The Power of Purchasing Plans

It’s June and our friend John Thomas of John Thomas Jewelers is getting ready to go to The JCK Show ~ Las Vegas. John’s going to look at merchandise for the upcoming holiday season. November and December are undoubtedly the busiest months of the year in the jewelry industry. John and his fellow jewelers will arrive at the show with a plan of what they need to purchase and how much they have to spend to prepare inventory for their peak season … right?

Well, some might, but not John Thomas.

As John packs for the trip, he suppresses a growing feeling of anxiety. John suspects that he already has enough inventory on hand. In fact, after a quick calculation of projected sales through November, he realizes that even with no additional purchases, he’ll still have a substantial amount of inventory on Nov. 1.

John’s anxiety rises even more when he looks at his checking account balance. Doing the math for sales and expenses for the next five months, John is stunned to realize that he doesn’t have enough cash available to spend any on the show floor in Vegas.

Alarmed, John begins to review his options. The first is to go to the bank and borrow the money to pay for holiday inventory. His banker may—or may not—increase his line of credit. (Of course, John’s chances of getting a loan might be greater if he’d managed to pay off his line of credit last year, but that’s the subject of another article!)

The second option is to go to the show and ask—okay, beg —his vendors for extended terms. Unfortunately, he may find that he’s not able to buy from some vendors because he may appear to be a credit risk: John is already 90-plus days late in paying many of his current vendors, so extended terms will probably not be the solution to his problem.

A third option might be to run a clearance sale, which would free up showcase space and provide cash for purchasing at the show, but it’s probably already too late for that.

John has been going to buying shows for the past 18 years, and lately he’s been wondering why it isn’t getting any easier. We do have to give John some credit: At least he knows he’s in cash flow trouble before he goes to the show. Many of John’s industry buddies catch that Vegas flight with nary a thought for their current or future inventory or cash levels.

If this situation sounds familiar, you might be asking if there’s a better way to handle it. Happily, there is a better way, and its name is OTB.

A man with a plan. The best way to prevent this situation is to have a purchasing plan, also known as Open-To-Buy, or OTB. The formal definition of OTB is “the difference between planned purchases and stock already ordered; the dollar amount of merchandise that a buyer can order for a particular period.” In other words, it’s a purchasing budget.

To set a purchasing budget, start by establishing monthly total-sales goals for the next 12 months. In addition, set targeted inventory turns, ending inventory levels, and targeted gross profit margin. These might be based on historical sales trends, a percentage increase (or decrease) from historical sales, historical turn levels, or industry benchmarks from a peer group or industry group.

It’s important to set targets, because that’s the basis of calculating a traditional OTB goal for the year. Let’s look at our friend John as an example. His sales goal for the year is $2,000,000. This figure includes only merchandise sales from the showcase. Sales from special orders and repairs would be additional, but for this example we’re using showcase sales only.

First, let’s calculate John’s targeted ending inventory for the coming year. To compute this, he’ll need to figure out his targeted gross profit margin, cost of goods sold, and targeted inventory turnover.

This year, John is targeting a gross profit percentage of 55%, which means that for every $1 in sales revenue, he’ll make $0.55 in gross profit margin. Determining his cost of goods sold is simple: Take 100% and subtract his gross profit percentage to get his cost of goods sold figure of 45%. Take this 45% and multiply his sales to get his cost of goods sold in dollars—i.e., .45 x $2,000,000, or $900,000.

John has targeted his inventory turnover (the rate at which he sells his inventory) at 1.5. To determine his targeted ending inventory, take his cost of goods sold and divide it by his inventory turnover number (1.5). That gives us a targeted ending inventory of $600,000. (Note: for more background on these formulas, see earlier articles in this series.)

  1. Cost of Goods Sold $900,000

  2. Inventory Turnover 1.5

  3. = Ending Inventory (line 1/line 2) $600,000

To determine John’s purchase budget for the year, take his ending inventory goal, add his cost of goods sold, and subtract his beginning inventory (taken from his balance sheet) to arrive at his purchases:

  1. Ending Inventory Goal $600,000

  2. + Projected COGS $900,000

  3. – Beginning Inventory ($700,000)

  4. = Purchases $800,000

To calculate John’s final purchase budget for the year, take his purchase budget goal and subtract out any purchases to date.

  1. Purchase Budget Goal $800,000

  2. – Purchases to Date ($250,000)

  3. = Open To Buy $550,000

Now that we have John’s OTB for the year, the next step is to determine OTB by department and the purchasing budget for different types of products within each department. However, the question still remains, “How do we know what to buy?”

OTB, Part II. The term “Open To Buy” actually is a misnomer. Open to Buy calculates a dollar figure on how much you can buy, but what’s missing is the other side of the buying decision—where to spend the money to feed your inventory. The traditional Open To Buy process doesn’t deal with merchandising, except to report when you have too much inventory and can’t buy any more.

