Courtesy of The Waldoff Group, Inc.
February 2006
Revised and Posted to The Waldoff Group Blog
August 8, 2008
Increase Inventory Turns to Get the Most Profit
From Your Inventory Investment
While the present economic sluggishness will continue for some time, you can avoid a head-on collision with its effects! Consider this game plan to keep sales up, improve gross margin and get out of the short-term credit market.
How? Push turnover rate up. Increasing inventory turnover is always a good idea, it is especially profitable for stores selling apparel, accessories, shoes … items that change from season to season, year to year.
In good times, turnover is important; in bad times, it is critical. Higher turns mean that fresh, new merchandise will represent a greater proportion of your total merchandise (something customers love!).
Increased turnover will reduce your dependence on borrowed money by trimming down inventory.
Inventory turnover rate is the measure of an inventory’s efficiency at producing gross margin. It’s the number of times you “sell out” your entire inventory in a specific period of time, usually one year. Since each “turn” represents the inventory turnover rate and is the measure of an inventory’s efficiency at producing gross margin.
Additionally, since each “turn” represents the maximum gross margin inventory can produce, increasing the number of inventory turns in a year will increase gross margin dollars for that year.
In reality, of course, different types of merchandise sell out at different rates. Higher-volume, lower-priced items turn faster than big-ticket items. Therefore, the overall inventory turnover rate will be an average of the turnover rates achieved among all merchandise classifications.
Calculating Turn Over Rates: To calculate turnover, you first must determine average inventory. To do so for 2007, for example, you would take the ending inventory (at cost or retail, whichever you use) from the last month of the prior calendar or fiscal year, say December 2006, plus the ending inventories for each of the 12 months of 2007 . Then divide that total by 13, the number of inventories in the sum. The result is the average inventory for 2007. (Note: If you do not have monthly inventory numbers, estimate the average.)
The formula for calculating turnover:
Retail Method: total sales divided by by average inventory @retail
Cost Method: total cost of goods sold divided by average inventory @cost
Either way, you should come up with the same turnover figure.
(Note: I am a great believer in looking at everything at retail, not cost.)
Once annual turn has been calculated, identify individual problem areas by going through each classification and calculate the turnover rate for each merchandise classification in your store. Once you have calculated the current turnover rate for each class of merchandise you carry, you have objective data at hand to show where improvement is most needed.
Should you have classifications that are only turning twice per year, you’re spending a lot of money to carry it. In order to justify tying up your money, slow-turning merchandise must give you a substantially higher gross margin.
To illustrate what a difference one additional turn can make, let’s say your sales plan calls for $720,000 in total sales over the next 12 months. At three turns per year, you will have to carry an average inventory (at retail) of $240,000 ($720,000 divided by 3).
However, if you achieve $720,000 on four turns, your average inventory at retail will only have to be $180,000 ($720,000 divided by 4), a reduction of $60,000. At a 50 percent gross margin, that’s a reduction of $30,000 in inventory investment (at cost).
Therefore, you could shrink your total investment $30,000, and pay down $30,000 in debt. Plus, you would reduce your interest expense by $3,000 (assuming interest at 10% times 30,000), which goes right to the bottom line, and dramatically improve your net profits!
Last but certainly not least, your inventory will be fresher (average in-stock time of 90 days versus 120 days). Thereby motivating customers to shop your store more often, reducing annual markdowns, improving the freshness of your inventory along with sales and gross margin, improving employee motivation and attract ‘sale’ customers who will look to your store for in season savings.
As your regular price customer becomes more motivated to shop more often she will have greater confidence in your store because she knows she’ll always find fresh new merchandise! She will realize you are not allowing old, picked over and/or rejected items to simply take up space, clutter your racks and require her to sift through merchandise she has already rejected.
Establish Your Turnover Rate Goal
The next step to improving your overall turnover rate is to set a meaningful target turnover rate. First, review the turnover rate you just calculated for “actual” results.
Turnover rate for a retail apparel store should be at an absolute minimum of 3 … with the great majority of classifications turning a minimum of 4 and many turning 5, 6, 7 even 8 or 10 times a year. Slow turning classifications in women’s are typically bras, hosiery, shoes. Men's slow turn classes are underwear, socks, clothing (suits, sport coats and dress trousers) and shoes.
IMPORTANT: The higher level of fashion the higher level of turn.
Next, let’s take a look at days of supply. Remember, inventory turnover measures how many times the inventory is “sold out” each year. A turnover rate of 1 would be a 12 months supply. This also can be stated in weeks, or days, depending on your retail segment. (For example, grocers are most likely to use days, especially for fish, meat, produce, flowers and other perishables.)
turnover rate: months supply; weeks supply; days supply
one turn: 12 months; 52 weeks; 360 days
two turns: 6 months; 26 weeks; 180 days
three turns: 4 months; 17.3 weeks; 120 days
four turns: 3 months; 13 weeks; 90 days
six turns: 2 months; 8.7 week; 60 days
eight turns: 1.5 months; 6.5 weeks; 45 days
ten turns: 1.2 months; 5.2 weeks; 36 days
twelve turns: 1 month; 4.3 weeks; 30 days
A quick test for whether you are over-inventoried is to compare
your on-hand “supply” to your sales forecast.
