A different path to inventory analysis and planning

By Peter Cox September 15, 2015 Industry news

It is 2015 and still many hardware stores are not planning their purchases nor do they have an idea of exactly how much stock they should have in the store or by department or stock line.

A lot of owners and manager guess or some simply don’t care. Their attitude is: “if I don’t stock it I can’t sell it”.

I have a different view, which is: the only reason why you go broke is that you run out of cash. And in this industry, where is most of the cash is tied up in an operational basis, you guessed it – it’s all about inventory.

In this magazine over the last 13 years I have written numerous times in using the Stock Productivity Index (SPI) and the Gross Margin Return On Inventory (GMROI) as two tools that can be used to analyse and target stock levels and purchasing.

Both the SPI and GMROI  use an index as a target. For example say you have a target index of 120 points using the SPI (for further information you can refer to my website www.petermcox.com.au), then if you’re after a target stock turn or are reviewing the performance of a store it would be calculated as follows:

Sales $5,000,000
Cost of Sales $3,500,000
Gross Profit $1,500,000
Expenses $1,350,000
Net Profit $150,000
Average Stockholding $1,750,000

GP Margin
$1,500,000 ÷ $5,000,000 x 100 = 30%

Stock Turn
$3,500,000 ÷ $1,750,000 = 2 xpa (times per annum)

SPI
30 x 2 = 60 points

 

INVENTORY AND EXPENSES

I recently came across another method which uses other financial information in the Profit & Loss statement.

It reviews the relationship between expenses and Gross Profit to establish a Target Stock Turn to establish a breakeven point in relation to inventory level and expenses. The calculation is: 

Expenses ÷ Average stockholding x 100
$1,350,000 ÷ $1,750,000 x 100 = 775%

To calculate the breakeven Stock Turn:
Expenses to stockholding % ÷ GP margin%
77% ÷ 30% = 2.6 xpa

This means we must turn the stock over 2.6 times a year to at least reach breakeven. As a result, 2.6 stock turns is the minimum requirement based on this example and the breakeven factor of expenses to inventory.

This is a different way to look at inventory management as targeting and analysing inventory levels has always been looked at in relation to sales.

If the result is 2.6 xpa then the target inventory is:
Cost of Sales ÷ target stock turn 
$3,500,000 ÷ 2.6 xpa = $1,350,000

Therefore the inventory level to breakeven to expenses is $1,350,000. If the inventory is $1,750,000 and the target is $1,350,000 then the store is overstocked by $350,000.

Our example store is overstocked whichever way you look at it. But, remember, this method is simply looking at the breakeven inventory level against expenses.

This method can be taken further, to a departmental level – that is, how many stock turns are needed to break even for each department.

Of course the question is how to allocate expenses for each department. My usual method is by space allocation but there are several other methods.

As long as the GP Margin and stockholding is known, then a breakeven level of inventory against the expenses can be calculated.

This article has been about managing your most important, valuable and largest cash investment – inventory.

_________________________

Peter Cox is a senior consultant for Macquarie Advisory Partnership based in Sydney. He has over a decade of experience training and consulting in the retail hardware industry. He conducts key-note addresses, and management and sales workshops, which are aimed at improving profitability and liquidity in one of Australasia’s most competitive retail environments. Phone 0061 438 712 200 or visit www.petermcox.com.au

share this