INVENTORY MANAGEMENT “RULE OF THUMB” – By Alan M. Friedman

Alan FSince the invention of the cash register, music product retailers have been searching for predominantly two things: (1) a ’59 Sunburst Gibson Les Paul in mint condition, and (2) a “rule of thumb” for buying inventory that really does work.  Since I don’t know anyone selling a ’59 Paul for less than the $600,000 it’s currently worth, I thought I’d offer up my sure-fire “rule of thumb” that every music retailer can use for buying the right musical instruments & products in appropriate quantities.

Some retailers believe successful inventory management can only be achieved by moving most, if not all, inventoried product at high profit margins with little regard to how long it takes. Others believe you don’t have to sell any goods at high margins (i.e. school bids) as long as you’re selling them fast. Frankly, they’re both sort of right, but mostly wrong. You can sell goods at low margins, but you’ll have the additional burden of selling “more” goods “sooner” to offset your low margin profitability. Or you can hold out for price & margin, but you’ll need to make sure you don’t lose sales in doing so which could ultimately put you right out of business. So, what’s the answer? Simply, it’s achieving that delicate balance of earning enough margin “dollars” (irrespective of whether at a high or low gross profit percent) quick enough to timely pay your bills and earn a decent living. And how do you accomplish this?  By using this simple “rule of thumb” formula that’s easy enough to do in your head…here’s how it works.

Let’s say you’re placing an order with your sales rep for some new product unveiled at the most recent NAMM Trade Show – a new digital keyboard with a “street price” of $800 and a cost (including freight-in) of $600.  We can pretty much calculate in our head that this keyboard will generate $200 of gross profit (= $800 – $600), at a 25% gross profit margin ($200/$800).  All you need to do now is multiply that gross profit percent (25%) times the number of days in the year…and let’s use 360 to make it easy.  When you get your answer of 90 days (= 25% x 360), ask yourself this simple question….”Can I sell this digital keyboard in 90 days or less?” If the answer is “yes”, then buy it – if the answer is “no”, then don’t buy it. If you’re buying 10 of these keyboards and believe you can sell them all, but not within 90 days, then reduce the quantity you’re buying until the answer becomes “Yes, I can sell all of these keyboards in 90 days or less.”

You now have the perfect tool to easily adjust what & how many you’re buying to the gross profit you expect to achieve and inventory turnover days you expect to incur. Start following this easy rule-of-thumb formula and watch your cash flow increase dramatically from this simple but highly effective inventory management tool.

Alan Friedman is a partner at Friedman, Kannenburg and Co. and can be reached at alan@fkco.com.

Established in 1985, Friedman, Kannenberg & Company, P.C., is a Certified Public Accounting firm that specializes in providing accounting, tax and consulting services to music industry. Our clients include musical instrument & product retailers, music product manufacturers, sales reps, musicians & bands, independent record labels, music venues, recording studios & engineers, music schools & educators, music trade associations, tour support firms and other music industry businesses and individuals.

 

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