Wednesday, February 25, 2009

No More Pollyanna, It's Time to Talk Cash

Okay, enough Pollyanna posts about being positive in a down economy. Enough about turning off and tuning out the media. You can only control a few things. Over the next few weeks we'll talk about those few things you can control in concrete ways.

First, and foremost, is Cash Flow. In retail cash is king. Without it you're dead in the water. With it you're ready to meet the new demands of a new market.

The tricky thing is that cash is directly related to inventory. Too much inventory, not enough cash. Too much cash, not enough inventory. How do you find the balance?

Let's be honest. Most of us don't have too much cash and too little inventory. We're just not that smart:-) So start with this simple thought. If cash is tight, if you're struggling to pay the bills, you probably have too much inventory. More importantly, you probably have too much bad inventory - what we call the dogs. And if these dogs won't hunt, you gotta set 'em loose.

How can you tell if a dog won't hunt? Some dogs are easy to spot. If you haven't even sold half of your inventory over the course of a year, it's woofing big time. Some dogs are harder to spot. A simple, very important mathematical equation called Gross Margin Return On Investment (GMROI) does the trick. GMROI basically is a measurement of how much money you make on the money you invest in your inventory. The formula is this:

GMROI = Gross Profit divided by Average Inventory at Cost

And Gross Profit is simply Sales x Profit Margin.

So you really only need three numbers to figure out your GMROI
1) Gross Sales
2) Profit Margin
3) Average Inventory at Cost.

I use a monthly average inventory and yearly sales, but you can choose to measure however you want. Also, you can use this formula on a single item, on a group of items, on a whole department or even on the whole store. I track GMROI very carefully for the whole store, each department, and each vendor, but I use it on individual items when a product I really like doesn't seem to be pulling it's weight.

Here's a hypothetical situation to put it into numbers:

Gross Sales = $5,000/year
Profit Margin = 40%
Gross Profit = $2,000 ($5,000 x 40%)
Average Inventory = $1,200/month
GMROI = 167% ($2,000/$1,200)

That means for every dollar I invested in this product over the course of a year, I made $1.67. If your GMROI falls below 100% then you are losing money on that product.

Calculate the GMROI for your store, for each department, and then for each product you don't think is selling well. Compare the product GMROI to the department and overall store. You'll have a quick idea of how well that product stacks up and if it's helping or hurting your cash flow.

If your GMROI is below 100% it's a no-brainer. If it's between 100-150%, you've got some serious work to do. Depending on your industry you may need a GMROI well over 200% to be successful. Only you can really know what you need to succeed. Fortunately, there are only three variables to manipulate.
1) Sales - sell more product and your GMROI rises
2) Profit Margin - raise your prices while selling the same dollars and your GMROI rises
3) Average Inventory - keep a smaller, tighter inventory and your GMROI rises.

Take the example above and play with the numbers. One by one, raise the sales, raise the profit margin and lower the inventory. See how a 10% shift in any one of those numbers affects your GMROI. You'll find that a 10% decrease in inventory has the highest impact and thus the best results for your cash flow. And how do you cut the inventory? By getting rid of the dogs. They aren't helping sales anyway.

Just do what I do. Identify them, pull them from the floor, mark them half off and have a big sale once or twice a year (not too often, you don't want to train your customers to wait for the next sale). Invite all your transactional shoppers in for the big event and watch those puppies fly out the door. Turn the dogs into cash and invest that cash in the products that give you the best GMROI.

Yeah, you gotta do some math. But believe me, it's worth it!

-Phil

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