Balancing Act: When Inventory Turnover Costs Profitability

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A large volume store recently came to us with an interesting dilemma. The store had a good gross margin and a fabulous inventory turnover yet was not making any money.

The merchant had a gross margin of 48% and operating expenses of the same. Not surprisingly the store accountant’s initial reaction was to mandate that my keyword000000 be cut from operating expenses immediately. So the accounting minions went to work examining every line item on the expense budget to see where cuts could in fact be made. Rents were examined and renegotiated where possible selling expenses were more ardently monitored and the scalpel was taken to the advertising and promotion budget as well. Travel freight insurance outside services you name it were scrutinized.

Careful Review and Control

Careful review and control of operating expenses is prudent for every retailer. The exercise however is a one-trick pony. You can only fire someone once! In other words once an expense is cut it’s cut. No retailer can continue to back into a strong profit and loss statement by continually chopping expenses. A retailer typically gets one pass at this strategy after which merchandising performance must improve in order to grow.

If you take the engine out of a car it will make the car lighter. That is true

The Car Analogy

The car will have less weight but won’t be able to move. So the objective of reducing the car’s weight is achieved but in doing so the car is not able to function as designed. The same concept is true when reducing operating expenses. Selling costs that are too aggressively cut will end up costing the company sales. Trimming the ad budget by too much can lead to lack of visibility in the marketplace. Cut out travel and pretty soon the store risks not showing the newest products available. The examples are endless. You can trim the fat only so far before cutting into muscle. You will need to find another way to increase profitability. Reductions in operating expenses may serve to accomplish a short-term profit goal but the strategy is not sustainable in the long run. You ultimately will need to increase sales volume.

Back to Our Example

The assumptions we made were that the majority of the major expenses once trimmed were for all practical purposes “fixed” expenses as opposed to “variable” expenses which adjust according to sales. We also were convinced that the store was able to maintain the same margin on any planned sales increase. We knew the margins were reasonable and the forty million dollar sales volume was no small piece of change. So where was the problem? A peek “under the hood” at the merchandising data showed that the store was turning its inventory way too quickly and losing thousands of dollars in sales in some classifications.

Turn Fast – or Too Fast?

Any regular reader of this column knows that I extol the virtues of faster turns at every opportunity. The benefits of faster turns have been discussed on many previous occasions. There is however a balance that must be struck between turning too quickly and missing business and not turning fast enough and having cash flow and markdown issues. This optimum balance can only be achieved if you regularly monitor the sales and inventory plan at the store and classification level.

In this case a 5% sales increase

Deemed Easily Attainable

By slowing the turn in areas where business was being missed a viable solution was found. By reviewing the sales and inventory forecast monthly with this retailer we were able to show him how his inventory dollars could best be allocated to achieve the volume increase he needed. By adding inventory in the right classifications at the right time we purposely slowed the turnover to maximize sales. Margins and operating expense dollars remained constant with the increase in volume yielding a 2.4% improvement in net profit. Any expense reduction possible only makes the end result that much better.

Get a Check-Up

Every retailer should periodically have a “check-up.” Much can be learned by allowing an independent third party to objectively review the merchandising data as well as the financials. This simple process generally involves emailing sales inventory and profit and loss information. Generally all that is needed is a couple of screen shots from most POS systems. When I do an analysis I try to get information at the class level if possible. The most rewarding part of the process is when I am able to discover areas of upside potential buried deep within a retailer’s data. To me this is like a big treasure hunt. Once the opportunities are discovered a plan of action is agreed upon and set into motion. The puzzle is solved.

Ritchie Sayner is vice president of business development at RMSA Retail Solutions. Retailers are invited to follow him on Facebook at http://www.facebook.com/RitchieSayner.

EDITOR’s NOTE: As a benefit to NSRA members RMSA will provide the analysis described above at no charge. Please contact the author at RSayner@rmsa.com or call him at 816-505-7912 for details.

Ritchie Sayner

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