Category Archives: Using the Math

Interpreting Turn Numbers – Part 2

In a previous post I discussed the reasons why a larger turn number is not always considered agrocery-store-2119702_640 healthier turn number.  The first reason involved negative profit margins.  The second reason was high out of stocks.

There is a close relationship between turnover and inventory levels.  Turnover is essentially a measure of how efficiently a retailer is utilizing their inventory in creating sales.  Looking at the turnover equation (Annual Sales/Average Inventory – see Inventory Turnover:  Retail, Cost, or Unit?), it is easy to see that there are only two ways for a retailer to improve their turn numbers.  They can increase sales or lower inventory.  For now, let’s concentrate on the latter.

Smart merchants spend a great deal of time studying their category’s in-stock (aka on-shelf availability) levels.  These numbers tell the retailer whether any particular product is in inventory.  When an item is 95% in-stock, the retailer may assume that 95% of the time that product was in the store and available for the customer to purchase.

Retailers typically lower their inventory levels (and improve their turn numbers) in healthy ways, by cutting excess inventory or dropping SKU’s for which there is little demand.  These changes should not impact the products in-stock levels.

However, when a product’s both a product’s inventory level and in-stock level drops, this is a bigger concern.  This means that for whatever reason – the retailer is not able to keep enough inventory on hand to satisfy customer demand.  In other words, products are not being replaced when they sell out.

The resulting increase in turnover rate is considered unhealthy for two reasons:

  1. If the product had been in-stock, customers could have purchased it and sales would have been higher.
  2. If customers wanted the product but couldn’t find it, they may have decided to purchase it at the competition instead.

 

Interpreting Turn Numbers

No Retail Math number is useful unless you are able to interpret it, 24607796422_e5979e3304_q
and this is just as true for inventory turnover rates as it is for sales or profit figures.

In general, retailers prefer high inventory turnover numbers.  The higher the inventory turnover, the more times the retailer has sold their average inventory.  This means that a higher turnover rate normally correlates with higher levels of sales and profits.

Let’s Calculate!
Retailer #1 carries an average retail inventory of $300,000 and has annual sales of $900,000.  This gives them an inventory turnover of 3.0 ($900,000/$300,000).  If Retailer #1 has no markdowns and a maintain margin of 10%, then they will achieve a profit of $90,000 ($900,000 * 10%).

Retailer #2 carries the same average retail inventory of $300,000, but manage their inventory more efficiently, turning it 4.0 times that year.  This gives Retailer B annual sales of $1,200,000 ($300,000 * 4.0).   If they also have no markdowns and a maintain margin of 10%, they will earn an annual profit of $120,000 ($1,200,000 * 10%).

Is it always true that a bigger turn number is better?  While retailers do generally prefer that their inventory turnover rates increase, there are 2 exceptions to this rule.

The first is when dealing with a loss leader.  If a retailer has a negative initial margin for a particular item, then they may not wish to drive their turnover numbers higher.

The second is when the retailer’s out of stock levels are high.  This situation is one which will be covered in a future post.

photo credit: danielfoster437 <a href=”http://www.flickr.com/photos/17423713@N03/24607796422″>Fresh Produce</a> via <a href=”http://photopin.com”>photopin</a> <a href=”https://creativecommons.org/licenses/by-nc-sa/2.0/”>(license)</a>

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.

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.