In our last article (find it at www.southernjewelrynews.com) we focused on the GAP in sales figures required and the level of gross profit needed to achieve your long term financial goals.
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 dividends. 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 of well chosen, well managed inventory will produce between $2.50 and $3 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 from the last article the OIL would be between $354,088 ($1,062,265 ÷ 3 = $354,088) and $424,906 ($1,062,265 ÷ 2.5 = $424,906).
Important: Anything less than this level of performance and 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.
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
Next month we will explain GROI and how to calculate your OIL for each product Category.
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