Like most industries, retail has its share of buzz words. It's important to know the common retail industry words so you are properly managing your inventory and finances. Will wrote an article talking about some of the most common ones and how to use them in your business.
Cost of Goods Sold (COGS)
This is not specifically a retail term, but is useful to understand so the rest of these terms make sense. A number of clients think that their COGS is what they paid for inventory during any given period of time. This is not correct. COGS is the cost of the items that were SOLD during a period of time. The easiest way to explain this is to think about what happens when you buy inventory. You are exchanging one asset for another. You use your cash (an asset) to buy inventory (another asset) there is nothing that should show up on your Profit and Loss. Then when we SELL our inventory, we reduce our inventory asset and increase our COGS. One of the biggest mistakes we see bookkeepers make is to code all purchases to COGS. Your POS or accounting software should make these entries for you automatically if you are receiving the inventory correctly.
Inventory Turnover Ratio
Also called Inventory Turns. This ratio gives you a number that measures how effectively you are managing inventory. It is determined by comparing the Cost of Goods Sold against the Average amount of inventory held for the same period. The higher the number is the better. For example, If your average inventory over the last 90 days was $100,000 and your COGS was $500,000, you are turning your inventory 5 times. The best way to look at turns is either by item or by department/categories. For example, in the Garden Center, we would expect that seasonal items to turn faster that perhaps hardscape, etc. But in our seasonal items, what is “turning over” faster and should be reordered.
Sell Through Rate
This measure the amount of inventory received from a specific vendor versus what is sold to the customer. Often vendors will offer special incentives to induce you to order product. That is great if the item has a high sell through rate. Otherwise if the items just sit on the shelf, it doesn’t really matter how great a deal the vendor gave you, the items are taking up valuable shelf space.
Gross Margin Return on Investment (GMROI)
This allows the retailer to determine of the products they are buying are earning enough margin to justify the investment in inventory to earn that margin. To calculate the GMROI, divide the gross margin of an item or department/category against the average inventory at cost. Another way to look at this is for every dollar that is spend on inventory, how much is that dollar earning. Of course the harder your dollars are working, the better for you.
I hope that this helps to explain some of the jargon that you sometimes hear. Any good POS or accounting software should help you to determine the amounts to plus into the various formula. In many cases, the software has an actual report that will do the math for you. The important thing is to consider what to do with those numbers. All of these formulas should help you to formula a buying plan which tells you what to buy when and how much.
