Feel like you’re constantly selling out of your best-sellers, you make a lot of revenue but never have a lot of cash, or maybe you have inventory collecting dust in your warehouse?
Whether you actively struggle with inventory management or just want to learn more about the process, today’s episode is for you. I’m breaking down the MOST IMPORTANT concepts and calculations you need to maximize your revenue while maintaining your cash flow.
When it comes to running your product-based business one of the most complicated parts is managing your inventory. This is especially true if you have a wide assortment of products like a clothing boutique or if you have long manufacturing lead times.
Why Inventory Management is So Important
Have too little inventory, you miss out on sales. Have too much, you have no cash flow. It truly is a delicate balance and honestly, you’ll probably never get it perfect… but you sure can try!
And it’s important you know this stuff as an eCommerce CEO, so I’m really glad you’re listening to this podcast. I will say though, managing inventory is definitely one of those positions you’re likely going to want to hire for at some point.
Now, if you’re a one-product store, maybe you’ll never have to do that. But if you’re one of those that do have a lot of different skus, I would definitely consider it. If you’re not sure if it’s time to hire someone, here are a few tell-tale signs.
- You’re constantly running out of your best sellers
- You’re making a lot of revenue, but you never seem to have any cash available in the business
- You seem to have a lot of items that are collecting dust in your warehouse
- You don’t even know what you have in your warehouse right now
If any of this is true for you… definitely keep listening. Even if you’re thinking you want to hire someone to manage it for you, it’s still important that you understand the concepts and calculations so you can keep your eye on how that person is performing.
One disclaimer before we get started… we’re not going to go through every last detail about inventory management, that’s more than we can do in a podcast episode. But the concepts I’m going to share with you today are the most important and we’ll get you off to a really great start.
Additionally, when it comes to how you apply these concepts to your business, there are going to be some nuances depending on the products you sell, the seasonality of your business, and the type of business you want to have. I’ll do my best to give examples of how would apply these concepts to multiple different business types, but remember that there are really no hard and fast rules here, these are meant to be guideposts in your decision-making. Take these calculations, these numbers, your knowledge of your business, and a bit of intuition to make the best possible inventory decisions.
Alright, let’s get into some calculations!
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What is Department Sales % & Why Does it Matter
So the first number I want you start wrapping your head around, especially if you’re a boutique selling a lot of different categories is your sales by department. Then I want you to look at the inventory you have on hand and on order by department. And compare those numbers.
Let’s run through an example.
Let’s say you look at your sales for the last 90 days and your departments are broken out into tops, denim, bottoms and accessories. And your percentages are as follows:
- Tops: 40%
- Denim: 20%
- Bottoms: 10%
- Accessories: 30%
Then let’s look at your on-hand and on-order inventory and it breaks out like this:
- Tops: 20%
- Denim: 40%
- Bottoms: 20%
- Accessories: 20%
What do you think will happen in this scenario?
Now if we assume all other variables stay the same, seasonality, customer behavior, etc. here are a few key takeaways:
- You’re wildly underbought in tops and you will likely sell out and be unable to keep up with demand
- You’re probably overbought in denim and bottoms. Denim might not be as detrimental since there are so many different styles, washes, sizes, etc. and it has a pretty long shelf-life. But when it comes to other bottoms that are generally seasonal, it’s likely you’ll have to mark some items down to move through them.
- And accessories are also underbought and you will have difficulty keeping up with demand.
Why the Way You Categorize the Products in Your Business Matters
Now one thing to note here is that the insights you’ll gain from this process are only as good as the categorization you use in your business. And there’s no perfect way to do this, it’s going to depend on your business and assortment but let’s run through some more examples.
What I gave you was a very basic set of categories, tops, bottoms, denim, and accessories. Now, if you’re a smaller business that might be fine. But the bigger you are, generally the more granular you’ll want to get.
Do You need Sub-Classes?
For instance, you might want to break down your tops into sub-classes or sub-departments such as knits vs. wovens, sweaters, graphic tees, long-sleeve tees, etc. These different sub-classes are likely to sell at different rates and have seasonal fluctuations too.
Here’s another example. I have a client who sells yarn alongside knitting accessories, patterns, and books. But yarn comes in so many different fibers, that tracking them all under one category likely isn’t going to give them nearly enough insight.
Another example, is what if you sell phone cases and other phone accessories like chargers, ring lights, and little wallets that stick on the back of the cases. Do you think tracking all phone cases in one department is going to be good enough? Probably not. You’ve got multiple different manufacturers and generations. You need to be able to look at those much more granularly.
How to Account for Inventory Seasonality with Department Sales %
Okay, let’s take this department sales a step further so we can take things like seasonality into account. The first thing I would recommend here is to record the sales by department month over month for the last 12 months. And put them all in an excel sheet column after column. This will help you to identify patterns in your department sales.
If you’re looking at a more granular set of data, you will probably see things like sweaters + long-sleeves peek later in the year, graphic tees are likely to be steady throughout and wovens will probably peak in the spring in summer.
Once you see where those peaks and valleys are, you can start applying those same patterns to your wholesale purchases or your production.
