real life scenarios
Here's a breakdown of the critical elements that make up your inventory management while overseeing your business operations and using OpenToBuy.co.
WHAT IS OPEN TO BUY?
Open To Buy (OTB) is an inventory purchasing plan designed to manage and streamline
purchases to ensure there is an optimal amount of inventory to meet demand, manage cash
flow and increase profitability.
WHAT IS COST OF GOODS SOLD (COGS)?
The COGS is the cost a retailer pays for merchandise from a vendor, whether a manufacturer or distributor, that is sold to customers. The retailer marks the product up to achieve the desired gross margin % to arrive at the retail price paid when sold to make a profit. Each sale that is transacted will have a retail price and cost (COGS) associated with it. At the end of a month all sales and cost are calculated to determine the overall gross profit from the monthly sales.
WHY IS MANAGING YOUR INVENTORY SO IMPORTANT?
As a product-based retail operation, your success or failure as a business revolves around having the correct amount of inventory to meet the demand, has the proper annual turns to generate cash flow, is priced properly to generate a profitable gross profit margin, manages product categories to align sales, inventory and purchases for each and maintain a base inventory commiserate with your beginning monthly inventory COGS and annual turns. If you are not using each of these factors in managing your inventory the result will be lower cash generated, decreased profits and lower chance of being successful.
WHAT ARE INVENTORY TURNS & WHY ARE THEY IMPORTANT?
Inventory turns is the number of times your total inventory turns on an annual basis. Ideally, for a retail business 4 turns, or inventory turning every 90 days. Turning too rapidly indicates not enough inventory is on hand to meet demand and sales are missed resulting in lost revenue and profitability. If the inventory turns too slowly that is an indication that there is too much inventory on-hand resulting in cash shortages and/or lost profits due to continually having to continually lower prices to sell the merchandise, thus not achieving the intended gross profit margin.
HOW ARE INVENTORY TURN CALCULATED?
The two factors for calculating annual inventory turns are average inventory and COGS. Over a 12-month period take the inventory at the beginning of each month, total and divide by the number of months you used. And for that same period determine what your COGS. These can usually be found through your POS system. The formula is:
COGS/Average Inventory
Example – a retail store during a 23-month period generated $1,000,000 in revenue at a 52% COGS or $520,000. This means you sold $520,000 in merchandise at cost to generate $1,000,000 in retail sales.
The retailer determined their inventory totals as follows:
1/1 $129,500
4/1 $132,250
7/1 $121,750
10/1 $118,500
12/1 $146,250
Total: $648,250/5 inventories used
= $129,650 average inventory
Inventory turns = COGS $520,000/Avg. Inventory $129,590
Average Annual Inventory = 4.02
WHAT IS BASE INVENTORY?
The base inventory is the calculation to determine how much inventory is needed to achieve your sales goals based, the number of inventory turns and COGS. When forecasting a new year sales projections are created for each month for the 12-months. Secondly, the anticipated COGS % is determined which will provide the projected dollars needed to be spent for each month and the years to reach the forecasted sales.
Example:
Forecasted sales for 12 months
$1,000,000
COGS 50.0%
$500,000
Projected Annual Turns: 4
Calculated Base Inventory
$125,000 ($500,000/4)
As each month is complete, the actual sales and COGS replace the forecasted numbers and will recalculate the base inventory to ensure it remains aligns with the 4 annual turns in the example above. He adjusted base inventory will change the monthly and yearly OTB.
WHY TRACK PRODUCT CATEGORIES?
Determining the % of sales in key product categories of overall sales is critical in developing the OTB to ensure purchasing dollars are invested properly for the highest return. This number can be accessed through the POS system that tracks sales in product categories and overall sales. Determine what categories comprise 85%-90% of your total sales. For a typical business this totals 6-8 categories as many can be consolidated to manage more effectively. What’s left are miscellaneous.
Remember, category sales are “customers talking to you” through their purchases at the store.
In our example above let’s assume shoes is a category for the business and it generates 18% of the overall revenue. If the COGS is projected to be $500,000, then at 18% the OTB for shoes for the year is $90,000 ($500,000 x 18%).
Every three months you should review your category sales % in the POS system and adjust as needed if sales % have changed in categories. When entering in initially or making changes, keep in mind the total category % must be 100% or equal to the projected or projected + actual COGS.
WHY ARE FORECASTED SALES & COGS IMPORTANT WHEN PLANNING?
To effectively create an OTB and purchase merchandise in future months, you must forecast your sales and COGS in order to determine how much you will need to replace what has been sold each month and maintain the base inventory to achieve the designated annual turns. Without projecting future sales and COGS a retailer will ne be able to accurately purchase merchandise and will, more than likely, purchase too much or too little, thus either tying up cash needlessly or missing sales and significantly impacting profitability.
WHY IS BEGINNING INVENTORY A PART OF AN OTB PLAN?
The beginning inventory plays an integral part in determining how much inventory is needed and is directly tied to the base inventory that has been established. If the beginning inventory is higher than the base inventory, the difference will be deducted from the first month’s inventory purchases. If its lower dollars will be added to the first month’s purchases to ensure there is not a shortage of goods purchased. And each subsequent month the ending inventory of the previous month will be the beginning inventory for the new month. And purchases for the new month will be dependent on the beginning inventory, scheduled purchases, forecasted sales and COGS.