Abe Sherman, CEO of Buyers International Group, has created a new tool to help expand the OTB process. Having spent years in retail, Sherman now assists jewelers nationwide in understanding what he refers to as “Balance To Buy”—a process similar to OTB, but taking into account inventory levels and on-hand inventory. The critical difference is the additional step of drilling down further into the data to develop a more merchandise-centric action plan, rather than simply an accounting tool. Balance To Buy takes into account not merely how much is sold, but what is selling.

Here’s where the balancing in “Balance To Buy” comes into play:

First, look at sales by category and sell-price as it relates to inventory on hand by category and sell-price. For example, if over the past 12 months you sold 20 amethyst rings for $300-$400, and you have three in stock, then you need more inventory. If you sold three, but have 20, you have too many. Throughout your inventory, misalignment exists by category and price. The job, therefore, is to balance what is needed with what you already own.

This is a four-step process:

  1. List all items sold by category and price.

  2. List all on-hand inventory by sell-price and number of days in stock.

  3. Re-price nonperforming inventory to fit into price points that are selling well

  4. Replace fast sellers as they sell.

Next month, Sherman will help us drill down further into this “Balance To Buy” concept with more specific tools and examples.

Advice from the experts. The majority of the businesses that fail do so with a financial statement that shows they are making a profit. Their problem is that they have no cash available to pay bills. That’s why a purchasing plan is vitally important to the health of a business. Every business owner who wants to be open for business and have the cash to buy inventory must understand how to create a purchasing plan by using Open to Buy and Balance to Buy.

To help get you through this or any other buying show, we surveyed several jewelers who are known for their strong inventory management skills. We asked two of our FIT Performance Group members—Andy Koehn of Koehn and Koehn Jewelers and Larry Rickert of Jim Kryshak Jewelers—to share their “Best Practices.”

Andy’s advice

  • Go to Vegas with a budget in hand.

  • Know what you’ve sold in the past, at what price points, and how much of an increase over last year you project. Do this for the top categories—the top 20% of inventory that produces 80% of sales.

  • Always fill the “basic” inventory categories first—the seemingly boring items like diamond stud earrings, solitaire pendants, anniversary bands, and tennis bracelets. People call these “bread and butter” goods. Subtract what you purchase in each category from its respective budget, and spend the remainder on more exciting (as we perceive it) and different products.

  • Know what price points in each category sell the best, and use that to decide which products will make the cut. For example, if you know you’ve sold [x] pair of .25-ct. t.w. round brilliant diamond stud earrings for $250, use that information when standing in front of the vendor. Here’s how:
    Most jewelers tend to look at the cost of an item and decide whether or not they can sell it for a certain price. Let’s say a pair of .25-ct. t.w. diamond studs costs $150, and I “keystone” (double) this particular product category. In this case, you’d have a retail price of $300. That may or may not work.
    The better way is to look at what price points have sold in the past, and “back into” the cost to see if it makes sense. Using the above example, you would look at the earrings and think, “This size and quality of diamond sells for $250 in my store,” then look at the cost. If it’s $150, pass—because you want at least a keystone markup for diamond stud earrings, so you need to find a pair that costs $125 or less.

  • Join B.I.G. (Buyers International Group) and FIT (Financially In Tune) Performance Group to take advantage of the expertise of management, marketing, merchandising, and financial professionals working with you to improve your bottom line.

Larry’s advice

  • Focus on the top 20 vendors, and set up appointments with ones you need to see, which may be different from the ones who want to see you!

  • Bring along sold reports and stock balancing reports, and have a preset idea of how much you want to spend at each vendor, leaving some dollars available for new items.

  • Set up two delivery dates: one for merchandise you need now (replacing fast sellers), and a September/October delivery for items stocked strictly for the holiday season.

  • If you have any special issues to discuss, let the vendor know in advance so you can make the face-to-face meeting more productive.

  • Finally, if there is money left in the budget and energy left in your body, check out potential new vendors and scan their booths. Always be on the lookout for that “better mousetrap” among the thousands of vendors at the show.

See you in Las Vegas!

Steve LeFever is founder and president of Business Resource Services (BRS) and a popular speaker at The JCK Shows. Working in partnership with JCK, he has developed customized presentations and workshops for the industry, all focused on helping jewelers make better financial decisions for their companies. For more information on how to use industry benchmarks like the ones discussed in this articl e to improve your company’s performance, plan on attending his special extended workshop, “Benchmark Yourself: The Power of Peer Comparatives,” on Thursday, June 3 from 2:30-5 p.m. For more information on the BRS FIT Performance Groups for jewelers, visit www.brs-seattle.com.