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Improving Cash Flow

Ted Hurlbut on Product Sourcing Radio

On October 8, 2007, Ted Hurlbut appeared on Product Sourcing Radio to discuss ways an ebusiness, as well as all independent retailers can improve cash flow. Here's a transcript of Ted's appearance, or if you'd like to listen to the interview click on the link below.

Segment One

Colette: Thanks for joining us today. I’m Colette Marshall, Business Development Manager for Worldwide Brands, and I’m filling in for both Chris Malta and Robin Cowie today. Part of successful product sourcing is understanding how much inventory to source and how often. A lack of inventory planning will result in surplus merchandise, forced discounts, and lost profits. Today we’re talking to Ted Hurlbut, Principal of Hurlbut and Associates, who will be sharing some of the good practices he’s learned in his more than 25 years of experience in inventory management.

Colette: Ted, welcome to the show.

Ted: Thank you for asking me to be on the program.

Colette: It’s wonderful to have you on. We know inventory management for our customers as soon as many online retailers out there is a big concern and it’s something online retailers should really understand. How significant an issue is inventory management?

Ted: If you think about the structure of a business and you even think of it from a financial perspective in terms of a balance sheet, inventory is the biggest asset. It ties up the biggest chunk of cash. It tends to consume cash very easily. Inventory is also what I call the active asset. Amongst all the other assets that an ebusiness may have inventory is going to be the one that generates the sales, that generates the gross margin dollars, that generates the profit. And also when an ebusiness company gets into trouble it oftentimes is what the source of the trouble is, the trouble being that cash starts to get tight. And oftentimes when cash is tight you see situations where there simply is too much inventory and it’s robbing a business of the flexibility that it needs financially, but also operationally, to do the things that it needs to do to grow the business.

Colette: That’s such a great point, and I’m sure there are many retailers out there who could definitely benefit from learning a little bit more about inventory management. Many may think that inventory is a good thing, however. They might say you can’t do business without it. But you seem to be saying that too much inventory is a bad thing.

Ted: Absolutely. It ties up a lot of cash, like I mentioned, but it also starts to erode a lot of other business fundamentals. Too much inventory, when it hangs around and gets shop worn, and starts to run up against the end of a particular selling season only leads to increased markdowns. And markdowns really rob an ebusiness of gross margin dollars. Gross margin dollars are those critical dollars that are needed to pay the bills and to grow the business. But there is a longer term, more insidious impact as well, and that is that it begins to destroy price integrity and it robs customers of a sense of urgency about the business. Customers are pretty smart and they come to understand that when there’s a lot of inventory and they see a lot of markdown activity, that inventory is not going anywhere and they learn in your business that they don’t need to respond immediately, that if they wait you out the price will come down. And what you end up doing is trading earlier fuller margin sales for later markdown sales where you may be selling the unit, but you’re not selling the unit and getting as much cash for that unit as you might have otherwise earlier. Inventory is what I call a necessary evil. In any ebusiness or retailing environment you’ve got to have it to do business, unless you can find some way to drop ship everything directly from your manufacturers, which in most cases is not workable, but too much of it can really begin to erode business fundamentals as time goes along.

Colette: Right. This is also, for the retailers out there listening, market research is key. When you identify what kind of products to sell, getting an idea of how fast that product is going to sell will give you an idea of how to control your inventory so you don’t have issues of inventory turnover and always consider that gross margin.

Ted: Mm-Hmm.

Colette: What are some of the critical tools a retailer needs for managing inventory?

Ted: In working with my clients the two basics that I like to make sure are in place are a cash flow plan and an open to buy plan. The reason that somebody might call me and ask for assistance is they’re finding that their inventory is getting heavy or their markdowns are getting to be a little bit out of control, or perhaps even they are tight with cash. But it all starts with cash. As I said earlier, inventory chews up such a large portion of a retail or ebusiness asset base, so it’s important to understand what’s going on with that cash. And a cash flow plan takes into the big picture of the business not just the inventory, but all of the other things that are going on from a cash perspective. And then the open to buy really is managing a subset of that cash flow, it’s managing the expenditures that a business is making for inventory.

