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Spring 2004 Money on the Shelf

Many retailers view inventory only as items to sell, the stuff that brings in customers. So they put very little effort into tracking it. Big mistake.

It takes money to buy inventory, of course, which means “money equals inventory.” To help make the point for yourself, take a look around your cart or shop and imagine your inventory—the merchandise on displays plus your back stock—as piles of $10 bills. Once you capture that image, you tap into a key business principle: Your inventory management system—how you track your inventory—can make the difference between profit and loss on your bottom line. Why? Because knowing what you have on hand, what you need to order, what sells and what doesn’t will give you a snapshot of your business now, and a plan for the future.

Gotta have a system

You need a system to track inventory on a regular basis. Don’t be put off by the idea of a “system,” though. It doesn’t have to mean complicated or expensive—but it does have to be routine. Here are eight tips for tracking your inventory for greater profitability:

Computerize your records. If you haven’t already, automate your inventory-management system by putting it on your computer. A computerized system will likely pay for itself in a year or less by making your business more efficient. The cost of computers, peripherals like printers, and software has dropped dramatically in recent years; and incentives (like rebates and freebies) and financing (interest-free deals, or leasing) are often available through sellers, including online retailers. And if you’re not yet proficient using a computer, there are affordable training packages through sellers, adult-ed classes at local high schools and colleges, and independent trainers who will come to you (try your local college for affordable freelancers).

Track inventory turnover. A good computerized tracking system will be a great help for calculating turnover, or “turns,” the number of times your inventory is replaced per year or per month. The more turns, the better—it means you’re getting more from your inventory investment dollar.

It can be stated as number of inventory turns per year. That’s calculated by dividing inventory into the cost of goods (cost of goods sold ∏ inventory = turns per year). So using $100,000 of inventory and $400,000 for cost of goods sold: $400,000 / $100,000 = 4 turns/year.

Or turnover can be stated as number of days of inventory on hand. That’s calculated by dividing the number of turns per year (or period) into the number of days you operate. So using the number from above: 360 operating days/year / 4 turns/year = 90 days of inventory on hand.

It doesn’t matter which method you use, but it’s vital that you stick with it and do the math on a regular schedule. Then compare the number you get to your own business’s historical averages and to industry averages. (Check with your trade group for these figures, or search online.)

By making these comparisons, you’ll be alert to positive and negative changes, and can adjust your inventory accordingly. For example, with the figures from the examples above, if your historical and industry averages were 60 days, you could adjust your inventory level down from 90 days to 60, and positively impact your cash flow by $33,333: 30 days (fewer) / 360 x $400,000 = $33,333

Even if you’re a small retailer with numbers at one-tenth of these, you’d realize a savings of $3,333.

One final point about turnovers; Calculate them not just for your overall inventory, but also by product line and SKU. Doing this will help pinpoint specific adjustments to ensure you aren’t overstocking items that sell less frequently than others.

Find the “right” amount. Even when you track turnovers with a computerized system, finding the balance between too much and too little inventory can be a challenge. Specialty retail customers expect to find what they’re looking for when they come to you. If you’re out of stock, well, you can’t sell what you don’t have, as the old saying goes. And if this happens often, your customers will stop coming. Conversely, if you keep too much inventory, customers might be happy but your lender won’t. Too much inventory means you’re not selling what you’ve paid for—that money’s not only tied up and isn’t turning into revenue, it’s also costing you interest.

The key is to keep up with the market. Watch trends. Stay on top of what’s hot. Know what sells. You can do this by attending trade shows, talking to your suppliers and other retailers, reading trade publications, and talking to your customers.

Refine your ordering system. Many retailers make the mistake of letting any employee order merchandise. Or they themselves are too busy or frazzled to order carefully and efficiently. But ordering requires attention to detail. So if you frequently open shipments and find several items you know you have plenty of on the shelves, it’s time to reel in the ordering process. It’s fairly easy to do: authorize just one person to do all of the ordering, and make sure that person has the latest inventory-management information when planning every order.

Get rid of dead inventory. Many retailers feel they have to carry a little of everything. For example, if customers inquire about a couple of specific items a few times a year, those items are ordered not as special orders but as general stock, so that if and when the customers ask again, those items there. This may be good customer service, but it’s bad inventory management, and bad for cash flow. So is keeping slow-moving items in stock “just in case” someone asks for it.

The remedy: Take inventory of the dead stuff. Mark down slow movers to irresistible prices, and when something slow does sell, don’t replace it. Instead, put that money into items that turn much faster—which means your money turns faster and your cash flow is better.

Understand Cost-to-order and Cost-to-keep. The actual cost of the inventory itself is only the beginning of the equation for your investment in inventory. The “soft” costs required to order and stock inventory are equally significant and must be held in check.

Cost-to-order—what it costs to order inventory beyond the cost of the merchandise—involves several factors. First is the time it takes to prepare and place the order. Time is indeed money, and a direct correlation exists between the frequency of ordering and what it costs your business. Second is the time it takes to inspect and return defective or mis-ordered merchandise. And since you can’t sell that merchandise, you lose potential sales revenue, too. And third are the ancillary costs like shipping and handling, which an inefficient ordering system can inflate.

Cost-to-keep—the money it costs to hold the inventory you have—is the direct cost associated with keeping inventory on hand. These costs include your rent, overhead, wages, insurance premiums, and any off-site storage rent.

Be proactive, not reactive. Just because you sell a lot of something doesn’t mean it should dominate your sales space. Be proactive: do a thorough inventory-cost analysis that calculates turnover, cost-to-order and cost-to-keep. It just might reveal that some of your most popular items are also your least profitable.

A reactive retailer may never realize this profit drain, particularly if he or she is too focused on sales at the expense of profits. But a proactive retailer can correct the problem easily. If your analysis reveals that you sell many items at or below breakeven, change the focus of your business. Redo your layout to give most prominent display space to the more profitable items. Also budget more marketing dollars for those items. Then raise prices on items that aren’t pulling their weight—you’re better off selling fewer of these at a higher profit margin and re-allocating your inventory dollars into more profitable product.

Do a physical inventory. A computerized inventory-management system is only as good as the information you or your staff puts into it. That’s why no matter how good your system may be, you still need to perform a physical inventory at least once a year. A physical inventory will verify the accuracy of the information the computer generates.

Another reason for an annual physical inventory is that a computer is not intuitive: it can’t think for itself: it won’t be able to tell you about market changes or trends, or what’s wrong with your displays. But you can. Doing a physical inventory periodically will put you “in touch” with your inventory, and keep you a step ahead of customer wants—and your competition.

Count on it

Remember, “inventory equals money.” An effective system for managing inventory helps keep your cash flow positive, your lender calm, your customers happy, and your bottom line bigger.

J. Tol Broome, Jr.

J. Tol Broome Jr. is a freelance writer based in Greensboro, N.C. He can be reached by e-mail at .

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