Inventory Turnover: Retail, Cost, or Unit?

Periodically I have students who are confused by the idea that there is not one, but three different ways to calculate inventory turnover.  What really confuses them is that when using all three formulas to calculate inventory turnover (turn) for a retailer, each formula provides a different answer.  And, that this happens even though each formula has the same two basic components:  Sales and Average Inventory.

Let’s start with the formulas:
Retail Turnover = Annual Retail Sales/Average Retail Inventory
Cost Turnover = Cost of Goods Sold/ Average Cost Inventory
Unit Turnover = Unit Sales/ Average Unit Inventory

Example:

Retailer Z’s Financials Show:

Total Retail Sales $2,000,000
Cost of Goods Sold $1,200,000
Unit Sales 180,000
Avg. Inventory at Retail $400,000
Avg. Inventory at Cost $220,000
Avg. Inventory in Units 30,000

Let’s Calculate!
Retail Turnover = Average Retail Sales/Average Retail Inventory
= $2,000,000/$400,000  = 5.0

Cost Turnover = Cost of Goods Sold/ Average Cost Inventory
= $1,200,000/$220,000 = 5.5

Unit Turnover = Unit Sales / Average Unit Inventory
= 90,000/ 15,000 = 6.0

While the inputs are similar, they are not identical, due to each one utilizing a different method of measurement.  Typically Retail Turnover will provide you with the most conservative estimate of your turn rate out of the three calculations.  This is due to the fact that the Retail Sales and Average Retail Inventory numbers both have initial margin (or markups) built into them.

Next time we’ll look at interpreting and using these numbers.

Gross Profit vs. Gross Margin vs. Gross Profit Margin

meadow-680607_640Some time ago Mame asked me the difference between gross profit and gross margin. As this is a question that crops up regularly in my classes, I thought it might be a good idea to tackle it here.

The truth is, there really isn’t a difference. Some retailers prefer to say gross margin, other retailers prefer to say gross profit. (Although some will use the term gross margin when referring to gross profit as a percentage of net sales.) Both terms refer to the difference between net sales and total cost of goods sold.

Much like the term gross margin, a few use gross profit margin to refer to gross profit dollars as a percentage of sales.

What is retail math?

I must admit that it never occurred to me that this term might need defined until I had a student ask about it in class.  Sometimes you work in and around an industry for so long you forget that has a language of its own that might be unfamiliar to those outside of (or brand new to) the industry.

As Valerie Lipow states in her article at career-advice.monster.com, “Math is used at every level of retailing, from the part-time sales clerk to the executive suite… And the higher up in retailing you go, the more math skills you need.”

The term retail math refers to those ratios and equations used by retailers in quantifying their performance.  Most of these equations utilize basic math skills that are no more complicated than high school algebra.  It is through the use of retail math that retail buyers and managers determine how fast their inventory is selling, whether or not they are making a profit, what their return on investment is, and whether or not they have cash available to spend.  On the Formula Sheet page of this blog you will find a listing of some of the most common retail math formulas used by retailers, wholesalers and manufacturers.  And in the Beginner’s Guide category you will find explanations of some of the more common retail math measurements.

Students often ask me how important it is for them to learn retail math.  My answer is that it depends.  It depends on how high you wish to go in the retail organization you are planning on working for.  The better you understand the meaning of each measurement, and the relationships between those measurements, the better you will be able to do your job – and the higher you will rise within your chosen profession.

If you would like to read more about how retail math is defined, I recommend Retail Math by Valerie Lipow at monster.com.

photo credit: <a href=”http://www.flickr.com/photos/eleaf/2536358399/”>Eleaf</a> via <a href=”http://photopin.com”>photopin</a> <a href=”http://creativecommons.org/licenses/by/2.0/”>cc</a>

5 best retail math articles from Summer 2012

Over the past few months there have been several good articles written concerning both retailing and retail math analysis.  What follows are 5 of my favorites.  Enjoy.

  • Basics of managing Retail Business Performance”  by applythinking.  This post provides an insightful analysis of how retailers must use both turn and gmroi to analyze their overall performance.
  • How Much Does Your Beer Really Cost?” by Scott Metzger.  This cost analysis article was originally posted in The New Brewer back in February, but I didn’t see it until it hit C-Store News in June – so I’m counting it as a summer article.  The cost analysis is thoughtful, and provides helpful explanations of the various methods as well as recommendations on how best to use the information (even if you sell something other than beer.)
  • 6 Tips to Drive Inventory Turnover” by Ted Hurlbut at the “All Things Retail” blog.  While this isn’t exactly an article on mathematical analysis, it is an excellent explanation of how a retailer can improve their inventory turnover.  You will also find a short Youtube video giving highlights from the article.
  • The Mathematics of Bookselling” parts one and two by Dave Sheets at Lessons from the Saddle.  Dave takes the reader through a thoughtful analysis of gross margin percentage and inventory turnover in the bookselling industry.  His examples are clear and easy to follow, and could be applied to any retail sector.  He also has a 5 minute video covering some of the same material.
  • Sales, Stock, and Inventory, Oh My! How to Use POS Data to Improve Retail Operations” by Scott Kreisberg at The Point of Sale News.  This article is a helpful explanation of the 5 key retail math measurements that should be used when assessing the performance of your inventory.

