SETTING YOUR INVENTORY at the right level is critical to profitability and liquidity.
I set up QuickBooks for many stores, so I see how they are run and the mistakes they make. For example, I recently worked with a store that has sales of about $2.5 million, and in their checking account they always have a bit over $500,000. Another store does over 10 million in sales and also has $500,000 in their bank account.
Then there’s a store doing $1 million with two owners. They complain that their bench jeweler is paid more than the two owners, which was about $45,000 each partner. Own a store, operate with the headaches, and their pay is about the same as an employee.
What do these stores have in common? Their inventory levels dictate their cash flow.
Unfortunately, many of today’s store owners once worked in a store where that owner ran the store starting in the 1960s or 1970s, and they follow their old advice. But if you could look at the P&L statement of these stores back then, you’d see their gross profit margin was easily 60 to 75 percent. When you have these high margins, you can afford to overbuy inventory. Today, most stores’ gross profit margins are 42 percent to 50 percent.
Here’s the solution: The amount of inventory you should keep in stock is about equal to your gross profit dollars in selling stock.
For example, if your product sales from the showcase (without memo and consignment) last year were $750,000 and the gross profit was $352,500 (a 47 percent margin), then the amount of inventory you should have on hand is about $350,000. The amount of “leeway” of this number is maybe 20 percent above (or $420,000) at most.
If this store has $750,000 in inventory at cost, it’s easy to look at their financials and see how this affects them. They have about $375,000 to $400,000 too much inventory.
Look at the store’s total debt by adding accounts payable, credit card debt and bank loans (other than for buying equipment). You’ll see total debt is about $200,000 to $300,000, and it’s all because of having more inventory than the store can sell in a year.
The store with the two owners who make $45,000 each? If they unloaded old inventory, they could almost double their pay.
As for the other two stores, the $2.5 million store has a gross profit margin of about 52 percent but manages inventory very well. The other store doing over $10 million has a gross profit margin of about 47 percent but way too much inventory. Every time they sell one item, they buy more than one more.
The secret to low debt and a bigger bank account is inventory level should be equal to about gross profit dollars for the past 12 months.