Here’s a really simple example. If you sell scented candles. You’re going to create more holiday-scented candles in the fall and winter and more beachy or floral-scented candles in the spring and summer, right?
How to Calculate Weeks of Stock & Why it Matters
Okay, the next calculation is called week’s of stock. And this is going to help you identify items you’re overbought in and help you figure out how many units of something you need to re-order or produce.
To simplify this calculation, we’re going to assume we’re dealing with an evergreen product, something that you sell over and over again, that doesn’t have a shelf-life. That tried and true best seller. If you are a one-product store, this is going to be the most important calculation we do today.
For the sake of the example, let’s pretend we sell widgets.
And on average over the last 90 days, you sell 100 widgets per week.
And let’s say that you have 1000 widgets on-hand.
We divide 1000 on-hand widgets by the 100 that you sell per week and that means you have 10 weeks of stock on hand.
What is a Good Weeks of Stock number?
So, is that good or bad? Neither. It’s relative to your products, your lead times, your business, and your industry.
For example, let’s say your manufacturer produces your widgets to order, which means it takes 15 weeks from the time you place your order to when you receive them. In that case, you don’t have enough stock and you’re likely to sell out because at your current rate of sales, you’ll be sold out before you can get that replenishment order even if you were to order it right now.
On the flip side, let’s pretend your manufacturer holds stock in these widgets and can ship 1000s of units immediately. So your lead time is only 1 week. Let’s say 2 weeks to allow for delays and to give yourself enough time to actually receive the inventory and make it available for purchase.
In that case, you’re actually overbought and you have a lot of money tied up in inventory that could be spent on other things like marketing, or just have been more money you paid yourself. Even if you wanted to leave yourself some safety stock for an unexpected spike in sales, and you kept 500 widgets on hand, you have twice the amount of units you need.
Now, in this example, we’re talking about an evergreen item so being overbought isn’t a huge deal. You can just wait a bit before you place your next order.
How Does Seasonality Affect Your Weeks of Stock Goals
But what if you have a seasonal business or a seasonal product. What if it’s August 1st and you have 10 weeks of stock of shorts. That stock in theory would last you beyond October, and by August 1st your current rate of sales in that item is likely slowing down. In that case, you’re going to want to mark those items down so you can move through them.
How Do You Slow Down the Rate of Sales for Your Products?
What if something is moving too fast and you’re not going to have inventory to support it, like in the first widget example. What do you do? How do you slow the rate of sales? In that case, you might want to actually raise the price or you can bring in something similar that would take some of the attention away from that first item.
How Should You Calculate Your Weeks of Stock number?
What if you’re a boutique that sells lots of different skus and you bring in new merchandise all the time. Looking at weeks of stock at the item level is probably not necessary and will be total overkill. So you can go back to the categories we talked about earlier.
But what about the yarn store I mentioned. We know looking at it by one big category of yarn is too general. But if they looked at every individual sku of yarn, that could be a nightmare. What if they looked at by sub-class, ie. by fiber? Well, that could work. But they also have a handful of skus that are their biggest and best-sellers. So if they lump those in with the fiber category, they might end up sold out of their best-selling items.
In this particular case, I would pull out those best-selling yarns and look at them individually, while looking at the rest by the fiber sub-class.
Does that all make sense?
How to Know if You Have Enough Inventory to Hit Your Sales Goals
Okay, before we move on. I want to touch on another way to look at your inventory at more of a high-level overview and how that compares to your sales goals.
Let’s say you currently do about $20k in revenue per month and going into Q4, you regularly see an increase in sales of 20%, so in the months of October – December you expect to do $24 thousand per month.
So, the question is, how much inventory do we need to have in order to hit those sales goals? Well, at least $72 thousand dollars at retail right? 24k per month for 3 months. And when I say at retail I mean the price you sell it at not the price you buy it at or make it for.
But what if you plan on doing a big sale for Black Friday where you’re giving a 20% discount for 3 days.
Well, that discount is going to effectively decrease the amount of revenue you can make from the inventory you have. So really you need to have a bit more. Plus, you know you’re not going to sell out every single unit you have. Depending on your products and customers, the smalls and mediums will go faster, the best-sellers will go faster, and you’ll have some other items that don’t move so quickly or don’t sell at all.
So look, I’m not telling you to go drop $72 thousand dollars on inventory in one shot. But, this is just to illustrate how these two numbers relate to each other.
And then of course, the opposite might happen. Maybe you look at your on-hand and on-order inventory for that period and you see that you have $200k at retail. In that case, you are probably overbought.
Whichever direction you end up, over or under, you’ll want to take it a few steps further, using the department sales % and the WOS to pinpoint where you need to make adjustments. Don’t just go buying additional inventory or marking down products without looking deeper into it.
Understanding Inventory Replenishment and How Much to Order
The first thing I want to remember is that in most cases, you only need to replenish what you sold. When you’re trying to decide how much money you have to spend on inventory, look at your cost of goods sold for the previous time period.
