David Brown: Know Your Hidden Costs

Is your Inventory a Worthwhile Investment?

BY DAVID BROWN

Published in the November 2013 issue.

It’s an old stumbling block for many a jeweler. Surplus product and too many slow moving items is one of the biggest financial drains that jewelers have to deal with. Many know it is costing them money, but do most jewelers understand the true cost? In this article we’ll work out what that inventory is really costing you.

Let’s look at the case of Bob (not his real name). Bob’s store is turning over $1 million a year in sales with inventory of $800,000. Given a keystone markup (50 percent margin) we know that Bob’s $1M is costing him $500,000 a year in cost of sales ($1M x 50 percent). His stock turn therefore is less than 1 ($500,000 ÷ $800,000) and in fact comes in at only 0.625 which means for every $1 in inventory he holds he only sells 62.5 cents a year.

How does this compare? Bob should be able to achieve a stock turn on 1.5 times a year on the product he holds (and quick look at his inventory shows 70 percent of his product is sitting in the 36 month and older column!). If he was able to achieve this, he would need only $333,000 of inventory ($500,000 ÷ 1.5) to make $1 million in sales. Bob is carrying $467,000 of inventory he doesn’t need ($800,000 – $333,000)!

Is this a little simplistic? No, because we know other people are able to do this so why shouldn’t Bob? This extra “investment” in old product is achieving nothing other than draining cash — and he needn’t claim it’s his retirement plan … anyone looking at buying his business would be unwilling to pay him anything for this surplus product that doesn’t even sell.

Plus this doesn’t take into account the annual cost of holding this inventory. What is the true cost of a $100 item if it is sitting on your shelf 12 months later?

Let’s look first at the one-off costs at time of purchase. There is freight to get it in-store, computer processing, time spent selecting the piece and time spent getting it displayed in the store. Let’s allow $5 for freight and another $10 for staff and your time in selecting the piece, processing it in-store and getting it on display.

Vendor cost: $100

Staff time: $10

Freight: $5

Initial costs: $115

On top of this we have holding costs for the 12 months. Let’s use 5 percent interest for the year (although in more prosperous trading times this would be closer to 10 percent). In addition we have the time spent cleaning and showing the piece during the 12-month period even though it hasn’t sold plus insurance, a percentage of rent, advertising, boxing, the tax you had to pay on it given that you diverted “profit” to purchase it … and so on.

Interest: $5 Staff cleaning and other costs: $10

NOTE: Most industry experts agree the “holding cost” associated with non-performing inventory is a minimum of 20 percent a year and could be as high as 35 percent.

If he was able to do this, he would need only $333,000 to make $1 million in sales. Bob is carrying $467,000 of stock he doesn’t need!

So what could you do with a spare $467,000? The college fund would be looking extremely healthy, so would the debt column (or lack of). You could be enjoying that trip to Europe you’d always planned, or upgrading the house and car.

If you were offered $467,000 in lottery winnings tomorrow, would you turn it down? Yet every day we see jewelers making the decision to not take the money that’s lying on the table.

Do yourself a favor and start cashing up that old product today.

If he was able to do this, he would need only $333,000 to make $1 million in sales. Bob is carrying $467,000 of stock he doesn’t need!