Edge Retail Academy Blog

Begin with the End in Mind, part 3 The ‘Inventory GAP’

by David Brown

After Reading Part 1 and 2 of this article, you should have completed a ‘GAP Analysis’ which will meet your future wealth & retirement requirements, as well as have calculated your ‘Gross Profit GAP’ and ‘Sales GAP’.

If you have not done these steps then please complete them before continuing with this step. You can find those articles in this blog as well.

If you have completed these steps then we are ready to answer the question, “how much inventory do I need to achieve my sales budget”, otherwise referred to as the optimum inventory level (OIL).

A definition of OIL is:

 Enough inventory to give your customers the best possible choice,

to give you the best possible return on your investment

and to allow for sustainable growth.

 The objective here is to help you understand and calculate your own OIL, however because this is a complex and highly important process it will be broken into smaller steps.

When calculating your OIL it is important to take into account other business circumstances such as:

  1. Is your business growing, static or declining?
  2. Are you intending to include new product ranges in your ‘buying plan’ to boost certain areas of your business?
  3. Are you planning to drop certain product lines that no longer fit your business model or market position?
  4. Categories which may show a below average gross return on investment (GROI) but deliver a high return on effort (ROE) … more on this later.

Having taken these factors into account, you are now ready to calculate your OIL but do so, understanding that GROI is not an exact science but rather a ‘rule of thumb’.

Also, remember that it is difficult to sell what you don’t stock … in other words investment precedes dividend. You don’t get interest from your bank until you deposit some money and so it is with retailing.

Arguably, it is possible to achieve a GROI of 200 i.e. $200 of gross profit per annum from every $100 invested in inventory. This should therefore be the basis for calculating your OIL if you are striving for ‘best practice’.

However, because most stores are achieving well below this, a more realistic ‘Rule of Thumb’ for a growing retail business is that every $1.00 of well chosen, well managed inventory will produce between $2.50 and $3.00 of retail sales per annum (excluding repairs, custom designs and special orders).

That means if your inventory level is $100,000, you should be achieving between $250,000 and $300,000 of retail sales.

Looked at another way, using our example of ‘GAP’ sales of $1,062,265 the OIL would be between $354,088 ($1,062,265 ÷ 3 = $354,088) and $424,906 ($1,062,265 ÷ 2.5 = $424,906).

GAP Sales Budget

Stock to Sales Ratio

Optimum Inventory Level

$1,062,265

3

$354,088

$1,062,265

2.5

$424,906

Important: Anything less than this level of performance, you are under performing, which means you either need to address the lack of sales compared to the inventory you are carrying, or you need to address the excess inventory. Our preference is that you consider both before deciding on a strategy because often the inventory is not the real problem … a lack of sales is (Do you have the right people?)

 Action Steps:

  1. Note any changes to your business circumstances as outlined
  2. Calculate your Optimum Inventory Level (OIL) as explained
  3. Calculate your ‘Inventory GAP’ by comparing your OIL with your current inventory level
  4. Based on your ‘Inventory GAP’ determine if your strategy moving forward will be to increase sales, reduce inventory or both

In part 4 of this article, we will explain GROI and how to calculate your OIL for each product Category.

As always, if you need strategies for your inventory, please do not hesitate to reach out to The Edge Retail Academy. We can do a complimentary Business Opportunity Analysis for you, which will highlight areas going well in your business as well as areas to strengthen.

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