There you have it.  The top 5 articles of the summer – in my humble opinion.  Please leave a comment if you feel there are others that should have been added to the list.

photo credit: <a href=”http://www.flickr.com/photos/simax/3390895249/”>Michael | Ruiz</a> via <a href=”http://photopin.com”>photo pin</a> <a href=”http://creativecommons.org/licenses/by/2.0/”>cc</a>

Measuring & Analyzing Sales

Sales are the lifeblood of retail.  Perhaps that is why we have so many different ways to measure, report and analyze sales.  I thought I would use today’s post to do a brief rundown of some of the different types of sales measurements that are used by retailers.  (Please note that because I am a marketer – I am not looking at these from the perspective of an accountant, rather I’m coming at them from the perspective of a merchant or a buyer.)

  • Gross sales– all sales on all merchandise and services during the given time period.  This one is the grand-daddy of all sales measures, since it is the only one to include everything.  Gross sales is an important measure because of its ease of comparability across different retailers.
    Formula = Average price * units sold
  • Net sales– gross sales less returns and allowances.
    Formula = Gross sales – (returns + allowances)
  • Overall sales– a retailer’s total sales.  Typically reported in percentage form.  Overall sales are used to measure a retailer’s growth.
    Formula = (TY Sales – LY Sales)/LY Sales  (Note:  for overall sales, include all sales from all stores.)
  • Comparable sales– also known as same store sales, are a measure of sales for all stores that have been open at least one year.
    Formula = (TY Sales – LY Sales)/LY Sales  (Note:  only include sales from stores open at least 12 months.)
  • Sales per square foot– average amount of sales generated per square foot of selling space in the retailer’s stores.  Sales per square foot is a popular measurement for determining how efficiently the retailer is using their sales space.  According to RetailSails.com, Apple has the highest sales per square foot of any U.S. retailer at $6,123.  If you would like more information concerning U.S. retailers performance in this area, check out RetailSails.com’s chart for all retailers or their listing for the grocery industry(Update 9/19:  RetailSails.com’s website is temporarily down.  Some of the same information can be found in an April post by ASYMCO.)
    Formula = Sales/Total square ft. selling space
  • Stock-sales ratio– the ratio between the amount of inventory (stock) you have available and the amount you are making in sales.  This measurement helps retailers determine if they are carrying too much or too little inventory.  If you would like to learn more about how to interpret this ratio, I recommend Rick Segal’s analysis at The Retailer’s Advantage.  And, if you would like some ratios to compare your numbers to, the U.S. Census releases reports for U.S. manufacturing and sales inventories/sales ratios every month.  (http://www.census.gov/mtis/)
    Formula = Beginning of month inventory/Sales for the month
  • Online sales ratio – the ratio between a retailer’s online sales and their total sales.  The online sales ratio was developed by Investopedia.  It is further explained in their article “Online Sales Ratio Key to Retail Success”.
    Formula = Online sales/total sales
  • Sales per transaction – this ratio can be calculated in either units or dollars.  Many retailers choose to calculate and track both.
    Formula = Sales/# of transactions

There are many more sales measurements than those listed.  For example, many retailers calculate sales per linear foot of shelf space, sales per department, sales per hour, or even sales per labor hour.  All are good measurements for determining base efficiency levels and the health of a retailer’s sales.  If you have a favorite that I haven’t mentioned, please let me know about it.

 

A beginner’s guide to sell-thru (sell-through)

Sell-thru is one measurement that seems to cause a lot of confusion.  And, it is probably the one I get the most questions about.  Much like GMROII, I can’t give comprehensive coverage to it in a blog post, but I can give you a start to understanding it.

Is it sell-thru or sell-through?  And what exactly is it?

Either sell-thru or sell-through is correct.  Sell-thru is the percent of a product’s (or category’s or department’s) inventory that sells during a particular period of time.

How do I calculate it?

Formula:  Units Sold/ (Units on Hand + Units Sold)  or  Units Sold/Total Units Received

Example:  A store received 100 units of a promotional cereal in a special display unit on the 1st of the month.  Because the product is a one-time buy, they would like to be sold out by the end of the month.  The buyer believes the product should sell evenly throughout the month.   Two weeks into the promotion 30 units have been sold.

Calculation:  30/100 = 30% sell-thru

To achieve the buyer’s goal, the store needed to sell half of their inventory by this date.  They are behind and need to find a way to increase their sales rate.

NOTE:  I have greatly simplified the example given here.  In the real world, there are always complications.

What do I use it for?

Buyers often use sell thru to determine whether a product that is purchased with a finite amount of inventory will be sold by a pre-determined date.  Sell-thru can also be used to monitor inventory levels for regular products by using beginning of month inventory instead of total units received.

If you have questions concerning sell-thru, or would like to see a similar beginner’s guide for a different measurement, please let me know via a comment or an email.

Note:  Other retail math formulas may be found on the Three Buckets CheatsheetBeginner’s Guides on other retail math topics are also available.