Let’s use the 20k example. And let’s say you have an average gross margin of 60%. So for every $100 in inventory you sell at retail, it cost you $40.
In that case, the COGS on the 20k that you sold would be $8000.
So, when you’re placing new orders, you essentially have $8000 to spend on that inventory.
Before you go placing orders though, you’re going to want to go back to that department’s sales % and allocate that 8k accordingly.
Using the same department percentages from earlier here’s how that would break out.
- Tops: 40% – $3200
- Denim: 20% – $1600
- Bottoms: 10% – $800
- Accessories: 30% – $2400
But of course, this isn’t always a perfect science. As we mentioned earlier, denim comes in so many different styles, washes, and sizes. And they’re typically more expensive. So you might have to put a bit more of your budget there in order to ensure you have a solid assortment of product.
Accessories are typically smaller and less expensive, so maybe you don’t need to spend all of that budget on accessories and can allocate some of that to your denim buy.
You’ll also want to think about seasonality. If you’re going into summer, you probably don’t want to fully restock in denim because your sales are going to slow down.
Or, if you’re looking at your sweater category and you’re at the end of the winter, it doesn’t make sense to fully buy back into sweaters because you only have a few weeks left to sell them.
Refer back to that spreadsheet we created earlier, where you put your department sales month over month for the last 12 months. You’ll want to allocate your buys in the same pattern that was revealed in that spreadsheet.
And one other thing to keep in mind, if you have solid inventory overall, you don’t necessarily have to spend every last available dollar on inventory. Consider holding some of that back so you can react to trends or replenish something that sells out really quickly as soon as it hits the sales floor.
How to Calculate Inventory Sell-Through Rate
This is the rate at which an item sells in a given period of time. It’s somewhat similar in theory to weeks of stock, but it’s different because it informs you how well something is moving, how popular it is, and whether or not you should buy more.
The way to calculate this is by dividing the number of units sold by the number of units received. Then you multiply by 100 to get the % rate.
What is a Good Inventory Sell-Through Rate
So let’s say you got 12 units of a particular style and you sold 10 of them. That means you have an 83% sell-through rate. That sounds pretty good right, shit you might need to buy more.
Well… that depends. How long did it take you to sell those 10 units? Was it in a week or 3 months? Those results are wildly different based on the time frame that you’re looking at.
For a boutique that turns and burns inventory quickly with customers coming back every week to see what’s new, selling 10 in 3 months likely means it was a bad buy and should have been marked down.
For a home improvement store that holds goods for a long time, 83% sell-through rate in 3 months probably means they need to order more. If they go and look at their WOS calculation that would tell them a lot more.
What to Do if You Have a High Sell-Through Rate
But what if you’re the boutique that did sell through 83% of their stock in a week? Then what do you do? Well, then you’re going to want to order more of the same item or something very similar. In many cases, the second order of the same item never seems to sell as well as the first. In all the years I’ve worked in brick and mortar and had my store, there are only a handful of items I can think of that I was really able to sell over and over and over. Unless it was a basic or staple of course.
That doesn’t mean you never replenish the same item, it just means you do it with caution. And just because you sold through your first pack in a few days doesn’t mean you should then go and buy 5 packs of that item.
What to Do if You Have a Low Sell-Through Rate
So what if you determine that the sell-through is not so great… what do you do?
If it’s an evergreen type item, you probably just need to give it more attention, or just hold out knowing it will eventually sell. And just make sure you don’t order any additional units until you get down to your target WOS number.
If you’re a clothing boutique or it’s a more seasonal type item… then I want you to ask yourself why.
Is it because it’s just not a good item and people don’t want it; or has it not even gotten much attention?
When to Markdown Your Unsold Inventory
If you already did a good job of showing it off, and customers just didn’t bite… then mark it down. You want to mark things down as soon as you realize it’s a dog. If it’s been sitting around for 180 days, you waited too long. If you think maybe it hasn’t quite gotten the attention it deserved, then consider spending a week marketing it first. and then if it still hasn’t picked up. Mark it down.
Most retailers typically take markdowns every 6 weeks or so with the first markdown being 30% off the retail price. Then you can do a second mark at 50% if it’s still not selling and then for your end-of-season blow out you can go down to wholesale or even a little below.
Just get in the habit of marking things down in an effort to move them. You want to free up that cash and invest it into something that will sell and make you more money.
How to Improve Your Inventory Management
As I’ve said, probably multiple times throughout this podcast episode… there are little to no hard and fast rules when it comes to managing your inventory. It’s part art, part science.
It takes some math, some intuition, and data. the earlier you are in your business, the harder this is to do. The longer you’ve been around, the more accurate you will get. And there are so many variables that can affect this. Supply chain issues, changes in customer behavior, and weird weather patterns.
All of this to say… don’t get discouraged if you start running these numbers and realize you’re off. Take small steps to get your inventory where you need it to be and then pay closer attention to it moving forward.
Hopefully, this helped clarify some things for you and hopefully, I did a good enough job explaining it!
If you feel like you need a bit more 1:1 support, book a strategy call with me. We can dig into the numbers together and get you moving in the right direction.