To many retailers, inventory turn is one of the most confusing concepts in the retail business. (Later in this module, we are going to use the humble banana to clear up some of that confusion).
Most know that improving the inventory turn rate means less money invested in inventory, therefore more cash is available to use in other areas of the business, or to keep in their pocket. The clouds of confusion seems to swell around two main issues:
1.Exactly what does it mean?, and
2. Exactly how do you do it?
EXACTLY WHAT DOES IT MEAN?
The definition of inventory turnover changes, depending on to whom you are talking and from what background they come. Some will talk about turning your inventory investment at cost; others will talk about turning your retail inventory at retail. The formulas they share with you for computing your inventory turn will be greatly different.
For instance, I just visited another website, where the author is talking to an audience of wholesale distributors- people who sell goods at bulk out of warehouses.
Here's the formula the author shares with his audience:
Inventory turnover is calculated with the following formula: "Cost of Goods Sold During The Past 12 Months Divided By The Average Inventory Investment During The Last 12 Months".
The author goes on to note: "Inventory turnover is based on the cost of items (what you paid for them), NOT sales dollars (what you sold them for)."
Now, compare this with the formula that most retailers use, and which we at The Hallman Company use in working with our clients:
"Inventory turn rate is calculated by dividing your retail sales for 12 months by the average inventory investment at retail during the past 12 months".
You see, in one instance, people are advised NOT to use annual sales in the formula, in the other instance they are encouraged to definitely use annual sales!
The reason, of course, that we believe you should use net sales (after the impact of markdowns and other discounts) and average retail inventory (fully marked up) is so that you can better "see" the impact of markdowns on the performance of your inventory.
A merchant's mission is not only to get as high an inventory turn rate as possible, but to do it while preserving the initial markup, or margin of profit, as possible. That's why we like to use the fully marked up retail value of the average inventory as a benchmark.
In actual practice, it really doesn't matter!
Either formula will show you how often you are turning your investment.
The question is, once you have gone to the trouble to work either formula and to know what your inventory turn is, what are you going to DO about it? What actions will you take?
It's enough to drive you BANANAS!
(In my corner of the world, the phrase "going bananas" means that someone is "very frustrated", or maybe even "gone crazy". I don't know how bananas got hung with such a rap as this, but we can use this humble fruit to de-fuse some of the confusion on this whole issue of "inventory turn".)
Ok, since someone mentioned bananas, let's talk about bananas.
Bananas are an interesting fruit- they come in their own ziplock covers, and they are good for you. I personally love to eat bananas. So do a lot of other people.
So, to better understand what inventory turn means, and also to help answer the question of "How do you do it?" let's go into the banana business together...
Let's say we own a little fruit stand, and from this fruit stand we sell bananas. We buy our banana stock from a local wholesale market. We pay 50 cents for each banana, and we sell it to our customers for $1.00. We sell, on average, 100 bananas per week (remember, it's a small fruit stand).So, bright and early, each Monday morning, before our stand opens, we go to the wholesale market, show our ID cards to prove we are real-life retailers and have a right to buy at this wholesale market, and we buy our 100 bananas.
We pay $50 for these 100 bananas. Our inventory investment in these 100 bananas is $50. We work hard for six days, and by Saturday night, we have sold all of our bananas. We made a $50 profit on our $50 investment.
We turned (bought and sold) our inventory of bananas one time that week. We take Sunday off- we deserve the rest!
Now, we begin to exchange notes about our business - how can we do more business? "Well," you say, "almost every customer who comes by the stand to buy bananas asks me if we carry apples. I think we could sell some appes, if we had them."
I agree, since many of my customers also asked about apples. We decide to do some high-tech market research. All the following week, whenever anyone asked us about apples, we put a hash mark on a sheet of paper. By doing this, we determined we could sell at least 50 apples per week. We can get the apples for 50 cents each, and sell them for $1.00, just like the bananas.
We only have one problem. We don't have an extra $25 to buy the 50 apples. We only have $50, and we need that $50 to pay for our 100 bananas. All the meager profit we make each week goes to pay the rent on the fruit stand, and for us to live on. We think about borrowing the extra $25 from your Mom, but you don't want to ask her - and she doesn't like me at all!
Oh, what can we do?
"Eureka!", you exclaim. "I know what we can do! This Monday morning, we'll go to the market as usual, but instead of buying 100 bananas, we'll only buy 50 bananas. With the $25 we save, we'll buy our week's supply of apples!"
"But if we only buy 50 bananas, we'll run out of bananas", I note.
"Not really", you say, "because we'll make an extra trip to the market Thursday morning, and with the money we made from selling all 50 bananas and half the apples the first half of the week, we'll buy the other 50 bananas we'll need for the second half of the week".
So, that's what we do, and of course, here is what happened:
Rather than investing $50 once per week to sell the 100 bananas which brings us a $50 profit, we invest only $25 to buy 50 bananas; we sell those for a $25 profit, get our original $25 back, and then re-invest it in another 50 bananas which we sell the other half of the week.
Now, we are making the same $50 banana profit on a $25 investment because we buy 1/2 the bananas twice as often during the week. With the other $25, we buy our week's supply of apples. By selling the apples, we make another $25 profit.
So now, our same $50 invested in fruit is returning us a profit each week of $75, rather than $50. That is what inventory turn is all about: buying, selling, and rebuying the inventory more often during the same time frame. And, it won't take us long to realize that we don't really need to buy our entire week's supply of apples all at one time, either.
After all, some customers have been asking about oranges...
Note: To improve your fruit stand's inventory turn, it is vital, even critical, that you know how many bananas you can sell per week.
No matter what your product is, from bananas to bras to bikes to bulldozers, you have to know with a relative degree of accuracy, how many can I sell per (week, month, season)?
At The Hallman Company, we use a proprietary forecasting tool (Winning @ Retail) developed especially for retailers, which forecasts sales by month, for up to 12 months out, with an accuracy rate tracked as high as 94%.
We can do this for any classification of merchandise, in any type of store, anywhere. That's one reason our client retailers invite us into their business on a regular basis. Armed with this and other vital infomation, they can make better merchandising decisions, which results in higher sales, fewer markdowns, more satisfied customers, and of course, higher inventory turn, which means less money tied up in inventory, or freed up for expansion of the business into other areas.
About the author:
James Hallman has over 20 years in retail management, both corporate and entrepreneurial. For the last 17 years, he has operated The Hallman Company, a retail consultant agency based in Atlanta, Georgia. The Hallman Company specializes in bringing best-of-class services to best-of-class specialty retailers. Services include inventory planning with pre-calculated open to buy, and team management training. Mr. Hallman recently launched an online retail store http://www.AudioCityBooks.com
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