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Slugging it out in a sluggish economy: increase inventory turns to get the most profit from your inventory investment
By Silverman Consultants CEO Bob Epstein for Southern Jewelry News [ October 2006 ]
The present economic sluggishness may continue, but you can avoid a head-on collision with its effects! Consider this gameplan: keep sales up, and, get out of the short-term credit market. How? Push turnover rate up. Increasing inventory turnover is always a good idea, but it may prove especially profitable during the coming months.
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!). And it 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.
Calculating Turnover Rates
To calculate turnover, you first must determine average inventory. To do so for 2006, for example, you would take the ending inventory (at cost or retail, whichever you use) from the last month of the prior fiscal year, December 2005, plus the ending inventories for each of the 12 months of 2006 . Then divide that total by 13, the number of inventories in the sum. The result is the average inventory for 2006. (Note: If you do not have monthly inventory numbers, estimate the average. Close counts!)
The formula for calculating turnover is:
Retail Method: divide total sales by average inventory at retail
Cost Method: divide total cost of goods sold by average inventory at cost
Either way, you should come up with the same turnover figure.
Begin by calculating the turnover rate for each merchandise classification in your store. Once you’ve calculated the current turnover rate for each type of merchandise you carry, you have objective data at hand to show where to improve. If you have a classification that’s only turning once 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 one turn per year, you will have to carry an average inventory (at retail) of $720,000 ($720,000 divided by 1).
However, if you can hit $720,000 on two turns, your average inventory at retail will only have to be $360,000 ($720,000 divided by 2), a reduction of $360,000. At a 50 percent gross margin, that’s a reduction of $180,000 in inventory investment (at cost). Therefore, you could shrink your total assets $180,000, and therefore pay down $180,000 in debt.
Last but not least, your inventory will be fresher (average in-stock time of 180 days versus 360 days).
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.
Then, identify the turnover rate of other jewelers like yourself. The benchmark for the jewelry industry is 1.3X. 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 2 turns that would be 6 months “supply”. Therefore, at any given time, you should have no more inventory on hand than you expect to sell in the next six months! More on-hand (at retail) than the next six months of expected sales means you’ve got too much!
How to Raise 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 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.
Here is 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.
Redefine “Full Wagon”
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 goods your customers need, 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 probably has no pulling power.)
- 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 stock.)
- Do I order larger quantities of this item than I actually need in order to take advantage of price breaks? (If yes, you may be coming out on the short end when you figure in all your carrying costs.)
- Do I have an emotional attachment to this item that reflects my personal taste rather than a businesslike response to my customer’s desires? (If yes, get rid of it.)
A Balancing Act
In practice, 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 have to 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.)
We all know that customers prefer newer merchandise over older, tired items. The ancillary effect of higher turns is fresher merchandise, a great anti-recession tactic.
Once you’ve carefully evaluated your merchandise in light of the factors we’ve discussed here, we believe you’ll find plenty of room for improvement. Don’t let too excess inventory cut the heart out of your profits. Any effort you put into speeding up your inventory turnover will be well invested.
Bob Epstein is CEO of Silverman Jewelers Consultants. Since 1945, Silverman has been considered one of the premier sales consulting firms to the jewelry industry, specializing in improving cash flow and maximizing the recovery on distressed inventory through professionally conducted sale events. Bob can be reached at 800-347-1500 or by e-mail at email@example.com.