Retailers face many challenges. The more complex of these tend to relate to juggling inventory levels and Delivered Gross Margins.

I have often heard the phrase ‘let the buyers do the buying'. We should follow this mantra but without abdicating the responsibility of providing them with budgets and targets and the ability to model the impact of their decisions on sales, margins and inventory levels.

Enter the discipline of Merchandise Financial Planning!

The process of Merchandise Financial Planning, often termed ‘Planning' is an effective approach to providing the buying or inventory team with the financial framework within which to make product and buying decisions.

It can simply be defined as the ‘creation and maintenance of a dynamic forecast of the key retail business drivers'.

So, what is the data you need? And what is the process?

The image shows our Basic Inventory Related Drivers, it is key to understand each of these drivers impacts the others.

Critically we want to understand what level of inventory we require to support our sales forecasts but which also takes into account our store sizes.

If our inventory levels are too high, we run the risk of cash flow issues and the eventual requirement for markdowns, and if the level is too low, there is the probability of lost sales.

The Defining of Inventory Levels

Obviously inventory levels have a dollar and unit value but deciding target levels based on these definitive numbers will not allow us to relate inventory requirements to the level of sales.

The only approach to making required inventory levels a dependent of sales is relating inventory to sales off-take, namely the rate of sale (ROS). If our ROS is based on sales dollars per period (let's assume weeks), then we can calculate the number of weeks or months inventory we need to sustain those sales and take into account supply chain lead times.

Therefore our inventory levels are required to be defined as weeks' supply or stock turns per year (the opposite of weeks' supply). The dollar value of our inventory targets can then be extrapolated from these numbers (number of weeks supply needed times average weekly sales).

The Fundamental Outcome from the Merchandise Financial Plan

 After forecasting our sales, margins and required inventory levels by week or month, the process will generate an Open To Buy (OTB). The OTB is the Purchasing Budget at cost required to deliver the target inventory levels.

If there is a variance in sales or margins, our inventory levels will be recalculated and there will be a requirement to increase or decrease purchases, in other words the OTB, to balance these levels back to target weeks supply.

This dollar amount of stock to be purchased is fundamentally what Merchandise Financial Planning provides to Buyers or Inventory teams.

Planning is Complex due to Volume Complexity

All the above is relatively straight forward. It starts to get confusing when we need to forecast by Product Category.

Categories will have a relative sales rate. Some will sell quicker than others. In addition, each category will have its own gross margin level and probably a different supply lead time.

Therefore the weeks' supply we are required to keep will differ by category.

 Finally if we add in the additional variables of seasonality and fixed fashion seasons (such as Winter or Summer ranges), we now introduce the concept of overlapping ranges and the requirement to ‘quit' old ranges whilst introducing new ones.

The complexity can continue! We will need to add the additional issue of Actual compared to Plan and Delivery Dates compared to OTB periods... Another time.

How do Retailers Improve their Merchandise Planning Capability?

Some fundamentals first. Planning is not a skill most Buyers have. It is part of an informed number crunching approach to inventory.

Secondly, if the Planning Process does not occupy a pivotal position in the Inventory Management process, then it is doomed to be irrelevant.

It must be a vital part of the budgeting process and should be reviewed weekly, as with sales, to determine reactions and possible changes in inventory and margin assumptions going forward.

Merchandise Financial Planning Tools

Many of the better Retail Software Systems have their own Planning Module. It is an obvious statement that a Planning System integrated with the sales and purchase ordering modules will reduce the amount of manual updating of the Planning System.

Planning processes can be quite different across retailers and often the flexibility required from the system is not there in these integrated modules. There are a number of ‘standalone' systems on the market and these range from complex and expensive to simple and easy to install.

The Key to Great Merchandise Financial Planning

The selection of the most effective system is of course important but the most critical factor is not the system but the internal processes and where within the inventory structure Planning lies. Planning must be given the level of authority so it can ensure the financial framework it provides the Buyers is not simply indicative but must be complied with.

We all understand that a level of flexibility is required, but sales, margin and stock levels are quantitative measures and the numbers must be followed to ensure effective inventory and maximise cash flow.

David Gordon - Principal Retail Advisory Services

This information contained in this newsletter was compiled by WHK Pty Ltd ABN 84 006 466 351 (WHK) and WHK Financial Planning Pty Ltd ABN 51 060 092 631 (WHKFP). This is an information service only and is not financial advice. WHK and WHKFP do not provide any warranty regarding the accuracy and completeness of information in this newsletter. All material contained in this newsletter is based on opinions, conclusions and forecasts that are reasonably held at the time this newsletter was compiled. WHK and WHKFP assume no obligation to update the material to reflect any changes. WHK, WHKFP, their