Merchandise Budget III
Merchandise Control
Estimating Monthly Reductions
• Markdowns are part of merchandising, particularly
in apparel or fashion lines—impossible to match all
consumers’ needs with certainty with respect to
sizes and styles.
• Employee discounts are important in building
“selling confidence” in merchandise.
• Shortages, such as errors in recording sales,
receiving goods, recording markdowns, employee
theft, and shoplifting.
Reductions
• Historically, department store reductions
(markdown, discounts) exceed specialty store
reductions (NRMA statistics).
• Initial markon, or initial markup percentage
must cover reductions:
(Gross margin $s + Markdowns $s)
(Net sales $s + Markdowns $s)
• Determine the dollar amount, and then
allocate to various months, consistent with
NRMA statistics.
Retail Inventory Method
• Retailers must maintain accurate records of
inventory investments, such as a perpetual
book inventory.
• Practicality and conservative approach.
• Pre-established initial mark-up and costcomplement (cost-multipliers), procedures.
• As markdowns become a larger part of
the business, RIM method become more
attractive.
Inventory Movements Tracked at Retail at Initial Markup
Total Goods Handled
Cost
Beginning inventory
Purchases
- Returns
Retail
$ 40,000
144,000
240,000
(6,000)
Net Purchases
$ 70,000
(11,000)
138,000
229,000
Transfers in
2,000
3,200
- Transfers out
(3,000)
(4,800)
Net Transfers
(1,000)
Freight in
3,000
Markups
1,400
- Markup cancellations
(400)
Net Markups
Total Goods Handled
(1,600)
1,000
$180,000
$300,000
Initial markon = $300,000 – 180,000 =$120,000 or 40%
In-Season Adjustment to Inventory All Completed at
Retail, or at the Sales Register
Total Goods Handled
Cost
Gross Sales
- Consumer Returns
Retail
$240,000
(10,000)
& Allowances
Net Sales
$230,000
Markdowns
20,000
- Markdown Cancellation
(2,000)
Net Markdown
Employee Discounts
Total Reductions to Inventory
18,000
2,000
$250,000
Applying the Cost Multiplier,
Cost Complement, Cost to Retail Ratio
Cumulative Markon =
(total retail - total cost) / total retail:
($300,000 - $180,000) / $300,000 = 40%
The Cost Multiplier = total retail -cumulative markon
(100% - cumulative markon%) =60%
Ending book
= total goods handled at retail - total
inventory at retail
reductions: $300,000 - $250,000 = $50,000
Ending book
inventory at cost
= ending book inventory at retail x cost
multiplier: $50,000 x 60% = $30,000
Components of Retail Inventory
• Markon, initial % markup
• Reductions: Markdowns, discounts, and
shortages.
• Cost complement (cost multiplier)
• Public Accounting Firm Audit
Initial Markup & Cost Complement
• A retailer with a maintained margin (gross
margin) of 35%, has planned sales of $230,000
for a season, with total reductions
(markdowns) of $20,000.
• What is the retailer’s initial markup % ?
• What is the cost complement, cost multiplier?
Sample Test Question 1
• A department store has planned sales of
$500,000, with $300,000 in gross margins for
a season, and expects no markdowns.
• What is the retailers initial markup % ?
Sample Test Problem 2
• A retailer with a maintained margin (gross
margin) of 25% has planned sales of $400,000
for a season, with total reductions
(markdowns) of $50,000.
• What is the retailer’s initial markup %?
• What is the retailer’s cost complement?
Sample Test Question 3
• A department store forecasts gross margins
$70,000 on planned sales of $180,000 for a
season, with total reductions (markdowns) of
$20,000.
• What is the retailers initial markup % ?
Sample Test Question 4
• A retailer adds $120,000 markon to goods that
cost the retailer $180,000. What is the initial
markup %?
• What is the retailer’s cost complement?
• If markdowns of $60,000 are needed to sell all
the goods, what are the net sales and the
maintained markup %?
Sample Test Question 5
• A department store with a maintained margin
(gross margin) of 40% has planned sales of
$500,000 for a season, with total reductions
(markdowns) of $100,000.
• What is the retailer’s initial markup % ?
Decentralized Inventory
• Retail Inventory should be in the stores—not
in distribution centers
• If inventory were in a single location, tracking
inventory movement, or “costing out” each
sale, might not be a problem, such as at an
auto dealership.
• Consider if you had highly trained specialists
versus the reality of highly untrained
generalists.
Markdowns
• Frequency of
– Early markdowns
– Markdown cancelations
– Additional mark-ons for price increases
– Vendor mark-down money for close out
• Without markdowns, or highly frequent
markdowns, the RIM is less important.
• A source of negotiation between buyer and
seller.
“Self-Serving Reasons” for Markdowns
• Markdowns provide motivations to move
“obsolete” merchandise.
• Markdowns are usually associated with
advertisements, or announced events.
• Markdown “money” provides a reason for
negotiations between a buyer and seller.
• Markdown money provides an incentive to
new sellers (or suppliers).
Stock-to-Sales Ratios
• Ratio of inventory (at retail) to monthly
planned sales.
• The inverse of a one-month turnover
ratio.
• Historical ratios are maintained to keep
store in-stock of merchandise—provided
to buyers, or embedded in software.
Basic Stock Method
• “Basic Stock” is an inventory amount “added” to
planned sales and reductions to create a BOM
Inventory. The difference of two components:
• Average stock: (Total sales +reductions)/turnover
• Average monthly sales: (Total sales +reductions)/months
Basic Stock Method
• Calculations for a six month merchandise
budget
BOM stock  Basic stock  ( Planned
Basic stock  Average stock
Average stock 
season
sales 
146,500
- Average
sales  reductions
monthly
sales  reductions
Total planned
Target tur
Ave. monthly
monthly
nover rate
 24 , 416
6
Basic stock  78,000 - 24,416  53 ,564 or 54,600
)
sales

