Intelligent Inventory

Q: I've just signed the lease on a shop in the historic district of our town. My dream is to specialize in regional foods and gifts. I'm hard at work on a business plan, but I can't figure out what to budget for inventory — or what to project for my annual sales.

A: These two figures are the hardest ones to come up with in a business plan. Since you already have a location, you have a pretty good idea of your fixed expenses, such as rent and utilities. Other expenses, such as payroll and advertising, can be controlled. But it's hard to know how much you'll need to spend to stock your shelves, and you won't know your annual sales until the first year is over. There are, however, a few factors to consider in coming up with usable estimates, and a few guidelines to follow when stocking the shelves for the first time.

You want your store to have an attractive, inviting selection of goods when you open, and costs for filling the same amount of space can vary widely. Consider your store size and the type of merchandise you want to carry in order to determine a realistic starting inventory. Remember, small, expensive items such as earrings and necklaces add up quickly.

Once you've decided what kind of inventory you'll be carrying, you've determined one of the most important factors in your annual sales. If your inventory is valued at $100,000 retail on an average day, you're not going to have annual sales of $1 million. You're more likely to generate $200,000 — or two turns of your inventory. This means that you have received, sold, and replaced $100,000 worth of inventory twice over the course of a year.

Retail products have a different average number of turns per year, and statistics about turns are hard to come by. But the rule of thumb is that one turn per year isn't enough, and more than three turns per year is unlikely, unless your operation is remarkably efficient. Start with a prediction of two turns. (Note: when calculating turns, be sure that you're comparing retail, not wholesale, value to retail sales.)

Many factors will influence your number of turns. For instance, the amount of advertising you do, the viability of your location, competition for customer dollars, and your selection of merchandise all have an effect. In addition, as your business matures, your turns should increase.

If you want your average inventory to be $100,000, you'd be wise to build up to that level by seeing what categories sell best. Don't spend all your money placing huge initial orders. Rather, you should buy just enough to give a good representation of each line, so you can judge its popularity with your customers. By buying "broad" instead of "deep," you'll have the flexibility to put reorder dollars into the merchandise that does best for your store.

To judge the success of different types of merchandise, consider using department codes to track sales by category at your cash register. Then, for example, if you find that food items are outselling gifts, you can devote more inventory dollars and shelf space to foods.

Q: At the winter gift shows, I saw lots of wonderful new merchandise. Still, I was afraid to order much because the amount we invest in inventory seems to be creeping up year by year. Should we borrow more money for fresh stock?

A: You're about half right. Without new products, sales stagnate, and eventually decline. But you can't just increase inventory levels to bring in fresh product. You need to clear out slow sellers on a regular basis.

Money invested in inventory that isn't selling is an unused resource. You need it to buy new, potentially more profitable goods. And the shelf space taken up by slow sellers is also a drain on profits. On top of that, goods tend to lose value as they become shopworn, so there is a high "lost opportunity" cost from keeping merchandise on hand in the hope that someone, someday, will love it as much as you do. There's an old saying: "Don't let merchandise become family."

One of the keys to getting rid of slow-selling merchandise is to track how long it's been in the store. If you have a small shop, you can probably do this so just by watching. For larger shops, with larger inventories, a date-of-arrival code can be printed on the price tag. A POS system also works to track this data.

Every store has its own standards for how long merchandise can stay on the shelf before being marked down. For trendy clothing, it may be as short as 30 to 60 days, whereas for antiques it's considerably longer. Once you've established a timeline that works for you, a system of graduated markdowns will allow maximum profit while getting the merchandise out the door.

For items that just won't go, hold once- or twice-a-year clearance sales, and promote merchandise at 50 percent (or larger) discounts. There are certain types of shoppers — call them sale vultures — who come in only during such sales, and help clean up your inventory. They'll give you plenty of shelf space in no time.

And what about the items that don't sell, even at 50 percent off? Give them a final day or two at an additional 20 percent off. If that doesn't work, it may be time to donate the merchandise to charity. Remove the tags and give it away. You won't free up dollars that way, but you can create shelf space and support a good cause at the same time.