WHAT IS OPEN TO BUY?
Open To Buy (OTB) is an inventory purchasing plan designed to manage and streamline
purchases to ensure there is an optimal amount of inventory to meet demand, manage cash
flow and increase profitability.
WHAT IS COST OF GOODS SOLD (COGS)?
The COGS is the cost a retailer pays for merchandise from a vendor, whether a manufacturer or distributor, that is sold to customers. The retailer marks the product up to achieve the desired gross margin % to arrive at the retail price paid when sold to make a profit. Each sale that is transacted will have a retail price and cost (COGS) associated with it. At the end of a month all sales and cost are calculated to determine the overall gross profit from the monthly sales.
WHY IS MANAGING YOUR INVENTORY SO IMPORTANT?
As a product-based retail operation, your success or failure as a business revolves around having the correct amount of inventory to meet the demand, has the proper annual turns to generate cash flow, is priced properly to generate a profitable gross profit margin, manages product categories to align sales, inventory and purchases for each and maintain a base inventory commiserate with your beginning monthly inventory COGS and annual turns. If you are not using each of these factors in managing your inventory the result will be lower cash generated, decreased profits and lower chance of being successful.
WHAT ARE INVENTORY TURNS & WHY ARE THEY IMPORTANT?
Inventory turns is the number of times your total inventory turns on an annual basis. Ideally, for a retail business 4 turns, or inventory turning every 90 days. Turning too rapidly indicates not enough inventory is on hand to meet demand and sales are missed resulting in lost revenue and profitability. If the inventory turns too slowly that is an indication that there is too much inventory on-hand resulting in cash shortages and/or lost profits due to continually having to continually lower prices to sell the merchandise, thus not achieving the intended gross profit margin.
HOW ARE INVENTORY TURN CALCULATED?
The two factors for calculating annual inventory turns are average inventory and COGS. Over a 12-month period take the inventory at the beginning of each month, total and divide by the number of months you used. And for that same period determine what your COGS. These can usually be found through your POS system. The formula is:
COGS/Average Inventory
Example – a retail store during a 23-month period generated $1,000,000 in revenue at a 52% COGS or $520,000. This means you sold $520,000 in merchandise at cost to generate $1,000,000 in retail sales.
The retailer determined their inventory totals as follows:
1/1 $129,500
4/1 $132,250
7/1 $121,750
10/1 $118,500
12/1 $146,250
Total: $648,250/5 inventories used
= $129,650 average inventory
Inventory turns = COGS $520,000/Avg. Inventory $129,590
Average Annual Inventory = 4.02
WHAT IS BASE INVENTORY?
The base inventory is the calculation to determine how much inventory is needed to achieve your sales goals based, the number of inventory turns and COGS. When forecasting a new year sales projections are created for each month for the 12-months. Secondly, the anticipated COGS % is determined which will provide the projected dollars needed to be spent for each month and the years to reach the forecasted sales.
Example:
Forecasted sales for 12 months
$1,000,000
COGS 50.0%
$500,000
Projected Annual Turns: 4
Calculated Base Inventory
$125,000 ($500,000/4)
As each month is complete, the actual sales and COGS replace the forecasted numbers and will recalculate the base inventory to ensure it remains aligns with the 4 annual turns in the example above. He adjusted base inventory will change the monthly and yearly OTB.
WHY TRACK PRODUCT CATEGORIES?
Determining the % of sales in key product categories of overall sales is critical in developing the OTB to ensure purchasing dollars are invested properly for the highest return. This number can be accessed through the POS system that tracks sales in product categories and overall sales. Determine what categories comprise 85%-90% of your total sales. For a typical business this totals 6-8 categories as many can be consolidated to manage more effectively. What’s left are miscellaneous.
Remember, category sales are “customers talking to you” through their purchases at the store.
In our example above let’s assume shoes is a category for the business and it generates 18% of the overall revenue. If the COGS is projected to be $500,000, then at 18% the OTB for shoes for the year is $90,000 ($500,000 x 18%).
Every three months you should review your category sales % in the POS system and adjust as needed if sales % have changed in categories. When entering in initially or making changes, keep in mind the total category % must be 100% or equal to the projected or projected + actual COGS.
WHY ARE FORECASTED SALES & COGS IMPORTANT WHEN PLANNING?
To effectively create an OTB and purchase merchandise in future months, you must forecast your sales and COGS in order to determine how much you will need to replace what has been sold each month and maintain the base inventory to achieve the designated annual turns. Without projecting future sales and COGS a retailer will ne be able to accurately purchase merchandise and will, more than likely, purchase too much or too little, thus either tying up cash needlessly or missing sales and significantly impacting profitability.
WHY IS BEGINNING INVENTORY A PART OF AN OTB PLAN?
The beginning inventory plays an integral part in determining how much inventory is needed and is directly tied to the base inventory that has been established. If the beginning inventory is higher than the base inventory, the difference will be deducted from the first month’s inventory purchases. If its lower dollars will be added to the first month’s purchases to ensure there is not a shortage of goods purchased. And each subsequent month the ending inventory of the previous month will be the beginning inventory for the new month. And purchases for the new month will be dependent on the beginning inventory, scheduled purchases, forecasted sales and COGS.