146 , 500
1.88
 78 , 000
BOM stock  Basic stock  ( Planned
Basic stock  Average stock
Average stock 
season

- Average
sales  reductions
monthly
)
sales
sales  reductions
Total planned
Target tur
146 ,500
monthly
nover rate
 78 , 000
1.88
Ave. monthly
sales 
146,500
 24 , 416
6
Basic stock  78,000 - 24,416  53 , 564 or 54,600
54,600 is added to each month’s projected sales + reductions
to create BOM inventory
Cautions: Stock-to-Sales Ratios
• Retailer specific—
• Reported as averages—a retailer does not
mind sharing their ratios as it does not have
divulge planned sales nor dollar amounts of
inventory at retailer.
• The multiplier effects will “exaggerate” any
anticipated shifts in planned sales without
readjustments for the season.
• Historically tracked by retailer.
Stock-to-Sales Ratios
• Ratio of inventory (at retail) to monthly planned
sales.
• The inverse of a one-month turnover ratio.
• Historical ratios are maintained to keep store in-stock
of merchandise—provided to employees, or
embedded in software.
• Once widely reported measure of inventory levels
(National Retail Federation surveys) for
“benchmarking.”
Merchandise Control
• Process of collecting and evaluating data on all
aspects of each retail merchandise category,
including sales, costs, shrinkage, profits, and
turnover. Control is achieved through the
maintenance of an inventory book where all data are
evaluated.
• The determination and direction of merchandising
activities, both in terms of dollars (dollar control) and
in terms of units (unit merchandise control).
• Control begins with a plan, and for the merchandise
category this begins with the merchandise budget.
Merchandise Budget
• Provide the plan for determining store
inventories—what inventories should be.
• Purchases and shipments of goods to stores
are required to follow this plan.
• Reductions to inventory, sales, returns,
markdowns, and discounts are tracked with
regard to the plan.
• Shortages are deviations from the plan, the
shipments in, and all recorded reductions.
Cost Complement
• Used to convert EOM Inventory from
Merchandise Budget (@retail) to cost
• Initial markup=45%,
• Cost complement=55%
Turnover: Retail versus Cost
• A retailer’s 6 month budget has planned sales
for season of $200,000, a maintained margin
of 30%, an average EOM inventory of 80,000
and an initial markup of 45%.
• By estimating markdowns, what is the
turnover for period?
• Using cost of goods sold, what is the turnover
for the period?
• Initial markup = (Gross margin + markdowns)
(Planned sales + markdowns)
• Cost complement = 1 – Initial markup
• Cost of goods = 1 - Maintained markup (gross
margin)
• Turnover = Planned/Inventory@retail
• Turnover = Cost of goods/Inventory@cost
Estimate markdowns and determining
turnover
Initial markon 45 % 
.45 
60,000  x
200,000
(.45  200,000)
 x
Gross margin
 markdowns
Sales  markdowns
;
 .45 x  60,000  x
30,000  .55 x ;
54 , 545  markdowns
Turnover

