Seven Inventory Blunders Of Small Retail Stores
In most retail stores, inventory is the largest asset. Unfortunately, many local entrepreneurs still employ outdated methods to manage their inventory. But modern merchants can no longer afford to be left behind on the latest best practices in inventory management.
With so much to learn, let us start with the worst blunders of which small retailers are guilty:
Not having an open-to-buy. An open-to-buy is simply a budget plan for purchasing. This is done to allocate resources optimally. An open-to-buy is extremely useful to avoid over- or under-purchasing of a category of items. Although open-to-buy usually refers to a category of items, it is possible to have an open-to- buy for a single item. It is also used at many levels. For example, in a department store there may be an open-to-buy budget for women’s clothing and a lesser open-to-buy for men’s clothing.
Underestimating the rapidity of product obsolescence. In their quest to get volume discounts, small retailers are more likely to overstock on items that shortly thereafter drop quickly in value. Some products deteriorate physically, like food. Others such as clothing may be functionally undamaged but whose value may be drastically reduced if no longer popular. Generally, it is better to be conservative and to forego the discount if there is too much risk of product obsolescence.
Allowing sellers to influence your orders. Salespersons are highly trained to convince you to buy. Oftentimes this leads to overstocking or the purchase of unneeded items. Buyers in small establishments are more flexible in their purchasing, but while this is normally an advantage, this also creates an opportunity for the creative seller to sway decisions.
Mixing items that are incompatible with your shop. Small retailers are frequently tempted to add items that, while profitable in itself, destroys the image of the shop. Displaying a fast-moving item that is popular with the masses may negatively affect the image of a high-end shop that caters to the elite. In this case, the loss of sales from the degradation of the image may be far more than the additional profits brought in by the incompatible item.
Not using a POS system or failing to maximize its potential. For those whose sales volume could no longer be tracked easily, having a POS (point of sale system) is essential if you are to manage your inventory properly. Prices of POS systems are now within reach of almost any retailer. There are tasks that cannot be done quickly, if at all, without the use of a POS. Among these are reducing inventory theft and better inventory management. Inventory theft is reduced because inventory shortage is easier to spot quickly since there is a running balance of the quantities of all items.
Not using cycle counting. Doing the traditional yearly inventory is woefully inadequate since you need more timely information. In situations where doing a physical inventory frequently and accurately is not feasible, cycle counting may be the solution. Cycle counting is an inventory-taking method where only a part of the entire inventory is counted on a particular time and location. Since only part of the inventory is counted, cycle counting could be done faster and more accurately.
Not knowing how to analyse financial ratios involving inventories. Many financial ratios involve inventory. Most of these ratios have a critical effect on the business. However, few people have more than a superficial knowledge of their significance. At least, three major qualities of inventory are not taken into account. These are profit margin of the item, liquidity of the item, and returns policy of the supplier of the item.
For example, looking at the Inventory turnover ratio, which is computed by dividing the cost of goods sold by the average inventory cost, it is generally advocated that the bigger the ratio, the better, and that an item with a low ratio should be discontinued. This ratio should take into account the profit margin from the item. Even if the ratio is 1:1, which means that you only turn over your inventory only once a year, this is not bad if your markup on the item is 100 percent.
Another ratio that is often not properly interpreted is the current ratio, which divides the current asset by the current liabilities. Usually two is considered an acceptable ratio. This may be true, but you must check if the inventory, which is part of current assets, can be turned into cash in a short time. Otherwise, the liabilities may already be due while the inventory is not yet sold and transformed into cash. Finally, a supplier who is liberal with returns would justify a larger inventory level since the potential loss from overstocking is lessened.
*Originally published by the Manila Bulletin. D-4, Sunday, July 28, 2013. Written by Ruben Anlacan, Jr. (President, BusinessCoach, Inc.) All rights reserved. May not be reproduced or copied without express written permission of the copyright holders.