To maximize profits, retailers must have the right type and amount of inventory on hand. They also must establish how much the inventory is valued at to determine how best to price it, how much it can be marked down throughout the season, and ultimately if they should buy more of the same product or invest in something else.
Historically, retailers have leveraged the Retail Method for financial planning. When it was first developed, it was advantageous because it eliminated the tedious, time-consuming process of manually recording each transaction in a ledger when sales for goods began to exponentially increase. It works by calculating a store’s total inventory value by taking the total retail value of the items, subtracting the total sales, then multiplying that dollar amount by the cost-to-retail ratio – i.e., the percentage by which goods are marketed up from their purchase price.
But, the Retail Method’s fatal flaw lies in the fact that it is only really an estimate of inventory value. A lack of visibility into the cost of goods sold can hamper a retailer’s ability to understand how much it can expect to make in profit versus what it has already invested in inventory.
Access to more data and better technology has facilitated a shift in the way retailers look at inventory valuation. The Cost Method provides a straightforward approach to inventory valuation in which true revenues minus true costs equals gross margin. It accomplishes this by managing inventory at an item-location level and tracking its cost using a moving average. The moving average cost is computed every time a goods receipt occurs. As such, planners can target assortments to stores based on product profitability at the store or cluster level.
Although the obvious drawbacks to the Retail Method have led the International Financial Reporting Standards to put support behind the transition to the Cost Method, many organizations are reticent to making a cold-turkey switch to their accounting style. Transitioning represents a change in their fundamental planning process. Such retailers may have concerns about how much money it will take to make the switch, disruption to the day-to-day business, and whether they have the right talent and resources in place to support it.
But, what if retailers could blend their use of Retail and Cost Accounting Methods? Doing so would help retailers better link their financial objectives with their merchandising needs. In this scenario, planners can continue to make decisions about inventory the way they know how best to. Most importantly, the finance organization has visibility into cost and how much of the budget is tied up in working capital by way of inventory.
At JustEnough Software, we believe valuable insight can be derived from using a holistic metric set that drives merchandising strategies, as well as the planning of inventory investments. Read the full version of our newest thought leadership article, “The Benefits of Blending Retail and Cost Methods of Accounting,” by clicking here.
Contact us today to learn how the 3.6.0 version of JustEnough Merchandise Financial Planning solution delivers a hybrid method of financial planning. Also, stop by our Booth #4214 or schedule a meeting with us at NRF 2018: Retail’s Big Show, Jan. 14-16 in New York City to learn more.