Open-To-Buy Retail Planning: How to Plan Inventory Budgets Using the OTB Formula

An open-to-buy plan is a purchasing budget for future inventory orders that a retailer creates for a specific period. It helps a retailer stock the right amount of the right products at the right time by showing the difference between how much inventory is needed and how much is available.

Having a solid handle on your inventory is the best way to guarantee you’ll always have enough stock on hand to meet demand. Excess inventory, or too much of the wrong product, can slow your cash flow and reduce profits, especially if you’re forced to mark items down. It’s this supply and demand imbalance that causes retailers to lose out on an estimated $568.7 billion in out-of-stock items.

At the same time, underbuying a product can result in missed sales opportunities, hurt your profit, and damage the customer experience. When products are out of stock, just 27% of shoppers go to a retailer’s website or return to the store to purchase the item when it becomes available. The majority will look in another store or skip the purchase entirely.

Creating an open-to-buy plan can help retailers decide how much inventory to buy or manufacture while keeping cash flow positive. This guide shares how to create one for your retail store.

 

What is open-to-buy?

Open-to-buy (OTB) is an inventory management strategy that helps retailers calculate how many products they need to buy. This includes physical inventory on hand and in transit, as well as any outstanding orders.

An OTB can be calculated in units or dollars, but is usually calculated in terms of cash, as there are variations in costs between products. OTB plans are also incredibly flexible—apply one to a single product category, a department, or across your entire retail business.

When to use open-to-buy planning

OTB planning is an inventory management practice used by all types of businesses, though it’s especially useful for retailers selling large numbers of SKUs—like fashion and apparel brands. You can plan merchandising budgets for future items based on historical data of how well products in t-shirt, shoes, and purchase categories have sold.

Because of this, some retailers strategically spend only a part of their OTB budget so they can take advantage of special buys. Your manufacturer might give discounts on summer products when the season ends, for example. A higher OTB budget here means you can capitalize on low-cost items in preparation for next summer.

The Charming Bench Company sells garden furniture to customers year-round, yet partner Chris Campbell says the main advantage of an OTB merchandise planning process “is that we can plan on seasonal buying trends.”

“In September and October, we know that pricings for summer patio furniture drop and we can expect an influx of buyers taking advantage of these deals in preparation for when they’ll be enjoying time outside again. We therefore make sure, earlier during the year, that we will have enough stock to meet these demands.”

Now that you have a better grasp of the concept behind an OTB plan, here’s a look at how to calculate OTB, along with definitions of some of the terminology involved.

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The open-to-buy formula

The open-to-buy formula will help you create forecasts for your OTB plan. The values in your open-to-buy are projections, so they may not be perfectly accurate. But a sensible way to check your numbers is if your actual month-end inventory is within 5% of your prediction.

💡 PRO TIP: Ready to leave your spreadsheets behind? To see your ending inventory, view the Month-end inventory snapshot report in Shopify admin.

Here are definitions of terms used in the OTB formula:

  • Planned beginning of month inventory: How much retail inventory (in dollars) you expect to have at the beginning of the month.
  • Planned sales: How much retail sales (in dollars) you forecast during a given month.
  • Planned markdowns: A projection of product markdowns (in dollars).
  • Planned open-to-buy dollars: The dollar amount that you have available to buy more inventory at the end of the month.
  • Planned end-of-month inventory: A forecast of balance inventory (in dollars) at the end of the month. End-of-month inventory carries over to become the beginning-of-month inventory for the next month.

The OTB formula looks like this:

Planned sales
+ planned markdowns
+ planned end of month inventory
– planned beginning of month inventory
= open-to-buy (OTB)

Here’s an example of an open-to-buy plan for a single month:

$15,000 (planned sales)
+ $350 (planned markdowns)
+ $25,000 (planned end of month inventory, October 31)
– $30,000 (planned beginning of month inventory, October 1)
= $10,350 OTB 

How to calculate your open-to-buy at cost

Initial markup (IMU) is the calculation used to determine the retail price of an item in your store. For example, if you have a wallet that costs you $15 to make or to purchase at wholesale, then the IMU is the measurement of how much you mark up the wallet when you sell it to the customer.

