This month Alan Fisher discusses ‘open-to-buy’ (OTB) financial budgeting for retail merchandise. OTB software tools are designed to assist retailers manage and replenish their inventory investment.
have met a lot of people who aren’t too good at predicting the future, but in retail, many people aren’t even good at predicting the past. With as little time as some retailers devote to reviewing the past, even less time is spent on the future.
Hopefully you agree that the time element of sales and inventory is an important factor in success. You may recall the Stock Turn Rate (STR) is calculated as:
Annual Sales at Cost / Average Inventory at Cost
It is interesting how many businesses are concerned about a turn rate. Restaurants monitor their table turns to minimise spoilage, and apparel retailers carefully watch turns because excess inventory becomes markdowns.
In order to improve the STR, either the Annual Sales must increase or the Average Inventory must decrease. Guess which one you have the better ability to control? That is where an open-to-buy solution assists in improving the situation.
Simply stated, an OTB is a budgeted amount of purchases required each month to maintain a planned level of inventory. It involves projecting an inventory plan by category for the next twelve months.
If in month one, I have 1,200 items in inventory and determine that I need 2,000 in month two, I need to receive 800 items before that month arrives. I also need to replenish what I sell in the first month. If I plan to sell 300 items at cost, then the total to receive is 1,100. The hard part is properly planning the inventory by month. If your history has been off, your future will be too. I use mathematical formulas to determine the optimal inventory levels by category, rather than history.
The STR is 2.3 based on *Cost of Sales divided by **Average Inventory. A simple way to plan for a 2.5 turn rate in the future is to calculate that the new turn rate is an increase of roughly 8 percent. The average inventory needs to DECREASE by 8 percent to 11,828.
After setting the planned inventory numbers, the next step is to use your crystal ball to project sales for next year. If you project a sales increase in golf balls by 3 percent, then project a 3 percent increase in inventory.
The final step is to determine the open-to-buy. If the chart represented your plan, growing the inventory from January (6,043) to February (7,986) requires an addition of 1,943. During January, the plan is to sell 358 at cost and that must be replenished. The total OTB for January becomes 2,301.
The values of an OTB include improved cash flow and improved profits due to decreased markdowns. The latter is accomplished by receiving more frequent deliveries to minimise staleness of the merchandise. If customers see the same merchandise month after month, the likelihood of sales diminishes.
One consideration is to review minimising excessive quantities during off-peak times. In the example above, taken from a US golf course, having $6,043 in golf balls in January was bad planning. With sales for the next 3 months at less than $2,000, it was wiser to revise the planned inventory to be lower in December, January, and February. It takes some manipulating but OTB is a great skill for a golf retailer.
I know that, even with an OTB, golf shops are at the mercy of the delivery schedules of the suppliers. Many shops stagger deliveries of competing products, bringing in one supplier in April, then another in May.
This is a good starting point to better plan for the future, particularly if you have no plan.
Alan Fisher is a US-based retail consultant focusing on open-to-buy, inventory analysis and profitability strategies. He works with golf shops, retail apparel and gift shops. He can be contacted at: email@example.com or call: 020 3289 4653.