In the previous 3 articles we have discussed the GAP between your required future wealth and where you are now. We have looked at how much gross profit you will require each year in order to achieve that level of wealth in the time frame allowed. We have worked out what level of sales you will need to reach that gross profit and the amount of inventory that is required in order to facilitate those sales. (If you haven’t completed this exercise read back through our last 3 articles or contact us directly for further information on how to do this)
Now that you understand how much inventory you need overall, i.e. across all categories, it is time to calculate the inventory requirements in each category.
In order to understand how this works, you first need to understand GROI.
Understanding Gross Return on Investment (GROI)
GROI is a formula whereby Markup multiplied by Stockturn equals GROI. For example if your markup is 100% and your stockturn is 0.8 then your GROI is 80 (100 x 0.8).
What this means in real terms is that for every $100 you have invested in inventory, you are generating $80 of gross profit per annum.
Here’s how GROI works in other retail sectors.
Important: We are not recommending the jewelry figures above. However they are typical of what we see when making these sorts of comparisons. As you can see, it is the combination of both stockturn and markup that is important. Groceries have by far the best stockturn and jewelry has the best markup, but overall clothing has the best GROI with $200 of gross profit from every $100 invested in inventory.
Here’s how GROI may work within a typical jewelry store.
Important: Again, these are not recommended figures, nor are we suggesting you throw out your diamond rings and replace them with silver because we also need to consider your Return on Effort (ROE). More on that later.
So in real terms, your GROI is the only way to genuinely compare the performance of one category with another. We often hear retailers complaining about markup and threatening to drop a product line that in reality has a better GROI than other products with a higher markup.
So how does this help you calculate the Optimum Inventory Level (OIL) for an individual category?
Well, following our example of ‘GAP’ Sales of $1,062,265, let’s say 10% of your sales are currently coming from diamond rings and you want this to increase to 12% this year. 12% of $1,062,265 equals $127,472 of diamond ring sales.
Let’s also say that you intend to increase your markup on diamond rings to 100% and achieve a stockturn of 0.8 (meaning on average you expect them to take 15 months to sell). The OIL calculation would look like this. (Please note we can quickly, easily and affordably help you setup a Sales and Inventory Plan if required.)
So, as you can see, in this example you would have $11,125 to invest in diamond rings. But alas, there is a little more to it than that because you are already arguably over stocked by $173,450 overall.
1. Decide what your business is going to look like in the next 12 months. For example, decide which categories you are going to build and which ones you are going to reduce (if any).
2. Take each category and determine what GROI you expect (remember this is a combination of your markup and stockturn in each category)
3. Using these figures, calculate your Optimum Inventory Level (OIL) in each category. Important: Do one at a time and start with the categories that can make the greatest amount of difference in the shortest amount of time.
4. If you are already over stocked in a category, decide whether you will increase your sales budget to match your inventory or reduce your inventory.
5. If you are under stocked in a category, look at other categories that may be over stocked and work out how you can redeploy the investment where it’s needed.
6. Before rushing out and buying blindly, think carefully about the price points and margin you want to achieve, the image you want to create and the vendors with which you want to partner.
Next we will explain how to break your annual budgets into monthly targets so you can measure, monitor and modify your results and strategies.