200 , 000  54,545
80 , 000

254 , 545
80,000
 3 . 18
Turnover is identical to cost method
Turnover

Cost of goods sold
Inventory
@cost
Cost of goods sold  Net sales - gross margin
Inventory

@cost
 Inventory
200,000 - 60,000
80 , 000 * . 55

@retail
140,000
44,000
* Cost complement
 3 . 18
Seasonality: Why We Need a Buying Process
• If demand were predictable
• If demand didn’t change with style and
fashion trends
• If there was no complications due to
reductions
• If there weren’t differences among suppliers
to changing styles or demand
• If there was no differences among competitors
Intertype Competition
• Single-line, “limited line,” specialty retailers
“Kiosk” based specialists
• Category specialist, category killer
• Family clothing stores
• Department store
• Discount department stores
• Warehouse club or supercenter
• Local seasonality combined with seasonality of the
merchandise line tends to favor…
Assumptions
• Change in the seasonal characteristics of
consumer demand for a merchandise line is
negligible, or “geological”
• Intertype competition shifts in demand are
“revolutionary” in comparison
• Management of the merchandise budget may
vary slightly from retailer-to-retailer, however,
the nature of supply provides standardization.
Seasonal Characteristics
• Predictable, recurrent seasons
– “Back to school,” school supplies
– Christmas Holiday, outdoor decorations
– Lawn mowers, lawn fertilizer, bedding plants
• Less predictable
– Men’s swimwear, shorts
– Sweaters, sweater vests
– Children’s “dressy” clothes
Intertype Competition
• “Generalists”
–
–
–
–
–
Discount Department Stores
Supercenters & Warehouse Club
Conventional Department Stores
“Dollar” Stores, “Big Lots”
Home Centers (Lowe’s, Home Depot)
• “Specialists” or Limited Line Retailers
–
–
–
–
Men’s, Women’s, & Family Clothing Stores
Limited-line sporting goods
Home electronics
Toy, hobbies, and games
We typically, we assign certain
product to classifications:
• Men’s underwear versus women’s underwear?
• Men’s dress shirts, collars, sizes—”expectancy”
of standards of fit, neck size.
• Men’s shoes versus women’s shoes
What are the implications of seasonal merchandise and
seasonal geography on retailing structure and competition?
• What conditions would be hardest for a yearround specialty retailer (limited assortment)?
• What combinations of seasonality favor a
general merchandise, wide assortment
retailer?
Inventory Control
• The validity of all of the prior discussion is
contingent on merchandise that was ordered
actually making it into retail display space and
remaining there until the sale is recorded at cash
register.
• Opportunities for fraud and theft are abundant
on and off the sales floor.
• How can the buyer be assured that the planned
purchases arrive, and are displayed, on the selling
floor?
Monitoring “Issues”
• Monitoring is important when employees are
in charge of operations and separated from
ownership.
• When the owner of the store is also the
manager, the buyer, and inventory control
manager—there is no need to monitor.
• When the manager of the store is also the
buyer and responsible for inventory control…
Avoid the following practices as a buyer:
• Spending time with vendors outside of the
buying offices.
• Spending too much time “receiving” goods at
the stores.
• Fraternizing with individuals within your own
firm’s accounting division.
Retailer
Accounts Payable
Purchasing
Receiving
Purchase
Order
Financial
Intermediary
Sales
Carrier
Shipping
Invoice
Accounts Receivable
Supplier
Bill of
Lading
Three areas of concern
• Planned purchases from merchandise budget
become purchase orders—do purchase orders follow
the plan—or exceed plan?
• Purchases orders become invoices—do the
quantities and prices match the purchase orders? Is
vendor allowed to substitute?
• Receiving: Do the goods received match the goods
invoiced? Are they in saleable condition? Who
determines if merchandise is returned?
Merchandise Budgets are Plan for Control
• Do purchases orders correspond to budget
plans?
• Can all accounts payable be assigned to
specific budget plans and from vendors in the
plan?
• Do actual goods in stock in stores correspond
to planned BOM inventories and sales.