Store owners and general merchandise managers know that good inventory management is essential to producing profits. You also know that bad inventory management can cause failure and limit profit.
Soaring Inventory Strangles!
Source: Outdated non-salable discontinued inventory leads to high taxes and increased opportunities for theft.
Result: Lower margin
Most studies show the annual additional costs for excess inventory can be 25 to 33%.
Here’s the deal: First, estimate the total inventory at cost you currently have on hand. For example, $100,000 of inventory on hand at cost. If you carry 15% more inventory than you actually need, what’s it cost you?
$100,000 inventory x 15% excess = $15,000 in excess inventory
$15,000 excess inventory x 25 to 30% = $3,750 to $4,500 annual waste.
The cost of holding excess inventory could be sidestepped if you invested in an inventory management system that would last you the life of your business and pay for itself in a year’s time.
Source: Low gross margin causes pressure to sell more in order to maintain appropriate cash flow. Pressure to increase volume results in higher selling, advertising and operating expenses.
Result: Increased expenses = reduced profits. Pretty simple!
Being over inventoried leads to two serious operational failures. Typically, once you figure out you’re in inventory overload the next step is to increase advertising in order to increase traffic by promoting some version of clearance, liquidation, or other gimmicky transactional promotion. As soon as the gimmicky promotion begins to drive foot traffic higher, your selling cost as a percentage of sales increases and the GM% decreases.
The process I’m describing is playing out daily in retail stores throughout America. Visually it looks like a 1980’s beer bong; profits seen funneling quickly into the belly of the already overly intoxicated crowd.
Source: High inventory causes poor cash flow.
Result: This results in excessive debt servicing, slow selling inventory remains in stock and best sellers become difficult to re-buy.
With every sales transaction, cash is generated, which drives the system. Cash is used to purchase inventory and pay expenses. The faster this cycle turns, the more efficient and expedient is your use of your investment.
Hopefully you have a good banker who will inform you of the destructive cycle that is beginning. If your banker loans you money, he or she will also want to improve your inventory control to squeeze the excess cash out of your inventory. This problem may appear temporary, but it may not be. The loan is a short-run solution: it will not eliminate the long-run problem.
Plan for Inventory Needs
How do you know if you have high inventory? One way to judge is to determine your current inventory turnover rate (sales divided by average inventory at retail OR cost of goods sold divided by average inventory at cost). To get the most out of your inventory, settle on a turnover rate producing just the right flow of merchandise to enhance sales, optimize cash flow, and maximize your profits.
Effective inventory management takes planning—not dumb luck!
I cannot emphasize enough the importance to plan your inventory needs, which means implementing an open-to-buy system. This enables you to commit yourself to receiving a certain amount of inventory in a given amount of time. These amounts are predetermined based on a carefully calculated sales plan and corresponding inventory level (based on your predetermined turnover goals).
Keep this in mind before you embark on your next season’s purchases. The hottest new merchandise is not always the solution to what keeps you awake at night. Cash flow improvements will only come from a conversion of bad inventory to debt reduction. And new inventory that turns at the correct pre-planned amount. Anything else is like moving your credit card debt from one interest card to another. It feels good now, but the problem remains.