How to Avoid Inventory Problems

For many small retailers, the largest asset on the balance sheet is inventory. But without careful planning, inventory can easily get out of whack, resulting in heavy markdowns due to overstocks and ultimately, serious cash flow problems.

I recently worked with a client who was concerned about excessive markdowns. Over the past several years, he had watched his markdown percentage steadily climb, his already slim profit margins erode and cash flow become a recurring problem. It did not take long to diagnose that his markdowns, the heavy inventory levels they represented, and resulting cash flow issues, were the result of mistakes made months earlier, when preseason planning was being done.

In fact, as our discussion continued, it became clear that there was really very little preseason planning being done at all. There was some financial budgeting taking place, but the detailed plans of what to buy, how much to buy, when to buy and when to have it in his stores didn’t exist. His buyers were, in fact, doing little more than buying to the prior years sales, shipping most of it into the stores early in the season, and then reacting to sales by buying even more to be sure they never ran out of key items.

Unfortunately, this story is not uncommon amongst small retailers. With all of the day to day urgencies that small retailers face, there seemingly is little time for detailed planning. In fact, the planning that does take place is frequently confined to financial planning or cash flow projections.

What exactly should a small retailer be planning? How should he or she go about preparing these plans? And what should he or she do with them once they are completed? Here are a few tips:

1. Plan sales. In order to effectively manage your inventory, you need to know what you expect to sell. For larger retailers that are stocking many SKU’s, sophisticated sales forecasting software may make sense. For many small retailers, however, developing a simple spreadsheet from your POS sales history, by month by key category, is most cost effective. Start with last years sales histories, and make adjustments for unusual events, such as weather, out of stocks, one-time promotions, etc. Then factor in the appropriate sales increase or decrease percentage, based on a reading of the sales potential for the category for the upcoming season. Finally, for larger categories, it may make sense to break the sales plan down by sub-categories, styles or vendors.

2. Plan inventories. It makes little sense to bring in more inventory at any given time than you need to set your displays, support your planned sales until the next delivery, and provide a safety stock in the event of an unexpected sales spike or a late vendor delivery. Buying inventory too far in advance is one of the surest ways to find yourself over-stocked down the road. For many small retailers, the best way to plan inventories is to plan to have enough on hand at month end to support the next two or three months sales.

3. Plan inventory receipts. If you’ve planned sales by month, and ending inventories by month, it’s easy to calculate how much inventory to bring in each month. You need to bring in enough to cover that month’s sales plan and ending inventory, less the prior months ending inventory. In this way, a buyer can know in March, when preparing for the fall season, for example, how much inventory to plan on bringing in each month of the season.

4. Plan markdowns. Planning markdowns goes hand in hand with planning inventories. If you plan the date of the first seasonal markdown before the season even begins, you can plan the inventory you want to have on hand at that point in time, and thus your markdown percentage, as well as your markdown sales before your second markdown, as well as all subsequent markdowns.

5. Plan dynamically. Once you’ve completed your preseason planning, don’t put it in a drawer never to be seen again. Use that plan as a dynamic tool to track the progress of the season. As each week goes by, and sales trends begin to develop, adjust future sales plans accordingly, and adjust inventory plans for those updated sales plans. If sales are exceeding plan, you want to be sure you have the inventory to keep the momentum going. Conversely, if sales are coming up short of plan, the sooner you adjust your inventory plans, and thus your scheduled receipts, the less likely you are to end up with excess inventory that needs to be marked down at season’s end.

The root cause of many inventory problems faced by small retailers is the lack of adequate preseason sales and inventory planning. It may seem that there’s never enough time for such planning, as if it’s a luxury that just can’t be afforded, but in reality, it’s a critical necessity, a vital investment in the future health of any small retailer.

(c) Ted Hurlbut 2004

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