Open to buy (OTB) plan - a tool to manage your inventory better - Part I
Inventory planning, budgeting
In the last few days, I got few requests to explain how to create an OTB plan for the categories. So in this post, we will discuss :
What is an OTB plan?
Why it is important to create OTB plan
Calculations and how to create OTB plan, inputs required
Scenario planning
Many of the category managers find creating OTB plan as the most difficult part of the job. It is calculation heavy and there are lots of moving pieces. In this post, I have tried to explain fundamentals of OTB. I will also share an EXCEL model which can be used to create OTB plan for your retail business. To get it in your inbox, subscribe to thinking category.
Let’s begin.
First of all, let’s discuss why do you need an OTB plan.
As a retailer, you biggest asset is your inventory. when you sell your inventory, you generate cash-flow, that’s required to run your day to day operation. If you have lot of slow-moving inventory and not enough money to pay rent, salary, you are stuck. You can’t plan tomorrow, if today you have no money to run the business. So cash-flow is an issue.
Even if let’s say you have money to run the business, inventory takes lot of space in your store or warehouse(if you running an online store). Items have their own shelf-life so you will lose the money if you are not selling the items in particular timeframe. For example - every year new smartphone models are being launched. Keep the old phone for a year, you will sell those at markdown. Not something that you would like as a retailer. it would hit your profit margin.
And, buy less and this will be an opportunity loss.
In short, you need to buy only that much you can sell. Understandably, you can’t get the exact number but you can forecast using forecasting tool and previous month data as a raw material.
Once you have sales forecast data, you can create an OTB plan to understand how much inventory you will be ordering for a particular time period. (It could be monthly, weekly, quarterly activity depending upon your business.)
In short, you need an OTB plan to manage your inventory in an effective manner.
Now, you might ask why not take sales no. and order just that. For two reasons,
This is a budget tool. Even if you have sales data, you just can’t just order without having a financial plan in your toolbelt.
You need to know your current inventory position. You need to know how much you already have and how much do you want at the end of the day before placing an order. Sales forecast could go wrong, so you might have left with some inventory that you need to enter into your purchase plan.
Now, let’s come to the definition.
What is an OTB Plan?
OTB plan is a budget to tell retailers how much money is required to buy inventory in a particular time period to meet the sales target. OTB is calculated in local currency.
Calculation :
Sales = forecasted sales
Ending inventory = The inventory that you might carry over to the next month considering your inventory turn-over
Beginning inventory = Inventory that you already have from the last month
Note- the ending inventory for the previous will be the next month beginning inventory.
In simple terms, OTB is the difference between the inventory that I need and Inventory that I already have.
OTB = inventory that a retailer need - Inventory that a retailer already have
Let me explain this with an example.
Grofers sell yogurt. They need to know how much they need to buy for the next week. (Week because yoghurt Shelf-life is short). At the beginning of Jan month, we are planning for the next 4 weeks. These are the sales projection :
You know that your inventory turnover is 2 for a month. That means that Grofers replace the yoghurt inventory 2 time in a month. So at any point of time, you have 15 days worth of supply. (Read what is inventory turnover here )
That means you got 2 weeks inventory as your ending inventory. Lets enter into the table, put it into formula and let’s see how your OTB plan would look like.
So you see for week -1, you need 150 Rs. for your purchase order. For month, yo need only 20 Rs. So on and so forth.
Now, we know that sales forecast might not be that accurate. What if sales goes up next week because there has been an article in the newspaper that yoghurt is good for digestion. In this case, you need to revise your OTB based on actual sales or revised forecast due to the recent interest in healthy choices.
Logically, If your sales goes up, that means your ending inventory will be less compared to what you have thought, that means OTB for the next week will go up to maintain the same level of ending inventory.
I think for today, this is all we need to know. We will discuss how to account actual sales in OTB after reviewing the existing plan, or order that has already been placed. Also how things changes when you enter markdown into the equation. We will also talk about WSSI report (weekly sales, stock and intake data).
We can also do some sensitivity analysis to figure out the range of amount required for a month. (I haven’t tested it yet, ideation stage)
For now, if you want to read more on this, here you go:
This will give you some idea of software that are used to create OTB.
This is also a good article on OTB factoring extra complexities of markdown, and actual revenue.
OTB is particularly useful for merchants planning for a highly seasonal business, companies with many new products being introduced, and businesses with aggressive revenue goals that need to be considered.
Lastly, I had an interesting conversation about inventory model with a friend who work with a leading player in e-commerce. Starting its business in B2B2C model. The company will be working with small retailers every nook and corner of India and provide inventory required for the business. Their vision is to redefine the inventory requirement - so for example, earlier shopkeepers have to keep 30 days worth of inventory, now they will keep 2 days inventory because of technology infrastructure and delivery speed. I call it - 2-days inventory model. Now this is all good but I foresee couple of issues with this and one is forecasting capabilities and forecasting cost. 2 days is a too short the time to forecast the sales so personally, I find it too visionary to happen. But who knows? right. Things are happening at revolutionary speed these days. What do you think? What roadblocks you can see to make this happen? Anything. Leave a comment below.
Next week, we will come back with part -2. Happy Valentine day in advance :)