Colette: So can you expand on that a little bit more?

Ted: Let’s talk a little bit more in-depth about a cash flow plan, because I really do think it’s pretty critical. A cash flow plan is basically a rolling budget, sometimes it’s called a roll forward budget, where you have a starting cash balance, you know what your planned receipts are, that’s the form of cash coming into the business through sales, and you’ve got budgets set up for all of the expenditures, whether it’s expenditures to pay for product, if there’s payroll involved, any utilities, if you’ve got a bricks-and-mortar presence, or any other expenditures associated with the business. And at the end of the month, or a week in some larger organizations, you’ve got a projected cash flow balance. And in the course of creating a cash flow plan on a monthly basis you can go through and see exactly where your projected shortfalls are, where your expenditures are, and you’ve also established on a monthly basis a series of benchmarks so as you go forward you have a means of measuring where you are falling short, where you are making your budget, you have a means of where you are going to fall short in some months, and that specific action is necessary to get you back on plan.

Colette: That’s such a great point. That’s where you can identify times of the year where you can maybe change what you’re selling on your ecommerce site, because that sells better in that time of the year and you need that to be able to get more cash flow going for you because you’ve identified that is a critical time.

Ted: For people that are selling on the web running an ebusiness inventory is even a greater percentage of the overall operating budget. So oftentimes when the cash flow plan is not coming in, when they’re deviating from the plan, it’s because the expenditures for inventory are breaking plan. And a cash flow plan is one tool for quickly identifying that the payables for the inventory is getting a little bit out of control. And there are different things that can be done, but you can quickly identify if you need to try to negotiate some extended terms or that you’ve actually got to cut back. The open to buy plan helps you identify that you’re getting too much inventory in and specifically where that inventory is getting a bit heavy, but from a cash flow perspective it helps you manage the payables piece of that, that portion that you actually have to pay back to vendors, and identifies that in a short term situation if things are getting a little bit tight or even if you’re projecting a negative cash flow position in a month or two, it tells you that you need, at an early point when you have the most leverage with your vendors, too push back on them and try to get some extended terms, extended dating, whatever it might be, in order to get yourself back into an appropriate cash position.

Colette: You mentioned again open to buy. Can you go into a little bit more detail on how this works?

Ted: It’s a very, very important tool. At a high level, an open to buy is something that’s specifically related to retail merchandise. It’s something that specifically addresses the needs of retailers. It’s a budget that starts with a planning process and it’s future oriented and it provides guidance on how much to buy and like any good budget it provides benchmarks. And it is a financial tool. Oftentimes open to buys are done in retail dollars as the unit of measure. Very rarely do you see it in terms of actual selling units. Sometimes you see it in cost dollars. But most of the time it’s in the retail dollars. And because it is a financial budget it does relate back, not necessarily directly, but indirectly, to a cash flow plan and to the financial performance of the company. And it’s also something that’s flexible. An open to buy typically is maintained at a department classification or sub-classification level.

Colette: I definitely would love to come back on this, so please keep that thought. It is time for a break. Subscribe to our free product sourcing newsletter at ProductSourcingNews.com to stay up to date with the latest product sourcing news, check for upcoming tradeshows in your area, and find spotlighted suppliers you can use in your ebiz. We’ll continue learning more with Ted Hurlbut when we return. I’m Colette Marshall.

Segment Two

Colette: Today we’re taking a closer look at managing your ebusiness inventory with Ted Hurlbut, Principal of www.HurlbutAssociates.com.

Colette: Ted, right before the break you were talking about open to buy and how this is a great tool that’s designed to assist retailers in managing and replenishing their inventory investment. This I giving them the ability to decide when is it better to order more product, when they need to do less, and be able to manage that cash flow. Can you go into a little bit more about open to buy, continuing where you left off?

