The most common question I receive from retailers is "how much inventory should I be carrying?"
Having too much or the wrong inventory is most often the root cause of a retail store's failure. I haven't been in a store yet that does not have a challenge managing it's inventory. The key to managing inventory is relating all inventory to sales. That is, inventory on-hand should reflect the expected sales for the current and upcoming month. The best way to do this is using an Open-to-Buy (OTB) system. An OTB system, if used properly can tell you if you are over-bought, under-bought or have the wrong mix of product.
There are many OTB tools available to retailers. These can be as simple as a spreadsheet or more complex programs that are integrated with the retail accounting system. Whatever the system used, the key is to understanding and using the information provided. In its simplest form, an OTB system takes into consideration your expected sales and factors in your GM% and markdowns. This will provide you with how much inventory will be moved during the selected period. The system will then subtract this from your beginning inventory and will compare the expected ending inventory with your planned ending inventory. If your expected ending inventory is less than plan then the difference is the amount of purchase dollars available to buy more inventory. On the other hand if your OTB is negative (expected inventory greater than plan) then there are no dollars available to buy more product. In fact action may have to be taken to move more inventory (markdowns, vendor returns etc.) The OTB system becomes more complex and often confusing for retailers because the system is actually a rolling calendar that looks at a number of periods at the same time to provide a forecasted OTB. While the OTB system can be quickly learned, the interpretation of the data can be difficult to master, especially for a new store with little or no history.
The first problem in interpretation is determining how much inventory to carry in the first place. Do I need twice or three times as much inventory to make my sales target? There are a few different ways to calculate this but the main one is the stock to sales ratio. Without a sales history this calculation should be based on a standard of between 3 to 1 or 4 to 1. This means that if I plan to have sales of $50K (retail$) in a period then I will require between $150 - $200K (retail$) of inventory on-hand at the beginning of the period. Another way of saying this is that I expect to sell approximately 20-25% of my inventory in the period. These ratios apply to most businesses for most months of the year. Some seasonal retail businesses may have to adjust this for their specific needs. Also, during the peak selling period (usually December) the percentage of product that will sell is much higher than 20-25% so the ratio may have to be reduced based on expected sales.
Once you start using an OTB system you can get much more finite in your inventory management by using the OTB at the category or department level. This way the OTB not only tells you whether you have enough stock but also if you have the right mix.
You can get a free basic OTB calculator at Tom Shay's Profits Plus website. Here you will find other retail tools as well as good retail information. For personal help in developing an OTB system you can contact me or visit our website.