Breaking in With an Ax, Target, and Inventory Turnover Ratios
It had been 30 minutes, and I still couldn’t get the bedroom door opened.
The doorknob was old, and now it wouldn’t turn. I took the doorknob off and saw that the mechanism inside had broken. Tried prying the metal parts out- no luck.
I was sweating, my hands were covered with grease, and I needed to shower and get to work. I looked at my dog, Collette, and we both had the same idea…
Break open the door with an ax.
I whacked at the area around the doorknob until it dropped on the floor. Swept up the wood pieces, looked at Collette again, and went about my day.
So, I’m in the market for a new door- and a doorknob. Since I’m the least-mechanical person I know, I’ll have Home Depot install it for me.
There’s a line I love from the movie Raising Arizona: “Crazy world- they oughta sell tickets.”
It’s been a crazy world for retailers since the pandemic started. Some retailers had sales blow through the roof during the pandemic, only to see interest crash once we could leave home.
Peloton is an example. I have two friends who bought Peloton bikes, still paying the monthly fees- and are back at the gym and not using the bikes at all.
A look at October Retail Sales
The AP reports on October ’23 retail sales:
“Americans cut back on retail spending in October, ending six straight months of gains, though the decline was partly driven by falling prices for both gasoline and cars.
Retail sales fell 0.1% last month after jumping a strong 0.9% in September, according to a report released Wednesday by the Commerce Department.”
Some retailers are thriving, some struggling. So what happened at Target?
How a well-managed retailer performs: Target
Target did a several things right, based on the 3rd quarter earnings release:
Making more on each dollar of sales: “Operating income margin rate of 5.2 percent was 1.3 percentage points higher than last year, driven by a higher gross margin rate.”
Careful decisions about inventory levels: “Third quarter GAAP and Adjusted EPS of $2.10 was 36 percent higher than a year ago and above the high end of the Company's guidance range, reflecting disciplined inventory and expense management.”
Disciplined inventory management…let’s talk about that.
It may sound odd, but smart inventory management is about bringing in cash faster.
Here’s why
Understanding inventory turnover ratios
The inventory turnover ratio can be calculated using several methods- I like this formula:
Sales ÷ Average Inventory for the period (month or year)
By “average”, we mean
(Beginning inventory + ending inventory)/ 2
Here’s an example:
If annual sales at Rugged Outdoor Gear total $100,000, and the average inventory balance is $25,000, the inventory turnover ratio is:
$100,000 ÷ $25,000 = 4
This means the company sells (turns over) its entire inventory four times a year. Imagine emptying the shelves and restocking them four times a year.
Rugged can then figure out how many days, on average, inventory is on the shelf by dividing 365 by 4.
365 ÷ 4 = 91.25, or roughly 3 months. Is that good, bad? It depends on your industry.
Here’s the point: The faster you can turnover inventory, the faster you collect cash.
If Rugged could generate $200,000 in sales on $25,000 in average inventory, the turnover ratio is ($200,000 ÷ $25,000), or 8 times.
Same $25,000 investment in inventory- double the sales (and double the cash inflows).
The Lesson
Managing inventory is about two things: minimizing your investment in inventory and driving more sales for every dollar of inventory on the shelf. It generates a ton more cash- which is critically important for business operations.