For example, if you want to achieve an annual turnover rate of 4 turns, that would be 3 months “supply”. Therefore, at any given time, you should have no more inventory on hand than you can reasonably expect to sell in the next three months!
In this case, more on-hand (at retail) than the next three months of expected sales means you have too much!
More inventory than you can sell in three months increases markdowns and reduces gross profit.
Once You Increase Turns
All these numbers are interesting, but when it gets down to specific cases, just where and how is inventory cut?
One helpful guideline is the 80/20 rule. That rule states that 80 percent of your business comes from 20 percent of your customers. Or, 80 percent of your sales come from 20 percent of the merchandise. In your particular case, the numbers may be more like 70/30 or 60/40, but the principle is the same: find the 80 percent of the merchandise that only 20 percent of customers want, and start some careful sorting.
Chances are, there will be a lot of slow-turning items among that 80 percent of stock. List all the items that are now turning at a below-store-average target rate. Find out if there is a way to continue carrying a representative selection of those items without tying up so many dollars. As you continue to focus on reducing inventory, you also will reduce your need for inventory loans. The process of selling inventory that you don’t replace will give you a one-time cash infusion you can use to reduce your short-term debt.
The #1 question you should ask yourself as you buy merchandise:
“Is this item so important to my store that I’m willing to share a good part of my profits with the banker to have it?”
If it’s not that important, you’re better off without it.
The trick is to reduce your inventory selectively.
Obviously, there’s truth in the basic retailing maxim that you can’t sell from an empty wagon. If you don’t have an appealing assortment of fresh new goods your customers need, want and desire, they have no reason to visit your store.
However, you may have to redefine “full wagon”.
Here are some questions to ask about each item added to your store:
Can my customers get this item at other stores in my market area?
If yes, it has less pulling power. Sometimes it makes sense to carry brands sold in other stores …i.e. Estee Lauder, Vera Bradley, Ralph Lauren, etc., are so important they are often in neighboring stores. That being the case, you need the lines and your focus must then be on improved customer service, selection and freshness of inventory.
Is this a good margin item, or is it subject to a lot of price competition? Slow turners with weak margins are double trouble.
Does having this item in stock help me sell other higher-margin merchandise? If not, you may not need it.
Can I get faster delivery on this item than I am now getting?
If yes, you may be able to cut back on your weeks or months of supply.
Do I order larger quantities of this item than I actually need in order to take advantage of price breaks or to meet the vendors minimum?
If yes, you may be coming out on the short end when you figure in all your carrying costs, including excessive mark downs. And, the item may not be as good a seller as you expect, or may lose its appeal and quit selling. If it is a gamble or risk ... why expose yourself? There is enough gamble and risk just being a retailer!
Do I have an emotional attachment to this item that reflects my personal taste rather than a business-like response to my customer’s desires? If yes, get rid of it. I have worked with stores that had old outdated merchandise in stock rooms, basements and attic's, even one that had a storage unit! Not only was the merchandise old, it was so old it now had no value.
Locating vendors that can supply you with quick re-orders can dramatically improve turn.
A Balancing Act
Stocking a store is like walking a tightrope. You have to balance your need to make your inventory investment as productive as possible against your need to offer an adequate selection of merchandise to your customers.
You must weigh the benefits of buying in small quantities against the quantity discounts you may lose by doing so. (In fact, some vendors may not be willing to sell small quantities at all.) That may be a reason to not use that vendor.
We all know that customers prefer newer fresh merchandise over older, tired items. The ancillary effect of higher turns is fresher merchandise, an important tool for bringing customers in more often and a great anti-recession tactic.
Merchandising is not just a balancing act, it’s a very subjective balancing act. However, you’ll be much better equipped to make subjective decisions if you have hard, objective facts about your inventory turnover rates at hand. Once you have carefully evaluated your merchandise in light of the factors we have discussed here, we believe you’ll find plenty of room for improvement.
Don’t let too much excess inventory cut the heart out of your profits. Any effort you put into speeding up your inventory turnover will be time and effort well invested.
Make more trips to market and buy less each trip! We are very strong believers in buying hand to mouth! You don't go to the super market and buy two to three weeks of tomatoes! Why? Because you know tomatoes spoil! Besides, the super markets always carry tomatoes in stock! You can take some risk out of your buying by remembering this! One more fact: In all my years of owning stores, merchandise managing, buying and consulting I have never ever been to market where there was not more desirable goods than we could use.
During World War II there were shortages ... however, that was in 1941 to 1945 ... 63 to 67 years ago! There were no shortages during the Korean War,
Viet Nam and Desert Storm! There are no shortages during the current conflict in the Middle East. Take a chance on there not being shortages and you'll decrease your risk and increase your gross margin!
Why stock up when you know you can always find more desirable merchandise!
Do not allow the cost of a market trip influence you to over buy! A market trip should pay for itself in terms of keeping your inventory fresh and increasing turn, besides you will be better able to keep up with what's happening, what's selling, what's not and what's on the horizon ... thereby making you a better merchant, merchandiser and buyer.
Finally … don't lose sight of your purpose for being in business. To make money, make a living, create profits so as to survive. Do not lose sight of this in the prestige and glamour of being a store owner, merchandise manager, buyer and the excitement of market trips.
Retail is not for sissies!
Take your eye off the ball and it will smash right in your face!