If your IMU is 75%, you would use this calculation to determine your retail price: cost or wholesale price / (1 – IMU %) = retail price.

  1. Convert the markup percent into a decimal: 75% = 0.75.
  2. Subtract it from 1 (to get the inverse): 1 – .75 = 0.25.
  3. Divide the wholesale price by 0.25.
  4. The answer is your retail price.

For example: $15 (cost or wholesale price) / (1 – 0.75) = $60 (retail price)

While your initial retail price must cover the cost of the product and the selling expenses that are associated with the item, remember to factor less obvious costs into your retail price. Consider covering a portion of your business’s day-to-day overhead, such as the cost of your website each month and marketing. You want to be left with some profit, right?

To figure out your OTB at cost, multiply the OTB value by the initial markup. If your initial markup is 75%, for example, your open-to-buy at cost is $10,350 x 0.25 = $2,587.50.

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The benefits of open-to-buy planning

Optimal stock levels

Managing inventory is one of the biggest challenges for retailers of all sizes. There’s a sweet spot between:

  1. Having too much inventory. With too much inventory, you lose money by keeping items in expensive storage or distribution centers—or worse, they become unsellable if they’re kept in storage too long. A food retailer that has unsold meat sitting in storage for two months is a recipe for disaster.
  2. Having too little inventory. “Sorry, this product is out of stock” is a phrase you never want your retail team to have to say to customers. But inventory shortages happen, with complete stockouts costing retailers $1 trillion every year.

OTB planning, however, helps retailers find the middle ground between bloated and sparse inventory levels. You’ll know exactly how much inventory you have and how much you’ll need for the upcoming period, giving you a clear budget to spend on purchase orders for new products.

If you have more inventory than you need, you are wasting money, space, and personnel dedicated to caring for that inventory. If you have variation, inventory can end up lost, damaged, or hidden, which can result in less stock and unsatisfied customers.

More flexible inventory

Unlike quarterly or yearly inventory replenishment, most retailers do their OTB planning on a monthly or weekly basis. Your budget will change accordingly, giving you the flexibility to order more (or less) inventory on any given week or month.

Let’s put that into practice and say you’re planning to do a last-minute pop-up shop in your local area next month. You’ve already done your quarterly inventory planning without factoring in the extra stock you hope to sell at the event. By doing an OTB plan the month prior, you know exactly how much inventory you need to order—both in terms of SKU quantities and the dollar amount you have to spend.

Identify trends

When managing inventory, it’s safe to assume that there’s always more than meets the eye. What seems like an obvious trend isn’t always as accurate as you might think.

We can see this in action with fashion retail stores. It’s obvious t-shirt sales would spike just before summer, right? But OTB planning research shows that trend starts to accelerate earlier than you’d expected—throughout April you see increased t-shirt sales.

Going without an OTB plan altogether means you’d get to April and not have enough inventory to cater to the shoppers buying t-shirts earlier than expected.

Not only that, but creating an OTB plan factors in sales and promotions. Retailers lose $40.2 billion when their marketing departments don’t communicate upcoming sales or promotions with their supply chain team. Inventory falls short; customer experiences are ruined. Shoppers don’t get the amazing deals they were promised if there’s no stock available to buy.

OTB planning takes all of those factors into account. You’ll see upcoming flash sales and year-round seasonal patterns, like Black Friday and Cyber Monday, when planning your inventory budget. The result? No stockouts during peak sales seasons.

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Prevent overspending

OTB not only helps you better plan inventory purchases, but it’s also a financial budget that can help you tighten your belt.

For example, you might have a total of $100,000 tied up currently in your retail inventory. Creating an OTB plan can help you carefully manage retail merchandise across your business for the year. As a result, this kind of planning can help you find “slack” in your inventory investment budget. Even a 10% cost-savings in this example means you’d have an extra $10,000 to invest elsewhere.

The limitations of open-to-buy

It’s not ideal for staple items

Staple items are products that customers rely on your store to stock. A grocery store’s staple items are bread, milk, and eggs. Staple items for a brick-and-mortar store selling home decor might be the plush throws you’re known for.

Regardless of what these staples are, it’s important to have them well-stocked at all times. OTB planning may not be the best method for staple items, since there’s a risk of losing order quantity discounts. Buying $300 worth of bestselling inventory every month won’t give you a volume discount. A $2,000 order every six months might.

