This month, we want to talk about two KPIs (Key Performance Indicators) - mark-up and stock turn which combined produces your Return on Investment (ROI). This is a measure of how much you get back for every $100 invested in stock. It is a multiplier of mark-up and stock turn – in other words, how much profit you make on each item you sell, times how often you can sell it.
ROI is an important measurement for any business as it determines how effective your investment has been. In the same way that interest rate per annum measures how effective your money has been performing for you at the bank, ROI determines how effective your money has been performing invested in inventory for your store. An ROI of 200 means the owner has generated $200 of gross profit for every $100 invested in stock.
In the US, the average ROI across the stores we measure is 70, or a return of $70 for every $100 invested in inventory. This is calculated by multiplying the mark-up by the stock turn. For an average store achieving a mark up of keystone, or 100%, this would indicate that they are achieving a stock turn of 0.7 times per year to achieve this ROI - 100% x 0.7 Stock turn = 70 ROI. The stock turn measures how often an item sells –a stock turn of 1 means every item in the shop is selling, on average, once per year. Of course some items will sell three or four times while others won’t sell at all. A stock turn of 0.70 as measured above means, on average, seven out of ten items are selling once, and the other three don’t sell at all.
Why is stock turn so important? In a nutshell it comes back to maximizing your resources. If you can achieve a good stock turn then it means the business can grow and achieve better profits without the cost of investing more capital in more inventory. If you double your stock turn, while maintaining your margin, you are effectively doubling your sales.
“Many stores will often cite a lack of capital as a reason for restricting growth, but often it’s poor management of capital that is the real problem. Better management of the existing capital, and in particular the investment in inventory, can yield a much better return for the business.”
Is an ROI of 70 good? In a word – no. Sadly this is an average for the US which indicates far too many stores are not utilizing funds effectively in their business – creating unnecessary cash flow pressures for themselves by carrying too much inventory, or applying too little mark up. Successful stores are able to achieve ROI’s of 200 or more, often combining mark ups of 130% plus with a stock turn of 1.5 times or better. A business achieving these sorts of returns can expect to have a more profitable business or less money invested in inventory. If you currently hold $500,000 of inventory on hand, and are achieving a stock turn of 0.70, then realistically you could be achieving the same sales and profit with half that inventory level. That’s $250,000 you could be using to pay off debt, buy a new home, or invest. Would you put $250,000 into a bank account for ten years that pays you no interest? Then why do it with your business?
There is more than one way to achieve a Return on Investment. Two stores may achieve an ROI of 200 in the following way:
Store 1: 150% mark-up x 1.3 stock turn = 200 ROI
Store 2: 100% mark-up x 2 stock turn = 200 ROI
Again the key to using this information each month is to compare it to your own store’s performance in each area and to identify opportunities. For example, let’s say your store was doing a 0.70 stock turn in line with the industry average but your mark-up was only 90% compared to the average above of 100%.
Your Store: 0.70 x 90% = 63 ROI
Average Store: 0.70 x 100% = 70 ROI
Comparing your store to one achieving the industry average you would be generating an annual gross profit of $252,000 with a $400,000 stock investment ($400,000 x 0.70 x 90%). The average store with the same stockholding would be generating $280,000 in annual gross profit ($200,000 x 0.70 x 100%), an improvement to the bottom line of $28,000. The same scenario would apply if you were achieving the industry mark-up but had a lower stock turn – an improvement in stock turn will put more money onto that bottom line.
How do you achieve a better mark-up or stock turn?
Improving your mark-up can be very simple. You just have to ask for it. By putting more mark-up on your inventory and by controlling your purchasing so your inventory reflects the level you need to achieve sales.
Improving your stock turn can come down to simply expecting more from the inventory you have. Inventory needs to be managed. You need to reduce and remove those items that don’t sell and make sure you reorder those that do. Carrying too much inventory doesn’t automatically generate more sales –in fact it can cost you sales if the old bloated inventory is stopping your customers from seeing the better pieces you have to offer. Nothing puts customers off more than a window or cabinet jammed packed with items. They often can’t see that special piece amongst the assortment of other items crammed alongside. If you have a stock turn of less than 1 then it is almost certain that you have more money tied up in inventory than you need.
Now’s the time for a New Years resolution. Make a decision today that your inventory and mark ups are on the payroll too, and that they need to be working for your business just as hard as you do.