For many independent retailers, the largest asset on the balance sheet is inventory. Inventory is the 'active' asset, which generates the business's sales and profits. But without careful planning, inventory can easily get out of line, resulting in heavy markdowns due to overstocks and ultimately, serious cash flow problems.
For retailers whose businesses are subject to seasonal fluctuations, the challenge of managing inventory levels is magnified. Seasonal fluctuations in sales levels require that inventory levels anticipate both the seasonal peaks in sales as well as the seasonal ebbs.
The way to manage these seasonal fluctuations, and maintain positive cash flows throughout the year, is to develop detailed sales and inventory plans before the season begins, use those plans to guide your merchandise purchases, and as benchmarks in-season to guide your progress.
Planning takes time, time you may not think you have, but invariably those independent retailers that take the time to carefully plan their sales and inventory are far more profitable than those that don't.
Before you begin the planning process, you will need to know what you've sold in the past, and how much inventory you had on-hand to generate those sales. While effective planning goes far beyond merely what you did last year, this information is an important reference point. You will need to extract that data from your POS system, by category and month.
Unfortunately, many POS systems do not maintain a history of monthly inventory levels, so all you may be able to extract is sales data.
Second, you will need to determine the unit of measure that you will plan with. The two primary options are to plan in units or in retail dollar value. In almost all instances, I recommend planning in retail dollars. If you are going to do your planning in units, be clear in your own mind why units are the way to go in your particular business, and planning in retail dollars is inappropriate.
Step 1: Plan sales
The planning process begins with building a sales plan. For independent retailers, most sales plans are broken out by category and month (although in some cases, especially highly seasonal businesses or categories, it may be more appropriate to plan sales by the week). The question to ask is a very basic one: 'What is the most likely level of sales from stock (excluding special orders) by month (or week) Note that the question is what's the most likely level of sales, not what's the most you could possibly sell. It's easy to get in trouble by planning what you might be able to sell, which has a relatively low probability of occurring, rather than planning for the most likely level of sales, which has the highest probability of occurring.
Start by reviewing the prior year's sales histories, and make adjustments for unusual events, such as weather, out of stocks, one-time promotions, etc. Then factor in the appropriate increase or decrease based on your current sales trend and your reading of the sales potential of the category for the upcoming season. For larger categories, it may make sense to break the sales plan down further, by sub-categories, styles or vendors.
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Step 2: Plan inventories
Once a sales plan has been developed, the next piece of the planning process is to build an inventory plan. The question to ask is this: 'How much inventory do I need at the end of each month to support the next month's sales (in some cases the ending inventory may need to support more than just one month of future sales), as well as maintain effective merchandise displays?'
It makes little sense to bring in more inventory at any given time than you need to set your displays, support your planned sales until the next vendor delivery, and provide a safety stock in the event of an unexpected sales spike or a late delivery. Committing to inventory too far in advance, and then bringing it in all in one shot is one of the surest ways to find yourself over-stocked down the road.
Step 3: Plan discounts
There are two primary types of discounts a retailer might take, promotional discounts during the season, and clearance markdowns as the season winds down. Planning these discounts goes hand in hand with planning sales and inventories if you are using retail value as your unit of measure. A discount, just like a sale, decreases the retail value of your inventory on hand.
Planning clearance markdowns are particularly critical to protecting gross margins, and cash flow. If you plan the date of the first seasonal markdown before the season even begins, you can plan the inventory you want to have on hand at that point in time, and thus your markdown percentage.
Step 4: Plan inventory receipts
If you've planned sales by month, ending inventories by month and discounts by month, it's easy to calculate how much inventory to bring in each month, by category. You need to bring in enough to cover that month's planned sales, planned discounts and planned ending inventory, less the prior months planned ending inventory. In this way, for example, a buyer can know before a season begins how much inventory to plan on bringing in each month of the season.
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Step 5: Plan pre-season commit percentages
Once inventory receipts have been planned, the next step is to plan how to execute those receipt plans. The question to ask is, 'How much of my receipt plan do I want to commit to buying now, before the season begins?'
The pre-season commit percentage is the percentage of the season's receipt plan that you commit to before the season begins. It's the bets you place before the season has even opened up. Every seasonal retailer has to place these bets. A seasonal retailer has to commit to enough inventory to set displays and cover early sales, sales which are a critical early indicator of the season to come. Similarly, a retailer frequently has to commit up front to merchandise scheduled for delivery later in the season to assure they'll have core stocks of key items and categories at that critical time.
This is a critical step that is too often overlooked. Too frequently, once a receipt plan has been set, buyers spend it. But that is fraught with danger. The greater the pre-season commit percentage the greater the risk associated with those commitments. The best way to think of this is in terms of the calendar. The higher the pre-season commit percentage, the further out into the selling season those commitments will cover, before any sales have been made to indicate which way the season will go. Will I run an increase or a decrease? Will the styles or colors I've bought be the hot sellers? The further out the commitments go the greater the risk that overall sales volume may not be as high as planned, or that the fashion trend may develop in a different direction than anticipated.
Step 6: Plan continually throughout the season
The process doesn't end with preseason planning. In-season planning is even more important. As each week goes by, and sales trends begin to develop, adjust your sales plans accordingly, and adjust inventory plans for those updated sales plans. If sales are exceeding plan, you want to be sure you have the inventory to keep the momentum going. Conversely, if sales are coming up short of plan, the sooner you adjust your inventory plans, and thus your scheduled receipts, the less likely you are to end up with excess inventory that needs to be marked down at season's end.
Every time you are about to place a reorder, or a new order on new merchandise, update your sales plans. A buying opportunity may look very attractive and seem like an easy decision, but if you are already bought up or sales are not tracking to the plan you could be unintentionally increasing your markdown exposure.
Step 7: Take markdowns expeditiously
When sales start to fall behind plan, it's very tempting to think that you'll make up the sales later in the season. But when sales fall behind plan, inventories begin to back up as well. When inventories back up, pressure builds on prices, which if not addressed can lead to steep markdowns that decimate margins. The first thing to do is adjust future receipts to get inventories back in line, but it usually doesn't end there.
When sales are soft, the weakest of your items or categories will usually suffer disproportionately. They simply aren't as desirable at their full retail price. Mark them down as soon as you identify them. A 25% markdown, for instance, taken immediately, will accelerate their rate of sale and get you out of that inventory. If you wait until clearance time, when everything is marked down, it may take 50% to 75% to clear the inventory.