The supply chain industry is also in limbo. Shipping containers are gridlocked and there’s a shortage of HGV drivers in some countries. Ordering your inventory one month in advance—using OTB planning—leaves you exposed to risk. Should something go wrong, you don’t have much time to fix it before shoppers visit your store for staple items and leave empty-handed.

Inventory budget should be set well in advance, as inventory purchasing should begin no later than one month prior to opening to account for potential shipping delays and merchandising needs adequately.

It needs to be supplemented with other metrics

An OTB retail plan takes only six metrics into consideration. However, inventory management and financial planning is like a machine with several cogs. You might run into problems if you’re not looking at the bigger picture.

Supplement your OTB plan with other metrics that could impact those you’re using in the OTB formula. That includes:

  • Order cycle time. Also known as lead time, this shows how long it takes for a product to be acquired, manufactured, shipped, and sold. OTB planning isn’t the best budgeting method for inventory with longer order cycles because of its short-term forecasts.
  • Inventory carrying costs. How much does it cost to keep your inventory in storage? If your planned end-of-month inventory is costing $3,000 to store but is only worth $3,500 in sales, consider cutting down your OTB budget.
  • Demand forecast accuracy. You have sales data to go off when predicting future sales. But unpredictable and unavoidable things happen (take COVID as the most extreme example). When OTB planning, look back over previous predictions to see how accurate your forecasts were.
  • Inventory shrinkagePlanned and predicted inventory are totally different from your actual inventory count. Stock can go missing for many reasons, including employee theft, return fraud, or admin errors. OTB planning doesn’t take shrinkage into consideration, meaning your predictions could be inaccurate.

How to create your own open-to-buy plan

Ready to create an OTB plan for upcoming stock replenishment? Here’s how to set an OTB budget that works for your retail store.

1. Know your inventory turnover

Part of creating an OTB budget involves planning inventory turnover—a calculation that measures how fast you sell through inventory and need to replace it. The quicker a retailer “turns” its inventory, the more it will need to buy or make in a year.

Calculate your inventory turnover using the following formula: Sales / inventory = turnover rate.

For example, if you sold $50,000 worth of product and had $25,000 worth of inventory, then your inventory turn would be $50,000 / $25,000 = 2. You turned over your inventory two times during the given time period.

Most retailers don’t set turns at the same level for every product or category, since it’s common for products to sell at different speeds. With the right open-to-buy plan, you can manage your product categories and stock levels by planning inventory turns for each.

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2. Run the financials

OTB planning doesn’t have to be anything complex. Many small- to medium-sized retailers plan their OTB month-to-month, but for businesses with high spikes in seasonal sales, try creating a weekly OTB plan.

You can start by creating a six-month open-to-buy plan in a spreadsheet. For each product you’re forecasting inventory budgets for, add the following rows for each month or week:

  • Planned sales
  • Planned markdowns
  • Planned end of month inventory
  • Planned beginning of month inventory
  • OTB dollars

Take this financial planning off your plate with open-to-buy software like Inventory Planner. The app pulls your Shopify ecommerce and POS data to forecast inventory and create budgets for restocks.

3. Sense-check your predictions

Over time, you’ll learn and adapt your OTB plan each season or year based on your unique business’ sales and markdown history. But regardless of which method you chose, make sure you carefully review each number and ask yourself if it’s realistic before you put your retail OTB plan into operation.

Example open-to-buy plan

Unsure what an OTB plan looks like? Alexis Damen shares an example OTB plan a fashion retailer might use over the Christmas period.

Peak shopping months—December and January—have higher planned sales, hence why the OTB budget for those months is higher. February’s OTB budget is even higher to account for depleted inventory in the months prior.

Six month OTB plan

Using open-to-buy planning for your retail store

Each year, countless retailers have to close up shop due to mismanaged inventory.

Use an OTB plan to stop going under or over budget. Know your inventory turnover, run the formula, and sense-check any predictions by comparing them against previous sales data. It’s a great starting point to creating accurate retail merchandise budgets.

Article source: https://www.shopify.com/retail/open-to-buy-plans