What’s the lifeblood of a retail store? Is it the location? The products? The in-store experience?
Those are all important, but the winner is cash flow.
Your retail store is in for a terrible fate without positive cash flow. The key to success in this area is ensuring optimal stock levels. Too much inventory means you have to be aggressive with markdowns, while too little inventory means leaving sales on the table. Neither extreme is great for business, so what’s the solution?
Enter the open-to-buy (OTB) strategy for inventory management.
We’ll walk you through everything related to OTB: defining it, why it’s important, the general OTB formula, and how to implement it in your business.
We’ll also show you how, if your point of sale (POS) system has the right capabilities, it can help you implement an OTB strategy. Let’s get started!
OTB Meaning: Defining Open-to-Buy and Its Importance to Retailers
If you're in the retail industry, you've likely heard the term "open-to-buy" or "OTB" thrown around. But what exactly does it mean, and why is it so crucial for your business? Let's break it down.
Open-to-buy refers to the amount of money a retailer has available to purchase new inventory during a specific period while maintaining its desired inventory levels and meeting sales goals. This budgeting tool helps determine how much you can safely spend on new products without overstocking or running out of cash.
Is OTB relevant to your business? The answer, for any retailer, is yes. Whether you’re running a small boutique or a chain of businesses, understanding open-to-buy is critical to managing your inventory and keeping your bottom line healthy.
Related Read: 5 Essential Inventory Management Software Features
You need to strike the right balance. If you don't order enough inventory, you risk missing out on potential sales and disappointing customers who can't find what they want. On the flip side, if you order too much, you could end up with dead stock that ties up your cash flow and takes up valuable shelf space.
By leveraging open-to-buy, you can make informed purchasing decisions and maintain optimal inventory levels. This helps you avoid over or under-ordering, keeping your cash flow positive and your business thriving.
Related Read: 8 Ways To Make the Most of Your Retail POS Data
Let’s dive into OTB, the formula to calculate it, and its benefits.
The OTB Formula
If you want to use OTB for your business, you need to understand how to calculate it. Let’s examine the key components of the OTB formula and see how they fit together.
The Numbers You Need
Before you can put the OTB formula to work, you'll need to gather a few essential numbers:
- Planned beginning of month inventory: The inventory value you expect to have on hand at the start of the month.
- Planned sales: The total sales you anticipate making during the month.
- Planned markdowns: Any discounts or price reductions you plan to offer throughout the month.
- Planned open-to-buy dollars: The amount of money you have available to spend on new inventory.
- Planned end-of-month inventory: The inventory value you expect to have left at the end of the month.
Putting It All Together
Now that you have your numbers ready, it's time to plug them into the OTB formula:
(Planned Sales+Planned Markdowns+Planned end of month inventory)-Beginning of month inventory) = OTB
You'll arrive at your open-to-buy figure by adding up your planned sales, markdowns, and end-of-month inventory, then subtracting your beginning-of-month inventory. This number represents the amount of money you can safely spend on new merchandise without running out of funds.
A Real-World Example
Let's say you're planning for the month of May. Here's how your numbers might look:
- $10,000 (planned sales)
- $200 (planned markdowns)
- $25,000 (planned end-of-month inventory, May 31)
- $30,000 (beginning of month inventory, May 1)
($10,000+$200+$25,000)-$30,000 =$5,200 OTB
In this scenario, you have $5,200 to spend on new inventory for May. You can confidently place orders with your suppliers, knowing you're staying within your budget and keeping your cash flow healthy.
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4 Benefits of Using OTB in Your Retail Business
Incorporating open-to-buy into your retail inventory management strategy can be a game-changer for your business. This tool offers a range of benefits to optimize your stock levels, improve your cash flow, and inform purchasing decisions. Let's explore four key advantages of using OTB in your store:
- Identify ideal stock levels: One of the primary benefits of OTB is that it helps you determine your business's ideal stock levels. By considering your planned sales, markdowns, and inventory targets, OTB gives you a clear picture of how much merchandise you should have on hand at any given time.
- Inventory flexibility: Another advantage of using OTB is that it gives you greater flexibility in managing your inventory. By knowing exactly how much you can afford to spend on new merchandise, you can quickly adapt to changes in customer demand or market trends.
- Uncover opportunities and trends: OTB can also be a valuable tool for uncovering trends and opportunities in your sales data and inventory KPIs. Comparing your actual sales and inventory levels to your planned figures helps you identify areas where you're over- or under-performing.
- Improve cash flow: One of the most significant benefits is that it helps you limit overspending and improve your cash flow. By setting clear boundaries on your purchasing budget, OTB ensures you keep up only a little capital in excess inventory.
A Word of Caution:
While OTB is a powerful tool for retail inventory management, it's important to remember that it's not a comprehensive solution. OTB only considers a few key metrics like planned sales, markdowns, and inventory levels. To get a complete picture of your business's health, consider various factors like customer behavior, market trends, and the competitive landscape.
Related Read: Cost to Revenue Ratio [Definition, Importance, and What's a Good or Bad Ratio?]
Applying an OTB Approach to Your Business
With a little planning and a commitment to consistency, you can implement an OTB approach. Here’s how.
Running OTB calculations monthly is a good starting point for most small and medium-sized retailers. This practice allows you to adjust your purchasing decisions based on the latest sales data and retail inventory levels without getting bogged down in your business' day-to-day fluctuations.
However, let’s say your store has high seasonal sales spikes, like during the holiday shopping season or summer months. In that case, you may want to consider running your OTB calculations on a week-to-week basis. This more granular approach helps you stay on top of rapidly changing demand and ensures you have the right products in stock when your customers need them.
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Another key component of an effective OTB approach is running your financials regularly. The more granular you get with your financial analysis, the more accurate your OTB budget will be.
For example, instead of running your OTB calculations on a month-to-month basis for all of your stores combined, consider breaking it down by week and by individual store location.
Similarly, analyzing your sales and inventory data at the lowest product sub-category or SKU level can provide valuable insights into which products are driving your business and which ones may be dragging you down.
Last, remember that an OTB approach is not a set-it-and-forget-it solution. Countless factors can impact your OTB plan, from changes in consumer behavior to shifts in the competitive landscape. To stay ahead of the curve, you'll need to revisit and revise your OTB budgeting process on a regular basis, adapting your strategy as needed.
Your POS System Can Help With OTB Planning
Mastering open-to-buy (OTB) planning can be a game-changer for retailers, but it's not always easy to implement. You need accurate and detailed sales reporting to make informed decisions and stay on top of your inventory management.
Without the right tools, this process will be nearly impossible. The most important tool you need to manage inventory and your OTB process is a strong point of sale solution.
A robust POS system can provide all the numbers and metrics you need to create a winning OTB strategy, including:
- Planned beginning of month inventory
- Planned sales
- Planned markdowns
- Planned open-to-buy dollars
- Planned end-of-month inventory
- Inventory turnover
- Demand forecasts
That's where POS Nation comes in. Our cutting-edge POS system is designed to shoulder the load in an OTB inventory management strategy, giving you the tools to make smart, data-driven decisions. With comprehensive sales reporting, analysis, and forecasting at your fingertips, you can optimize your inventory levels, reduce dead stock, and keep your cash flow healthy.
Schedule a demo of POS Nation today to see how our solution can help make implementing OTB practices in your retail store a breeze.
