Appendix 12A Merchandise Budget Report and Open: Fashion Merchandise Category oko MERCHANDISE BUDGET PLAN In this appendix, we describe the steps in developing the merchandise budget plan for a fashion merchandise category. These steps are taken to develop the bottom line—line 8, “Monthly ‘Additions to Stock”—in Exhibit 12-16. The figures on this line tell the buyer how much merchandise in retail dollars he or she needs to have, on average, at the beginning of each month for the retailer’s financial goals to be met, Note that Exhibit 12-16 is the same as Exhibit 12-10 in the chapter. Sig 16 Six-Month Merchandise Budget Plan for Men’s Casual Slacks ae fe noeeyasanonstecee |420 Retailing Management Monthly Sales Percentage ition to Season (Line 1) Line | of the plan projects what percentage of the total sales is expected to be sold in each month. In Exhibit 12-16, 21 percent of the six-month sales are expected to occur in April. Historical sales data provide the starting point for determining the percentage distribution of sales by month. The percentage of total category sales that occurs ina particular month doesn’t vary much from year to year. However, the buyer might adjust the historical percentages to reflect changes in buying patterns and special promotions. For instance, the buyer might feel that the autumn selling season for men’s casual slacks continues to be pushed further back into summer and thus increase the percentages for July and decrease the percentages for August and September. The buyer might also decide to hold a special Easter sale promotion, increasing the April percentage and decreasing the other percentages. Monthly Sales (Line 2) Monthly sales are the forecasted total sales for the six-month period in the first column ($130,000) multiplied by each monthly sales percentage (line 1). In Exhibit 12-16, monthly sales for April 5 $130,000 3 21 percent 5 $27,300. ? Monthly Reductions Percentage Distribution to Season (Line 3) To have enough merchandise every month to support the monthly sales forecast, the buyer needs to consider other factors that reduce the inventory level in addition to sales made to customers. Although sales are the primary reduction, the value of the inventory is also reduced by markdowns (sales discounts), shrinkage, and discounts to employees. The merchandise budget planning process builds these additional reductions into the planned purchases. If these reductions were not considered, the category would always be understocked. Note that in Exhibit 12-16, 40 percent of the season’s total reductions occur in April as a result of price discounts (markdowns) during end-of-season sales. Markdowns also can be forecasted from historical records. However, changes in markdown strategies—or changes in the environment, such as competition or general economic activity— must be taken into consideration when forecasting markdowns. Discounts to employees are like markdowns, except that they are given to employees rather than to customers. The level of the employee discount is tied fairly closely to the sales level and number of employees. Thus, employee discounts also can be forecasted from historical records.Managing the Merchandise Planning Process 421 Shrinkage refers to inventory losses caused by shoplifting, employee theft, merchandise being misplaced or damaged, and poor bookkeeping. Retailers measure shrinkage by taking the difference between (1) the inventory’s recorded value based on merchandise bought and received and (2) the physical inventory actually in stores and distribution centers. Shrinkage varies by department and season, but typically it varies directly with sales as well. So if sales of men’s casual pants increase by 10 percent, then the buyer can expect a 10 percent increase in shrinkage. 40.00% 14.00% 16.00% 12.00% 10.00% Monthly Reductions (Line 4) Monthly reductions are calculated by multiplying the total reductions by each percentage in line 3, The total reductions for this example are based on historical data, In Exhibit 12-16, April reductions = $16,500 x 40 percent 5 $6,600, BOM (Beginning-of-Month) Stock-to-Sales Ratio (Line 5) The stock-to-sales ratio, listed in line 5, specifies the amount of inventory that should be on hand at the beginning of the month to support the sales forecast and maintain the inventory turnover objective for the category. Thus, a stock-to-sales ratio of 2 means that the retailer plans to have twice as much inventory on hand at the beginning of the month as there are forecasted sales for the month. Both the BOM stock and forecasted sales for the month are expressed in retail sales dollars. Rather than specifying the stock-to-sales ratio, many retailers specify a related measure, weeks of inventory. A stock-to-sales ratio of 4 means there are 16 weeks of inventory, or approximately 112 days, on hand at the beginning of the month. A stock-to-sales ratio of 1/2 indicates a two- week supply of merchandise, or enough for approximately 14 days. The stock-to-sales ratio is determined so the merchandise category achieves its targeted performance—its planned GMROL and inventory turnover. The steps in determining the stock-to-sales ratio for the category are shown next.422 Retailing Management Step 1: Calculate Sales-to-Stock Ratio The GMROI is equal to the gross margin percentage times the sales-to-stock ratio. The sales-to-stock ratio is conceptually similar to inventory turnover except the denominator in the stock-to-sales ratio is expressed in retail sales dollars, whereas the denominator in inventory turnover is the cost of goods sold (sales at cost). The buyer’s target GMROI for the category is 123 percent, and the buyer feels the category will produce a gross