As if the fourth quarter isn’t busy enough, it’s also time to plan for next year. The end of the year is naturally a time for reflection - a time to see what worked well and what didn’t go according to plan.
Looking ahead to the new year, it’s useful to measure performance against a set of predetermined criteria. An open-to-buy plan is an inventory management tool that helps you figure out how much inventory you need to buy on a monthly basis to make your sales projections.
Most retailers use product categories for planning rather than analyzing hundreds of individual products. This is possible because products in a category usually behave in a similar fashion. Open-to-buy planning is particularly useful if:
- Your store catalog has hundreds or thousands of SKUs
- You add products quickly (ie fast fashion)
- Your store has a strong growth rate
Retail price, cost price and unit-based approaches
Open-to-buy can be figured based from three different points of view:
- Retail price/revenue goals
- Cost price/value of inventory
- Number of units
Don’t know which approach to use? Here are considerations to help you decide how to calculate your open-to-buy.
- Looking at forecasted revenue compared to inventory needs, open-to-buy using the revenue approach will show what your cash flow needs might be.
Cost price/inventory value
- The goal of open-to-buy is to see how much inventory to buy to meet your needs. By using a cost price approach, you can easily use the calculation to know what funds need to be deployed to have enough inventory on hand.
- You will need to know your margins to ensure that you’re hitting target revenue goals and profitability.
Units of inventory
- Use this approach when the cost of your products are roughly the same. You will use the average product price in your open-to-buy calculations. This is not a good method to use when your products vary widely in price.
- Unit-based planning is useful when you have space considerations, either with shipping (what fits in a container) or storing (what fits in your warehouse).
To start calculating your open-to-buy amount, you’ll need the following information from the last year both for your total store and by category:
- Opening and closing stock
- Markdowns (optional)
Use last year’s information as-is if you were happy with the performance of your inventory spending and turnover. As a general guide, if you were within 5% of your budgeted spending, then your inventory financial planning is on track. If you were off by more than 5%, then keep that in mind while making calculations for next year.
For the coming year, you’ll need:
- Growth rate or forecasted sales
- Financial goals
- New promotions or product launches (by category)
- Purchases (open purchase orders if any)
How to calculate your open-to-buy amount
Let’s look at an example.
- the actual opening stock for the current month was $424,340
- the desired opening stock for the next month is $500,000
- planned revenue is $200,000 and $250,000 respectively
The open-to-buy budget for the current month is computed using the following formula:
Open-to-Buy (OTB) = Closing Stock + Planned Sales - Opening Stock - Purchases
For the example above it's $272,932 which is the stock retail value that is needed to generate $200,000 as the revenue and start the new month at $500,000.
Planned sales can be seeded from the last year, forecasted sales, or your company’s revenue goals.
To get the most accurate open-to-buy plan, the opening stock should be set correctly.
Let’s say you plan to generate $100,000 of revenue for the next month. You may think you need to hold just $100,000 worth of products in your warehouse, but in reality it’s not true. You always sell a percentage of your stock, not all products contribute to the revenue and therefore you need to have more than your planned sales.
Stock to sales ratio represents this difference and is computed as following:
Stock to sales ratio (SSR) = Opening Stock / Planned Revenue
That means when SSR is 2 then you will sell every second product of your inventory during this month. It also can be seen as the inverse of sell through.
To get the OTB in cost, set the planned margin for future months
To get the OTB in units the average product price should be set.
Consider creating different versions of a plan for “what-if” analysis. It helps to simulate what will happen if you have more sales or your stock days changes. Retailers use this modeling to understand the impact of moving performance variables and their impact ultimately on cash flow.
How to use open-to-buy information
With your open-to-buy amount in hand, you’ve answered how much to buy. To figure out what to buy, pair that with your product assortment plan. Using the two together, you can determine which items will be received and when.
Plan to reserve some of your planned spending for new products or to respond to trends that emerge during the planning period.
Like any plan, you need to compare your forecasting to actual results to evaluate the effectiveness of your efforts. Watch for:
- Variance between your plan and actual spending to see how close your forecast is to reality.
- When monitoring the difference between your plan and actual spending, is there a consistent difference between the two? If so, are there structural changes to make to your open-to-buy planning for future spending.
- Are opening and closing stock levels consistent with plans? How is this tied to either overstock (cash sitting on the shelves) or understock (missing out on sales)?
- How is cash flow? Open-to-buy should give you a guide for inventory spending. Is too much cash tied up in inventory? How quickly are you turning over inventory so that you can reinvest it in your business?
- Are you forced to markdown inventory too often? If you’re not meeting planned margins, does that mean you’re overbuying in a category or product line?
Open-to-buy planning can be a powerful tool to inform cash flow, merchandising, inventory optimization and more. By looking at your business on a category level to see what inventory needs will be months in advance, you can be better prepared to meet customer demand.