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Profitable Times Newsletter

Inventory Management

The controlling of inventory, resulting in increased profits, is probably the most important reason to address inventory management. Nearly every museum I know could use as much money as they can muster for a host of projects. Inappropriately high levels of inventory rob the museum of incremental funds and can put a strain on the overall financial soundness of some museums.

Use of an Open To Buy

The primary tool for controlling inventory is the consistent use of a Merchandise Buying Plan; usually know as an Open to Buy or OTB. This is the most important retail financial tool for cultural commerce of all kinds and sizes. First, let's make sure we're all on the same page about what an OTB is. It is a disciplined mathematical approach to making sure you keep your inventory levels in balance with your projected and actual sales. Recognizing that it helps to control cost of goods, the largest expense category in any retail store, summarizes the importance of this tool.

While relatively rare by comparison, too little inventory, so that a store doesn't look full and doesn't provide the customer with enough choices, can also negatively affect revenue and profitability.

When done right and consistently, the calculation of an OTB will tell you how much more to buy when sales are better than expected. More importantly, however, it will help you slow down buying when sales are less than projected and inventory is growing too big. And make no mistake about it; the most common reason our store assessments uncover for disappointing museum store results is having too much inventory sitting in the back room tying up financial resources while slowly deteriorating in value.

Some people don't use an OTB because they feel it doesn't apply to their product lines or because they think their store is too small. In all my years of retailing and consulting, I have yet to come across a product mix or store that couldn't use an OTB. Sometimes the OTB needs to be adjusted to reflect a unique situation, but one can be designed for any set of circumstances.

Others don't use an OTB because they think it will take too much time and recordkeeping. Sure, the first couple calculations will take some time, but once you get into a routine of data collection and calculation the time commitment is minimal, and nothing compared to the benefits. Most point of sales systems include an OTB module as part of their software, further reducing the required effort. The best way to calculate a comprehensive OTB is to do one for every product category and amalgamate them into one for the store as a whole.

Benefits of the 80/20 Rule

When allocating inventory dollars remember the critical 80/20 rule — approximately 80% of revenue is driven by just 20% of the products. As a result, it's important your core products are always in stock. When you're out of these products you're not just out of an item, you're out of a product with a disproportionate impact on revenue and with the real potential of disappointing repeat and destination store customers. So attention to this rule is about overall inventory levels and the product selection within the inventory.

Impact on Storage Space

Another advantage of a proper inventory level is striking a balance with storage capacity. Of course storage capacity has to flex with ebbs and flows of inventory, especially proprietary and custom products, but inappropriate inventory levels can make demands on storage space that has ramifications well beyond retail. Every museum department has space needs, but using an extraordinary amount of storage space because inventory has not been controlled properly can be a particularly contentious circumstance.

Consignment

The management of products sold on consignment can help alleviate the stress on inventory dollars. But consignment comes with its own burdens including paperwork, sometimes-difficult interactions with artists and responsibility for unsold items. If you're not sure about the salability or popularity of, especially higher-priced products, a 50%/50% consignment split can help you build sales experience with limited inventory investment risk.

Calculating Inventory Turnover Ratio

Calculating the inventory turnover ratio, 'turns', will help you control inventory levels. ‘Turns' is really a measure of how hard your inventory dollars are working; i.e., how often each inventory dollar is used per year to buy products.

To calculate this ratio in the most popular manner you need two numbers:

(1) Annual Cost of Goods Sold
(2) Average Inventory @ cost

If you take two inventories a year average them. If you take only one inventory a year you should average it with the inventory taken at the same time the previous year. In any case be true to yourself. Don't use an inventory taken when the stock on hand is extremely low, which will result in an artificially high number of turns. Similarly, don't discount your performance by using a large inventory number, perhaps overly affected by the inventory for a special exhibit, resulting in an artificially low number of turns.

(1) Annual Cost of Goods Sold
Inventory Turnover Ratio  = 
(2) Average Inventory @ cost

 

$240,000
Inventory Turnover Ratio  = 
 = 2.0 Turns
$120,000

In general, the more turns the better. High turns mean you are using your inventory dollars efficiently thus reducing the need for cash, your stock looks fresher and you probably need less storage space. On the other hand, rapid turnover can put a strain on personnel who need to process more purchase orders and receiving documents and deal with all the activity associated with frequent deliveries. Beware, if you don't keep up with the work associated with high turnover you may loose sales because the most popular items (remember the 80/20 rule), fall out of stock. As with the OTB, this number can be calculated for the store as a whole or by department.

 
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