventory into money that is just sitting in a checking account is not going to do any better when it comes to the ROI. With these three free online calculators, you are going to be in a much better position to deal with dead inventory.

Enjoy the extra sales; the improved ROI; and the extra profit.

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