Q: Is there any kind of rule of thumb for what percentage of your monthly sales you should budget for purchasing given a relatively stable monthly sales rate (e.g., no major holiday or seasonal increases)? Or do you go by your gut and observations of what is selling? I’m looking for an overall percentage for a store where almost every product’s retail is at a keystone markup plus $1-2. I have been using a purchasing budget of 50% of sales–is that too much, too little or, about right?
A: The standard formula for a purchasing budget, commonly called Open-to-Buy, is usually figured each month as the inventory levels in your store rise and fall. Open to Buy calculations take a few minutes, but they can be an integral part of financial success.
Open-to-Buy Calculation:
Planned Sales + Inventory Needed (at retail) – On Order (at retail) = Open-to-Buy at Retail
Example: $5,000 + $4,000 – $2,300 = $6,700 Open-to-Buy Dollars at Retail
Open-to-Buy Dollars at Retail X COGS % = Open-to-Buy Dollars at Wholesale
Example: $6,700 X .55 = $3,685 Open-to-Buy Dollars at Wholesale
This means that if you project your sales for the month to be $5,000, and you have $20,000 in inventory and you’d like to maintain a level of $24,000, and you have $1,000 on order (which translates into $2,300 in projected retail sales at a 2.3x markup), and your overall COGS % is 55%, then your Open to Buy amount is $3,685.
If you use this same formula for each area of the store (books, music, candles, jewelry, etc.), you will have a far more accurate way of projecting merchandise purchases, since each area has a different mark up and COGS %.
The answer your question concerning whether a purchasing budget of 50% of sales is the right amount also depends on other significant financial indicators on your Profit and Loss statement, such as your Cost of Goods Sold percentage (COGS) and your Gross Profit Margin (GPM).
First of all, there is not a magic number that is right for every store. Your Gross Profit (or Gross Profit Margin which is the same number expressed as a percentage) is the amount of money that you have after you have deducted your Cost of Goods Sold from your Total Sales. It is the amount that you have left to pay all expenses other than the cost of merchandise.
Your Gross Profit Margin (GPM) will probably range from 48% to 58% of your Total Sales. You want your GPM to be as high as possible as this then allows you to pay your expenses and have more left over in bottom line profit.
As a rule of thumb, I suggest that your GPM be 52% or higher. This percentage varies based on how much you have to pay for your merchandise and your mark up. For instance, books cost you approximately 60% of the pre-priced retail price. (If you have electronic order, you might only pay 58% or 59%, or you might pay up to 65% because of shipping costs.) So, for books, your GPM is fairly low – 35% to 42%. Because books are pre-priced, your profit margin is fixed. The same is true for cards (50% GPM) and music, which runs closer to books.
So, if you want your GPM to be 52% or more, you have to make up the difference in gift items. Some retailers have had great success packaging their own merchandise, essential oils, for instance, because there is a much higher mark up. Other items such as jewelry and stones typically have a 2.5-3.5 mark up (necklace $10 at cost might sell for $25 to $35). Personal Care products and candles can often be marked up at the higher rates and still offer a good value to the customer. It is in these areas that you can compensate for the lower profit items and keep your business healthy and your GPM strong.
To create an Open-to-Buy plan, first establish how much money you need to have in inventory to have our store look well stocked without being overcrowded. Once you have that number in retail dollars, the next step is to project what your sales will be over a given time period. When you have your projected sales number, multiply it by your Cost of Goods Sold Percentage (COGS – the % of sales that it costs you to buy your inventory overall), and then deduct any orders that you have already placed that have not yet been received. This final number is the amount of money that you have Open-to-Buy. Spend more than that number and you may experience an unpleasant cash crunch. Go below it, and you may be missing out on sales, and therefore, profits.
When you talk about your pricing philosophy as Keystone plus a dollar or two, I am assuming that you are talking mostly about gift items and that you do not markup pre-priced merchandise. If you find that you need to decrease your COGS and therefore increase your GPM, a good place to start is to take the price gift items and multiply it by 2.3. Then manipulate the price up or down until it “feels right”. At a very minimum, you have to cover the cost of the item plus the shipping, and then add a bit to offset other items (books, cards, CD’s) that are pre-priced, and you are unable to mark up. Example: Take an item that costs you $8.50. When you “keystone”, you double the cost and charge $17.00 for the item. With this new formula, $8.50 x 2.3 = $19.55. Look at the perceived value of the item and then round down to $19.50 or up to $19.95 or make it a flat $20.00. The extra $2.50 to $3.00 will help cover your receiving and shipping costs and decrease your COGS.
