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October 24, 2017

Is SOS Inventory Killing Your Profits and Cash Flow?


By Robbie Brown

A dearth of slow-moving inventory can fade customer interest and negatively affect your bottom line.

A retailer’s inventory has both sweet and sour properties. It can sweeten your bottom line or significantly sour profits and cash flow. It all depends on how much of your inventory investment is tied up in A-grade (in strong demand) merchandise and how much is in surplus, obsolete and slow-moving (SOS) inventory.

A healthy inventory is one that has a balance between that which sells quickly (the As) and that which doesn’t (the Cs). In practice:

  • “A” items represent approximately 20 percent of total SKUs, but produce 80 percent of sales.
  • “B” items represent approximately 40 percent of total SKUs, but produce 15 percent of sales.
  • “C” items represent approximately 40 percent of total SKUs, but produce only 5 percent of sales.

If inventory levels of the As, Bs and Cs do not mirror their sales, the result is glutted inventory, reduced profits and lousy cash flow.

Excessive inventory is that which is more than what is needed to sustain sales according to your turn rate objective and which, if totally eliminated, would have little negative effect on the sales and image of the company. SOS inventory steals profits! By definition, SOS inventory is unneeded. It is also loaded with cost components that are inescapable; inventory carrying costs (insurance, handling, obsolescence, shrinkage and opportunity costs) run about 20 percent per year, compounded. Additionally, SOS inventory reduces a retailer’s flexibility to respond to market conditions, diminishes buying opportunities, clogs open-to-buys, decreases margins and inflates ending inventory, thereby increasing inventory carrying costs.

In truth, inventory is in a constant state of going obsolete as it collects, ages and loses consumer appeal. Cash flow ultimately suffers. Thus the objective for improving your FFL’s financial health is to seek sales and inventory parity, i.e., move inventory dollars from the B- and C-grade merchandise into the A-grade items that should account for approximately 80 percent of your sales.

Sounds like a no-brainer. However, the process is more difficult than one might think. Part of the problem stems from the fact that management often simply does not look for the C-grade merchandise because it is not “romantic.” This merchandise physically resides in small pockets and marginal areas of the store (the back room, bottom shelves, etc.). In fact, SOS inventory is too often considered benign and remains opaque, yet consumes vast inventory dollars and steals profits as referenced above. This problem of accurately identifying SOS inventory is exacerbated by the fact that item status often changes over time, for example, when an A item in April becomes a C item by October.

In order to really identify your As, Bs and Cs, you need three specific reports:

  1. An ABC Analysis — aka, your hot-seller list. This defines and ranks the A, B and C items relative to dollar sales and inventory investment in each.
  2. An Aged Inventory Analysis — This ages your inventory (in descending order, worst first) in terms of weeks of supply (units on hand divided by average weekly sales). This then indicates where the inventory exists. The two reports — ABC and Aged Inventory—taken in tandem identify the best sellers opposite their available inventory (weeks of supply). With this, your targets are identified and you can get rid of the excess inventory and channel the dollars from C inventory to those A and B items that are generating all the sales.
  3. Inventory Turns by Class — This report should be run by class — for example, guns are a department and shotguns are a class within the department — measuring turn rates over a 12-month period. Any class with a turn rate of 2.5 or less is in trouble. You should strive to achieve four or more turns across all classes. Low turns mean you are investing too much in inventory to support the sales generated.

These three reports plus a turn rate-driven open-to-buy report will define your sales and inventory targets. You may have these reports resident in your current business management software, or you may need some assistance in developing these analyses.

SOS inventory is a terrible consumer of capital, space, time and labor. It is in your best interests to focus on your core merchandise and to reallocate dollars from C inventory to A inventory. In doing so, you will gain space, cash and profit.

 

You may also be interested in: Excess Inventory Stifles Profits and Cash Flow

 

About the Author
Robbie Brown has an extensive background in retailing, wholesaling, distribution service industries and consulting. He has been CEO of numerous companies in the shooting sports industry, including several retail chains and distribution companies. Brown consults for businesses of all sizes in both the merchandise and service industries, as well as for a variety of corporations, industry groups and trade associations. He is a frequent round-table moderator and speaker before industry trade shows, conventions and other corporate groups, and he has published more than 300 business-related articles in various trade magazines, delivered hundreds of speeches and served as a business advisor to many CEOs both inside and outside of the firearms industry.