How Much Inventory Do You Need?
by Ted Hurlbut
Sure, you know how much your on hand inventory is worth, but do you know how long it should be on your shelves? Being able to answer that question is the key to keeping your cash flow in the positive.
“What’s the value of your inventory on hand?” This is one of the first questions that I ask a prospective client during our first conversation. And they can almost always give me a straight-forward answer.
Then I ask, “How many weeks of supply is that?”
For many small retailers I speak with, thinking of inventory in terms weeks of supply is a new concept. They can easily talk about inventory in terms of quantity, in terms of units, cases or casepacks, as well as how much inventory they need to build an effective display. They may have heard of terms like ‘inventory turnover’ or ‘open-to-buy’ without fully understanding what they mean. They understand return on investment, but in managing the day to day urgencies of their business they are much more focused on sales, believing that maximizing sales will lead to positive cash flow.
This perspective on cash flow is ironic, because almost every small retailer I speak with who can’t answer my weeks of supply question also experiences recurring cash flow problems. Let me explain why.
Thinking about inventory in terms of time is the essential starting point in effectively managing inventory. Stated in simple terms, the goal of effective inventory management is to have on hand at any given time only enough inventory to support planned sales until the next delivery arrives, plus a safety stock to cover any short term sales spike and the possibility of a late vendor delivery. This quantity can be stated at any point in time as forward weeks of supply; that is, the number of weeks of planned sales going forward that the current inventory represents. When thinking in terms of weeks of supply the focus is on maximizing the return on the inventory investment by linking inventory levels directly to planned sales.
However, many small retailers instinctively focus on how much they might be able to sell if they had the stock on hand, rather than the amount of cash they are committing to inventory. Their focus is on having the stock to be able to capture the ‘last sale’. The problem with trying to capture that ‘last sale’, however, is that it’s not possible to know exactly which sale is the ‘last sale’, resulting in inflated inventory levels. And unless they can quantify the number of weeks of supply they have on hand, and the number of additional weeks of supply they are purchasing, they have no way of projecting when they can expect to sell that inventory and convert it into cash.
Clearly, a critical component of forward weeks of supply is
planned sales. For small retailers of non-seasonal items, these sales plans can be arrived at quickly by taking the current weekly rate of sale and applying a factor for the current sales trend. For seasonal items, a quick sales plan can be developed by taking the prior years sales for the same period and applying the sales trend factor. For larger retailers, more elaborate demand forecasting software applications are frequently utilized. The point of this discussion is not to review various forecasting methods, but to emphasize the importance of a well thought out sales plan arrived at through careful analysis of past sales volume and patterns, and current trends.
To become a truly powerful inventory management tool forward weeks of supply needs to be calculated continually by category or item. For categories of fashion merchandise, for instance, where specific items are constantly changing as assortments, forward weeks of supply should be calculated by category. For staple replenishment items, forward weeks of supply should be calculated by item. And just as on hand inventories should be thought of in terms of forward weeks of supply, purchase quantities should also be evaluated for the number of additional weeks of supply that they represent. Every purchase order should be accompanied by the following question; “How many weeks am I buying?”
Finally, after I’ve taken a moment to explain the concept of weeks of supply to a prospective client, they invariably ask what the weeks of supply should be for their business. And just like they started the conversation by not knowing what their weeks of supply was, I end it by not being able to tell them what their weeks of supply should be. Every retailer has a different optimal weeks of supply, due to their unique mix of product offerings, which have unique selling characteristics, customer expectations and supply chains. And for most retailers, especially those whose product offerings are highly seasonal, the optimal weeks of supply may vary significantly throughout the year.
The point is not necessarily to identify what the optimal weeks of supply is, but to continually challenge the current forward weeks of supply to identify opportunities for eliminating unnecessary inventory, and free up cash for other urgent needs. For as every retailer understands, there’s no such thing as standing still; if you’re not going forward, you can be almost certain that you’re going backwards.
Small retailers who think of their inventory in terms of weeks of supply almost always experience fewer markdowns and fewer build-ups of dead inventory, faster inventory turnover, and healthier cash flows. With healthier cash flows, and a keen eye on weeks of supply, a small retailer will always have the ability to be a true merchant, to make that advantageous purchase, chase a key item or capitalize on the latest emerging trend. And those are the true keys to generating consistent sales increase and profitability.Source: www.businessknowhow.com
Category: Personal Finance