On Day
One you spend $1000 on an initial inventory of staple
goods. You mark the merchandise up to $1500 and put it on sale.
In the first week your sales from that inventory are $600.
That means you recovered $400 of your investment in merchandise
and received an additional $200 from mark-up - also called margin
or gross profit. You use that $200 gross profit to cover your
expenses for the week. The other $400 you invest in more merchandise.
Remember, turnover is a cumulative measure that quantifies
activity over time. In real life your rate will vary by week,
month, season - whatever. Nevertheless, to make this example
easy to follow, every week the same cycle repeats - $600 in
sales, $400 in merchandise cost immediately reinvested in more
products, and $200 in gross profit to cover expenses!
Here's how your operation's numbers stack up twelve months
later. Annual sales are $31,200. Cost of merchandise to generate
that sales figure is $20,800. Gross Profit to cover expenses
is $10,400. You did well and achieved a turnover rate of 10X
(ten times). $1,000 was invested (put at risk) and in
one year it earned a gross profit of 1,000% under your management.
But to achieve that you worked your tail off examining sales
records each week and promptly reordering to maintain a balanced
inventory.
Now turn the example around. Here we have the same $31,200 in
retail sales from the same $20,800 invested in inventory at
cost and the same$10,400 in gross profit. The big difference
in this example is that you were lazy. To avoid monitoring and
reordering stock, on Day One you order a full
year's inventory. Your operating strategy is to sit on it for
twelve months until it sells out, leaving you with empty shelves
and $31,200 in the till.
Remember now - in both examples annual sales are the same,
inventory investment is the same, gross profit is the same.
But on Day One of this example you invested $20,800 instead
of $1000, right? You got the same gross profit from tying up
all that money for a year.
In the second example your turnover rate is .5. That's
half a turnover of your inventory investment. Your gross profit
(before operating expenses) is 50% of the amount you put at
risk. Compare the difference in results. When you were aggressively
managing inventory your gross profit - the same amount - was
a turnover of 10X and a return on the investment of1000%.
