Merchandise financial planning is the process of mapping a retailer’s financial targets (such as topline goals, profitability targets or inventory utilization) into merchandise receipts and sales plan for the year. This process can be done seasonally or at cadences that are more in line with fiscal reporting, such as quarterly, semi-annually or annually.
Merchandise financial planning is particularly important for retailers in seasonal product categories, where merchandise has limited shelf-life. Without a rigorous merchandise financial plan in place, a retail organization will end the season with unwanted inventory at hand, run out-of-stock on important product classes and leave hitting their financial targets to chance.
In this article, we will go over the steps for putting together a merchandise plan for a retailer that is planning to increase annual sales by 10% and is planning to grow the gross margin from 40% to 42%. Assume that this organization is a vertically integrated retailer that is keeping the product strategy the same, i.e. cannot arbitrarily increase AUR. Let’s go through the workflow that a footwear planner will go through, given these top-down requirements to build a merchandise plan to meet the financial targets.
A planner will go through their merchandise financial plan in the following order:
- Update sales targets
- Set margin targets
- Calculate inventory levels
Below, we go into each of the steps in more detail:
Update Sales Targets
The easiest way to update the sales targets for the footwear planner is to first seed last year’s sales into this year and to adjust the aggregate sales by 10%. This will ensure that the monthly spread and the penetration across classes and subclasses are kept consistent. This process will require a lot of copying and pasting in Excel, but a tool like Toolio can really help simplify this process. If you want to explore what a merchandise planning tool can do, check out our RFP template. Once the sales targets are updated, it will have implications on either Sales AUR or Sales Units, as shown in the following formula from our post on fundamental retail math formulas.
Sales $ = Sales AUR * Sales Units
Assuming that the company’s product strategy is staying the same, it is safe to assume that Sales AUR will stay steady, so Sales Units will need to be updated, which will have implications on inventory targets, which we will focus on later on.
Set Margin Targets
Next up is increasing the gross margin % by 2% in the footwear department. The levers a planner has in place are:
- Lower the markdown %: In the initial merchandise plan, the markdown percentage will be coming from those achieved last year. Since markdown percentage is a lever typically controlled by marketing, this might not be one that can be impacted by the planner. However, the planner can adjust the product mix to prioritize products that will require less markdowns to induce sales.
- Increase the Initial Markup (IMU): This will require better negotiation with the suppliers to reduce the cost of goods sold (COGS).
- Change the Product Mix: Updating the product mix, i.e. increasing the penetration of classes that have higher `gross margin %` is another strategy the planner can use.
Calculate the Inventory Levels
Lastly the planner will have to calculate the amount of stock, i.e. inventory level, to meet the sales targets and generate a receipt plan. Inventory calculations typically rely on ratios such as `stock to sales` or `turn`. Let’s take `stock to sales` for example. Using historical data, we will have seen that `footwear` business requires a stock to sale ratio of 3:1, which will indicate how much inventory we would need to have to meet our newly adjusted sales targets. Leveraging a monthly inventory flow and beginning of stock we will have in each month, we will then generate a receipt plan and calculate the open to buy (OTB) for each month.
These steps are typically repeated for each class in a retailer’s product hierarchy, i.e. many tens of times per quarter. Some retailers desire to get it even a step lower and do this planning on the sub-class level. Now that you know how to effectively plan your merchandising, check out Toolio’s Merchandise Financial Planning Guide for Excel.
Sounds like a lot of work?
We get that. That’s why we’ve designed Toolio to automate a lot of these processes. If you’re ready to see how we can make your merchandising better, request a demo of Toolio.