Ted: Sure. Quickly to recap the initial points that I made, an open to buy is something that is used to assist in managing and replenishing inventory. It’s a budget, therefore it has a financial base, and it’s flexible because it can be used to track at a department, a classification, or a sub-classification for a retailer. And as it relates specifically to ebusiness, I think there is an important point to be made here, and that is that category management, even on an ebusiness level, is very important. It’s not necessarily on an item-by-item basis. As ebusiness entrepreneurs are establishing websites on the web they are developing a brand identification from a consumer’s perspective and it’s important to understand that from a consumer’s perspective. Consumers come to expect that certain products, certain categories of merchandise, are going to be available at that website. So it may not be that they’re necessarily looking for specific items, but they are there because they recognize that’s a place to go for dresses or curtains or whatever the product category may be. So the concept of category management and segmenting your business into those critical categories and managing your inventory by those classifications is just as valid for an ebusiness as it is for a bricks-and-mortar retailer. How does an open to buy work? Well, like any budget it starts with a plan. Planning is the first critical step and one of the things I like to say is those that take the time to do the planning are going to find that they’re far more successful than those that don’t. Oftentimes, especially in smaller operations, there’s a sense that there isn’t time to plan or planning is not as important, but it is just as important. And an open to buy, to really make it work, has to start with planning. The first thing you want to plan is sales and in most cases you’re planning sales by month. And the critical question is, what’s the most likely level of sales we’re going to achieve by month? And there’s an important point here, because I said what is the most likely level of sales. What you’re really asking is what’s the level of sales that has the highest probability of occurring. So let’s say my answer is 100. That doesn’t mean that I might not sell 99 or 98 or 101 or 102, but the most likely level is 100. I could also sell 110.

Colette: Ted, do you mean the level of sales for that category or the level of sales overall?

Ted: That’s an important question. If you are, in fact, breaking down the open to buy into a given category, then that question would be asked at that category level. So the planning you’re doing is at that level that you’ve broken your business down into. So let’s say your business is made up by ten discrete categories that you’ve identified, you’re going to want to plan each of those categories.

Colette: So in other words, make an open to buy type scenario for each of those categories.

Ted: Correct.

Colette: Okay.

Ted: So the beginning of the process is what’s the most likely that I’m going to sell. Not the most that I possibly could sell, but what’s the most likely level of sales to be for that period of time.

Colette: I nice conservative number.

Ted: Well, again, most likely. What’s the highest probability. Oftentimes retailers and ebusiness get in trouble because they focus on what’s the most I possibly could sell.

Colette: I see. It is time for another short break. We have a lot more to talk about with Ted Hurlbut when we return. Go to ProductSourcingShow.com to listen to any of our past shows, read written transcripts, and more. I’m Colette Marshall. We’ll be right back.

Segment Three

Colette: We’re speaking with Ted Hurlbut of HurlbutAssociates.com about good practices in inventory planning.

Colette: Ted, you were mentioning about building a sales plan and the first question you have to ask is what’s the most likely level of sales from stock, excluding special orders, by month? And then once you’ve done that, what is the next step in developing your open to buy plan?