As a final thought, be sure to add in a percentage for profit on your bottom line. Healthy retail businesses plan for 3-10% profit. According to the American Booksellers Association ABACUS Study, successful book and gift stores have a profit margin of about 6%. If you are always just breaking even, it’s hard to find money to replace fixtures, reward employees, and support growth.
If you set 6% as your profit goal, you can achieve it by maintaining a 52% Gross Profit, holding COGS at 48%, and keeping your expense level at 46% of Total Sales.
We could also achieve a 6% profit with a 48% Gross Profit if you can lower your expenses to 42%. The important thing to remember is that a good profit level doesn’t usually just “happen” on its own.
Q: How important is it to move things around in a store that is mostly visited by tourists?
A: The main reason that most retail store consultants emphasize changing displays and rearranging merchandise is so that your store looks “fresh” and, rather than being bored, customers have the impression that there is always something new and exciting to be found each time they visit. As your question suggests, when your clientele is mostly tourists, you do not have to rearrange and create new displays as often as if you have a regular, home-town customer base, but it is still important.
One thing to consider is that, while you many have a large number of tourists visit your store, there are probably some regulars. These may be people who live nearby and bring their family and friends (some of the tourists) when they come to visit. So, it is essential to provide them with new items to explore and appreciate too, if only because it makes them excited and that excitement gets them talking and thinking about sharing that excitement with friends.
The other thing to consider is that moving merchandise around is not just for appearance sake. There is the cleanliness aspect – when things get moved shelves get dusted and cleaned. And also, energetically, holding, touching, dusting and relocating items helps them sell better. I have no scientific proof of this, but I do know from years of experience that changing a display, or switching merchandise to a different shelf, somehow makes it noticed and more desirable.
And that includes customer attention. I can’t tell you how many times an item will sit for days or weeks and not sell, and then a customer will notice it, love it, and even plan to come back and buy it, and another customer will walk in and buy it later that day! Items simply sell better when attention has been paid to them.
So, if you decide to move things around less, be sure that you have some kind of rotation timetable, so merchandise does not just sit, as well as a regular cleaning schedule so everything is clean and inviting.
Q: I have been hiring and paying staff to do weekly physical inventories of our individual departments since 2011. Our annual shrink rate has ranged from 0.16% to 0.19% in that timeframe. Is it worth it for me to continue paying for these inventories given our stellar shrink rate?
A: With a shrink rate that low, I agree that weekly physical inventories are an unnecessary expense for your business. But kudos to you for being on top of this and knowing what your shrink rate is! Not all store owners/managers have that information.
Most independent bookstores do inventories once a year although my opinion is that this is not enough – too much can happen in 12 months and if you are having a shrinkage problem, it’s best to find out as soon as you can.
There are a couple of ways I would suggest that you approach taking inventories throughout the year. The simplest way is to expand your time between inventories and take them monthly or quarterly. If your shrink rates remain low, you could even stretch it to six months.
The second way is to take inventory by vendor, especially when a larger order arrives. You did not list the different departments you provide, but I will assume that you have candles and jewelry (most stores do) in addition to books. Utilizing this method, when a candle order, for instance, arrives, the individual in charge of that department would take an inventory of the candles in stock from that vendor and be sure that your inventory records agree before the new order would be added to stock.
This practice provides three benefits: First, you get to verify that your physical inventory is correct for that vendor. Secondly, it highlights product that may be overstocked or not selling well and brings them to the attention of the person in charge. And thirdly, it is easy to identify where you might be losing sales when a best-seller, that is not on the incoming order but is low stock, need to be ordered in a larger quantity to avoid missed sales.
From S.G.
Cassadaga, FL
Published in Vol32/Issue 2/2018
Author: Kim Perkins
Kim Perkins is a business consultant, author and national speaker. She is the former co-owner of Elysian Fields, Books & Gifts, located in FL. As a consultant, Kim specializes in helping small businesses achieve financial health and excellent employee relations.
