Your inventory finances need a checkup, stat!
The finances of your inventory depend on each business, but with three metrics – margins, understock, and overstock – you will be able to determine where you need to have your inventory to optimize your profit and invest those profits back into your business.
Profit divided by revenue will show you your margins. Of course you, as a merchant, must cover the cost price (what you pay your vendor). But you must also have enough margin to pay for the rest of your overhead costs including salaries, rent, marketing and other expenses.
How do you calculate this? Consider non-inventory expenses and ensure you are building in enough margins so that you are able to cover that as well. Those expenses include the rest of your overhead, and part of that function is volume. However, if you don’t have sufficient margins, no amount of volume is going to save your business. Take a total-business look at fixed and variable costs. How much do you really need to cover? What are appropriate margins?
Understock and stockouts are dangerous to your inventory financial health. Look at your replenishment needs. You are missing out on sales when you are understocked or have stockouts. One key metrics to consider is forecast lost profit (stockouts during the lead time multiplied by profit). What are you missing out on in terms of profit?
Lead time is how long it takes to get your merchandise once you place the PO. That is the very quickest time you can get the items in. You are losing out on revenue for every day you have a stockout.
You can also look at replenishment retail value. What is the revenue you can bring in based on the forecasted replenishment needs? For all these units forecasted in order to meet demand, take replenishment times price to get the replenishment retail value. That is another way to look at future revenue you can get in for these items if you order them.
When deciding what items to replenish, consider using an ABC class analysis of recent sales. That looks at each variant or product’s contribution to your revenue over the last thirty days. Alternatively, you could calculate the contribution to your profit instead of your revenue to maximize your return on investment.
To calculate the contribution of each variant to your total revenue, divide the variant revenue by the total revenue. Then sort variant contributions from highest to lowest. Finally, create a running total or cumulative sum of the variant contribution.
The variants contributing to 80% of your revenue are considered A class items. The next 15% of variants are B class, and the final 5% are C class items.
The highest priority is keeping A class items in stock when determining replenishment priority because that is what is delivering revenue. Then determine if C class items are worth the investment. Alternatively, you could potentially eliminate C class items since they contribute the least amount to your overall revenue. The cost (fixed and variable including time to maintain inventory levels and storage costs) may outweigh the contribution of C class products to the revenue.
Look at your planning period (lead time plus days of stock). What will you have on hand past that date? This is your money sitting on a warehouse shelf. Items in stock beyond your planning period are tying up capital that could be generating a better return on investment elsewhere - that could be used buying different inventory, or it could be in another area of your business such as advertising.
Here are the number of units and their retail value. Keep in mind overstock retail is going to be the full retail value of your overstocked units. There is a high probability that you could discount this amount.
Look at how steep your discount is going to be. If your brand proposition is quality, then you should consider shallower discounts. If you want to move through quantity, then you can do steeper discounts so you are not sitting on that inventory any longer than you really need to. Think about your overall brand value as you are discounting. There are a variety of approaches you can take to move out overstocked inventory.
There is no one right or wrong way to assess the financial health of your inventory. But factor in margins, understock, and overstock, and you will begin to get a firm grasp on it. And that will allow you to redistribute stock as needed, so you have the right item going to the right customer at the right time.