Ted: The next piece of it, Colette, is to determine an inventory plan by month for each of the categories that you’re planning. The critical question to ask is how much inventory do I need at the end of each month to support the next month’s level of sales that I planned. In some cases you may need to have a little bit more than one month forward, you may want to plan for the next couple of months of sales. But the critical question is how much inventory do I need at the end of each month to support the future sales? And then from there you’re able to determine how much inventory receipts you need to bring in, what your level of receipts are. If you know what your beginning inventory for a given period is, for instance, and you know what you expect to sell in that period and you know what you want to end with in that period, you can from there calculate how much you need to bring in to support those sales and support that ending inventory. And that’s the critical thing that we’re trying to get to. Many smaller independent retailers, ebusiness sites, will look at the receipts and say, what do I want to bring in, but they haven’t started at the beginning of the process by asking themselves, how much do I expect to sell and how much inventory do I need to have on hand to support those sales? Those are the two questions that really drive the answer of, how much do I need to bring in. And once you have that by category by month, how much I need to bring in, having derived that from your sales and your inventory plan, you now have a purchasing budget. So if you’re doing this pre-season, when all good planning should be done, you can go into the market and you know on a monthly basis, by category, in retail dollars, what you need to be buying and slotting for delivery into those periods. It helps you flow your inventory. It assures that you don’t have too much inventory too early in a season that could back up on you and create some markdown pressure. It really does answer the question, how much do I need to bring in and when do I need to bring it in? In addition to that, it gives you a real check on if I’m bringing this inventory in at this period at this point in time I know that I’m going to have a payable on that, maybe thirty days out, maybe sixty days out, and now you’ve got those numbers that you can plug into your cash flow plan as well.

Colette: That’s good. The other thing it does for you is if you have a long lead time with your suppliers and you know that lead time and you know what that projection is going to be, you can plan much more accordingly.

Ted: Well I’m a big believer that if you are operating a seasonal business, and most businesses do have some seasonality to them, that as soon as the season ends that’s when you should be planning for the next season for a couple of reasons. First of all, that’s when your experience from this prior season is most fresh in your mind and second of all, for those things that have the longest lead times it gives you the opportunity at a very early stage to know what you want to do going forward so that when you’re dealing with those vendors that do have the longer lead times you are, in fact, dealing from a plan as opposed to dealing a little bit more from the seat of your pants because you haven’t gotten around to doing a plan just yet. So I do recommend trying to put your plans together for a season as soon as that prior season is just completed.

Colette: That’s great advice. What about new entrepreneurs who are just getting started and they don’t really have a prior season to work from, do you recommend continually going into that open to buy plan and making adjustments based on the current information they have, what their projected sales were maybe just the previous month?

Ted: Even for somebody that’s brand new starting out I think that at the beginning of the process, as they are starting out, it’s important to try to craft a plan as best as you can. Vendors oftentimes can be a valuable source of information. You can’t count on them to do your planning for you, but they can provide you guidance as to how much you should expect to sell, how quickly you can expect to sell, what month it might be most saleable in. One of the key things a plan does give you is a series of benchmarks and as you get into a season, whether you’re established or whether you’re new starting out, it’s important to have those benchmarks so you can evaluate your progress as you’re going through a season against what you expected to happen. You’re able to compare planned sales versus actual sales, planned ending inventory versus what you actually did end with, what you planned to bring in for inventory receipts versus what actually did come in. Whether you’re just starting out or whether you are established, having those series of benchmarks going into the season, having done that planning, is critically important so that once you do get into the season you’ve got some basis for making decisions and managing your inventory so that you are staying on track and inventory is not building up and pushing you into a place where you’re going to have excessive markdowns and you’re going to start seeing your margins start to erode.

Colette: Are there any existing systems that have open to buy functionality already incorporated into them?

Ted: Some retail software packages have open to buy modules as an add-on option. There are very few where it’s part of the core package, especially for smaller, more entrepreneurial type of retailers or ebusinesses. They do struggle with this because they don’t have the functionality in their systems. Larger retailers have got this functionality and more to manage it. For many of my clients I find the most cost effective solution, both from a cash flow basis as well as from an open to buy is to develop something off system on a spreadsheet. It’s not that complicated to do and for a lot of my clients that’s exactly what I do for them.

Colette: Good ol’ Excel.

Ted: Yep.

Colette: For my personal site I swear I use Excel for nearly everything.

Ted: Well you know, the great thing about it is that no two businesses are alike, so their needs from an open to buy basis are never alike and for smaller, independent retailers, ebusiness websites, having the capability to tailor something to their specific need is critical to really making the tool work for them.