margin of 45 percent. Thus, GMROI = Gross margin percent 3 Sales-to-stock ratio Sales-to-stock ratio = GMROWGross margin percent = 123/45 $2.73 Because this illustration of a merchandise budget plan is for a six-month period rather than a year, the sales-to-stock ratio is based on six months rather than annual sales. So for this six- month period, sales must be 2.73 times the inventory cost to meet the targeted GMRO! Step 2: Convert the Sales-to-Stock Ratio to Inventory Turnover Inventory turnover is Inventory = Sales-to-stock x (1.00 — Gross margin %/100) turnover ratio =2.73 x (1.00-45/100) 1,50=2.73 x55 This adjustment is necessary because the sales-to-stock ratio defines sales at retail and inventory at cost, whereas inventory turnover defines both sales and inventory at cost. Like the sales-to-stock ratio, this inventory turnover is based on a six-month period. Step 3: Calculate Average Stock-to-Sales Ratio The average stock-to-sales ratio is Average stock-to-sales ratio = 6 months/Inventory tumover 4 =6/1.5 Ifpreparing a 12-month plan, the buyer divides 12 by the annual inventory turnover. Because the merchandise budget plan in Exhibit 12-16 is based on retail dollars, it’s easiest to think of the numerator as BOM retail inventory and the denominator as sales for that month. Thus, to achieve a six-month inventory tumover of 1.5, on average, the buyer must plan to have a BOM inventory that equals four times the amount of sales for a given month, which is equivalent to four months, or 16 weeks of supply. One needs to be careful when thinking about the average stock-to-sales ratio, which can be easily confused with the sales-to-stock ratio. These ratios are not the inverse of each other. Sales are the same in both ratios, but stock in the sales-to-stock ratio is the average inventory at cost over all days in the period, whereas stock in the stock-to-sales ratio is the average BOM inventory at retail, Also, the BOM stock-to-sales ratio is an average for all months. Adjustments are made to this average in line 5 to account for seasonal variation in sales. Step 4: Calculate Monthly Stock-te-Sales Ratios The monthly stock-to-sales ratios in line 5 must average the stock-to-sales ratio calculated previously to achieve the planned inventory turnover. Generally, monthly stock-to-sales ratios vary in the opposite direction of sales. That is, in months when sales are larger, stock-to-sales ratios are smaller, and vice versa.‘Managing the Merchandise Planning Process 423 To make this adjustment, the buyer needs to consider the seasonal pattern for men’s casual slacks in determining the monthly stock-to-sales ratios. In the ideal situation, men’s casual slacks would arrive in the store the same day and in the same quantity that customers demand them, Unfortunately, the real-life retailing world isn’t this simple. Note in Exhibit 12-16 (line 8) that men’s casual slacks for the spring season start arriving slowly in April ($4,260 for the month), yet demand lags behind these arrivals until the weather starts getting warmer, Monthly sales then jump from 12 percent of annual sales in May and June to 19 percent in July (line 1). But the stock-to-sales ratio (line 5) decreased from 4.4 in May and June to 4.0 in July. Thus, in months when sales increase (e.g. July), the BOM inventory also increases (line 6) but at a slower rate, which causes the stock-to-sales ratios to decrease. Likewise, in months when sales decrease dramatically, like in May (line 2), inventory also decreases (line 6), again at a slower rate, causing the stock-to-sales ratios to increase (line 5). When creating a merchandise budget plan for a category such as men’s casual slacks with a sales history, the buyer also examines previous years’ stock-to-sales ratios. To judge how adequate these past ratios were, the buyer determines if inventory levels were exceedingly high or low in any months. Then the buyer makes minor corrections to adjust for a previous imbalance in inventory levels, as well as for changes in the current environment. For instance, assume the buyer is planning a promotion for Memorial Day. This promotion has never been done before, so the stock-to-sales ratio for the month of May should be adjusted downward to allow for the expected increase in sales. Note that monthly stock-to-sales ratios don’t change by the same percentage that the percentage distribution of sales by month is changing. In months when sales increase, stock-to-sales ratios decrease but at a slower rate. Because there is no exact method of making these adjustments, the buyer must make some subjective judgments. BOM Stock (Line 6) The amount of inventory planned for the beginning-of-the-month (BOM) inventory for April equals BOM inventory = Monthly sales x BOM stock-to-sales (line 2) ratio (line 5) $98,280 = $27,300 x 3.6 EOM (End-of-Month) Stock (Line 7) The BOM stock for the current month is the same as the EOM (end-of-month) stock in the previous month. That is, BOM stock in line 6 is simply EOM inventory in line 7 from the previous month. Thus, in Exhibit 12-16, the EOM stock for April is the same as the BOM stock for May, $68,640. Forecasting the ending inventory for the last month in the plan is the next step in the merchandise budget plan. Note that EOM inventory for June is high, which indicates planning for a substantial sales increase in July.424 Retailing Management Monthly Additions to Stock (Line 8) The monthly additions to stock needed is the amount to be ordered for delivery in each month to meet the inventory turnover and sales objectives. ‘Additions to stock = Sales (line 2) | Reductions (line 4) + EOM inventory (line 7) — BOM inventory (line 6) “Additions to stock (April) = $27,300-1 6,600 + 68,640 2 98,280 = $4,260 At the beginning of the month, the inventory level equals BOM stock. During the month, merchandise is sold, and various inventory reductions affecting the retail sales level occur, such as markdowns and theft. So the BOM stock minus monthly sales minus reductions equals the EOM stock if nothing is purchased. But something must be purchased to get back up to the forecast EOM stock. The difference between EOM stock if nothing is purchased (BOM stock 2 sales 2 reductions) and the forecast EOM stock is the additions to stock. OPEN-TO-BUY SYSTEM The open-to-buy system is used after the merchandise is purchased and is based on the mer- chandise budget plan or staple merchandise man- agement system. The merchandise management systems discussed previously provide buyers with a plan for purchasing merchandise. The open- to-buy system keeps track of merchandise flows while they are occurring, It keeps a record of how much is actually spent purchasing merchandise each month and how much is left to spend. In the same way that you must keep track of the checks you write, buyers need to keep track of the merchandise they purchase and when it is to be delivered. Without the open-to-buy system keeping 7 : Open-to-buy is like the buyer’s checkbook. It track of merchandise flows, buyers might buy too ,eeps track of how much money has been spent much or too little. Merchandise could be delivered and how much money is left to spend.Managing the Merchandise Planning Process 425 when it isn’t needed and be unavailable when it is needed. Thus, sales and inventory turnover would suffer. For consistency, we will continue with our example of an open-to-buy system using the merchandise budget plan previously discussed. The open-to-buy system is also applicable to staple goods merchandise management systems. a To make the merchandise budget plan successful (i.e., meet the sales, inventory tumover, and GMROI goals for a category), the buyer attempts to buy merchandise in quantities with delivery dates such that the actual EOM stock for a month will be the same as the forecasted EOM stock. For example, at the end of September, which is the end of the spring/summer season, the buyer would like to be completely sold out of spring/summer men’s casual slacks so there will be room for the fall styles. Thus, the buyer would want the projected EOM stock and the actual EOM stock for this fashion and/or seasonal merchandise to both equal zero. Calculating Open-to-Buy for the Current Period I Buyers develop plans indicating how much inventory for the merchandise category will be available at the end of the month. However, these plans might be inaccurate. Shipments might not arrive on time, sales might be greater than expected, and/or reductions (price discounts due to sales) might be less than expected. ‘The open-to-buy is the difference between the planned EOM inventory and the projected EOM. Thus, open-to-buy for a month is: Open-to-buy = Planned EOM inventory — Projected EOM inventory If open-to-buy is positive, then the buyer still has money in the budget to purchase merchandise for that month. If the open-to-buy is negative, then the buyer has overbought, meaning he or she has spent more than was in the budget. The planned EOM inventory is taken from the merchandise budget plan, and the projected EOM inventory is calculated as follows: Projected EOM inventory = Actual BOM inventory + Monthly additions actual ~ (received new merchandise) + On order (merchandise to be delivered) ~ Sales plan (merchandise sold) ~ Monthly reductions plan Exhibit 12-17 presents the six-month open-to-buy for the same category of men’s casual slacks discussed in the fashion merchandise planning section of this chapter. Consider May as the current month. The BOM stock (inventory) actual level is $59,500, but there is no EOM actual inventory yet because the month hasn’t finished. When calculating the open- to-buy for the current month, the projected EOM stock plan comes into play. Think of the projected EOM stock plan as a new and improved estimate of the planned EOM stock from the merchandise budget plan. This new and improved version takes information into account that wasn't available when the merchandise budget plan was made. The formula for projected EOM inventory for the category isete Pee Six-Month Open-to-Buy System Report ewe B [Eou sear [ow Acne [son seexrian [BOW Shek teua Mont adtions Pian Monty sions Aes Projected EOM inventory = Actual BOM inventory $59,500 + Monthly additions actual 7,000 + On order ~ 18,000 — Sales plan~ 15,600 — Monthly reductions plan 2,310 “al $66,590 The open-to-buy for the current month is: Open-to-buy = EOM inventory — Projected FOM plan planned inventory $2,050= $68,640 — $66,590 Therefore, the buyer has $2,050 left to spend in May to reach the planned EOM stock of $68,640. This is a relatively small amount, so we can conclude that the buyer’s plan is right on target. But if the open-to-buy for May were $20,000, the buyer could then go back into the market and look for some great buys. If one of the vendors had too much stock of men’s casual slacks, the buyer might be able to use the $20,000 to pick up some: bargains that could be passed on to customers. If, however, the open-to-buy was a negative $20,000, the buyer would have overspent the budget. Similar to overspending your checkbook, the buyer would have to cut back on spending in future months so the total purchases would be within the merchandise budget. Alteinatively, if the buyer believed that the overspending was justified because of changes in the marketplace, a negotiation could take place between the buyer and the divisional merchandise manager to get more open-to-buy.