The race season is about to begin. Many of your customers are coming in to buy equipment, while some are ordering from your website. You are probably putting in long hours, with inventory arriving from vendors and going out the front door with customers, or to UPS or FedEx to deliver to them. You would be glad if this business boom went on forever.
However, you know from years of experience that as the season continues, sales are going to slow down. For this to be a profitable year for your business, the inventory intake will have to match the outflow.
There is a theory in business that says replenishing inventory is a simple formula. You start with your sales from the just-completed month and multiply that amount by the inverse number of your gross margin. The resulting number is the amount you should spend for replacement inventory in the following month.
The math is simple and correct, but it can get you and your business in a lot of trouble. How can that be? If your sales were the same amount for each month of the year, this concept would work. However, having a level amount of sales is not likely the case for any business, including yours.
For a ‘brick and mortar’ business, depending on what part of the country you are located in, your sales likely build quickly over the first couple of months of the season before reaching a peak. For the Internet-based business, even if the gross sales were the same for all 12 months of the year, different parts of the business would have peaks and valleys over the course of the year.
As your business continues through the season, and the season eventually winds down, your sales will decrease—either for the business as a whole or in some of the various departments.
If either of these scenarios describes your business, the trouble your business will experience with this math will be the excess inventory your business is going to quickly build up. This is because you have used the previous month’s sales to determine how much inventory to order for the current month.
Instead, the scenario you desire is for the inventory on hand to decrease as sales decrease. Likewise, at the point in the season when sales are increasing, you want your inventory to be increasing.
With the decrease in inventory, your cash on hand will improve. And with the decrease in inventory and cash in hand, the end of the season will find you back in Indianapolis in December, at the PRI Trade Show, looking at new merchandise.
All of this puts the business in a good position to start the next season—having the newest and latest products, as well as having paid all of your bills during the off-season, and having cash on hand to start the new season.
Having shown the failure of the ‘replace what you sold’ method of inventory control, let’s take a look at how to make the scenario you want a reality.
To fully utilize this inventory control system, you need your sales history according to the categorization of your point-of-sales system. The breakdown of sales is important information because, in planning your inventory needs for the coming season, you must have the right inventory as well as enough inventory. After all, having plenty of transmissions on hand won’t help you with the customer who needs a block, and you don’t have the right block on hand.
As an example, we will look at a category that has a gross margin of 30 percent. If you sell $10,000 in this category during a month, you have sold $7,000 of inventory at cost. The math behind this is your having a 30 percent gross margin, which means you have a 70 percent cost of goods sold. Multiplying the $10,000 by the 70 percent cost of goods sold produces an answer of $7,000 in inventory at cost.
The second step is to determine how much inventory you need to produce that $10,000 in sales. Unless you are psychic and know exactly what every customer is going to ask for before they contact your business, the answer is going to be more than the $7,000 we have just calculated. Whatever the number your business needs, this amount of inventory can only be determined by your expectations based upon your experiences.
This would be all you’d need to do if you were ordering all your inventory only a day or two before you sold that same inventory. Instead, there are many parts of your inventory that you have to order months in advance. Therefore, your inventory control system has to involve planning your needs as many months in advance as you have to order inventory.
To that point, think about extending this exercise for 12 consecutive months. You have just created your sales budget for the year. As you apply your gross margin math as in the above example, you change from calculating the inventory you need for this month to the 12 months ahead. In performing this calculation, you will also likely expect that the gross margin will have some variation from month to month.
To help you master this technique, let’s try this exercise for your business for the summer months of June, July and August. You begin with your estimate of your sales and gross margin for each of these three months.
Using the math previously explained, you calculate the inventory you need to produce the sales for each of these months. The difference in the way many businesses operate and what you are doing is that you know what you need in the coming summer during the later part of winter.
Again, this exercise is performed in each category of your business. As the winter ends and the big selling season begins, you monitor the sales in each category. When you placed your orders at PRI in December, you did so with the original estimates you made for the spring and summer.
If the sales for spring in any category exceed your budgets, you now know you will need additional inventory to meet your needs. In the spring, you are able to adjust your orders upward to cover those needs.
Likewise, if bad weather, racing budgets, or fewer parts failures on your customers’ race cars cause your sales in the spring to be less than planned, you can diminish your orders for summer delivery. This is because the inventory you have left from the spring will be available for sales during the summer.
A race shop that fails to plan in such a way finds itself late in the season with excessive inventory sitting on the shelf, and the need to make deals to move inventory and generate enough cash to pay the bills in the off-season.
Using this plan means your inventory levels at the end of the season will be where you have predicted they will be, and the necessary cash will be in your checking account, thereby allowing you to purchase the newest products at the PRI Show in December for sale in the coming season.
They say the best drivers don’t just watch what is directly in front of them, but rather, they see what is going on behind them as well as looking well ahead on the track so they can visualize the best line to take.
If that is what the best drivers are doing, shouldn’t that same technique work for your race shop?
Tom Shay of Profits Plus in St. Petersburg, Florida, is a fourth generation small business owner and manager with more than three decades of experience as a successful independent retailer. He has authored 12 books on small business management and a college textbook on small business accounting. He has also produced hundreds of articles on management for over 75 business publications worldwide.