Colette: What about other critical metrics that a retailer should keep an eye on, beyond sales and inventory levels?

Ted: I think the one great overlooked metric is gross margin, both gross margin percentage and gross margin dollars. Gross margin dollars is the lifeblood of any retail business, ebusiness. It’s those dollars that are available after you’ve paid the vendors to pick up all the other things, whether it’s advertising or payroll or utilities, whatever it may be that needs to be picked up, those are the dollars that are paying for it. So I’ve oftentimes seen clients that are concerned about sales in any given period, but we’ve been really focusing on margin and I point out to them, yes, but look at all the additional gross margin dollars you generated in this period, and suddenly they’re starting to realize that what they thought was maybe a bit of a soft period in their business, really they had done very, very well because they generated a lot more gross margin dollars than they had in the prior year and they were really feeling good about it.

Gross margin as a percentage metric is very important as well because that’s a function of what your initial markups are as well as what kind of markdowns you’re having to take in order to move product through. Your gross margin dollars can be improved by trying to find opportunities to get additional markup as well as by trying to manage your inventory a little bit tighter so that you don’t have that markdown erosion.

Colette: So how about some other terms that we’ve heard like inventory turnover, gross margin, return on inventory investment? There are so many keyword terms in this subject.

Ted: There certainly are. These are critical metrics for measuring how well inventory is being managed. And even for smaller businesses these types of metrics can be very illuminating and help people understand really how successful they’re doing. The key to any retailer’s success is to turn their inventory into cash at the best possible markup as quickly as they can and then buy more inventory and turn that into cash as quickly as they can. It sounds sort of simple, but at the core that’s really what the mission is. And implicit in that kind of a statement is the fact that turning your inventory over as quickly as you can is a critical mission to keeping the inventory fresh and keeping the cash flow coming. So inventory turnover is pretty straightforward, it’s how many times was I able to turn my inventory during the year into cash, buy more and turn that into more cash. And the basic calculation there is you take the sales during the course of the year at the retail value and then you take the average inventory and divide the sales by the average inventory. You derive the average inventory by most times looking at the ending inventories for each of the months. You do sales at retail value, you do average inventory at retail value, and that will tell you what your turnover is. In some cases you need to do it on a cost basis, the cost of the inventory that you sold versus the average inventory value it cost. But basically we’re saying, based upon the average inventory, how many times did you turn that over? And keeping your inventory fresh is critically important, again, from a business fundamental standpoint, customers like fresh inventory, they like new things. Things that aren’t hanging around for a long time create a greater sense of urgency in customers. So inventory turnover is a critical metric.

The second one is gross margin return on investment and that’s a little bit more involved, but it really answers a basic question, how many gross margin dollars, which we just talked about, did the inventory investment generate during the year to pay all of the other business expenses? Here’s where it factors in inventory turn combining a little bit with the margin percentage. And the basic calculation there that I like to use, I like to state it in terms of dollars, is you take the total gross margin dollars that were generated for the year and you divide that by the average inventory value. And basically what it’s saying is if I had a dollar of average inventory during the course of the year how many gross margin dollars did that generate for me in return? And it’s a critical measure of how well that inventory is performing. Again, we started out the program by saying that inventory for an ebusiness is the critical active asset and so now we’re measuring how well did that active asset perform during the course of the year.

Colette: Ted, thank you so much. Do you have any final thoughts on inventory productivity that you’d like to go over?

Ted: I guess I would just leave with the concept that once you measure what your metric is, how you’re doing in turnover, how you’re doing in TMROI. There’s no such thing as standing still. If you don’t know that you’re moving forward, then most likely you’re going backwards and it’s always important to be moving forward.

Colette: That’s a great comment. That is our time today with Ted Hurlbut of HurlbutAssociates.com. Ted, thank you so much for being here.

Ted: Thank you Colette.