Open to Buy Planning: Definition & Formula for Retailers
Meaghan has provided content and guidance for indie retailers as the editor for a number of retail publications and a speaker at trade shows. She is Fit Small Business’s authority on retail and ecommerce.
This article is part of a larger series on Retail Management.
Open to buy (OTB) planning is a process by which businesses create budgets for future purchases during a specific period. In other words, an OTB budget tells retailers how much they can spend on inventory. By creating these kinds of plans, retailers can forecast sales, remain cash flow positive, and avoid excess, unpopular, or aging inventory.
An OTB plan gives retailers the ability to get ready for seasonal surges, ensures that demand for popular products can be met, and makes it possible to keep track of how much inventory is on hand compared to what you need to keep customers happy. Having an OTB plan in place also allows retailers to reduce wasteful spending and minimize potential waste. It even ensures that a business’ buying power isn’t stunted because of mismanagement or over-ordering.
OTB budgets measure multiple factors, but one of the most important things they gauge is your inventory turnover ratio.
Inventory turnover ratio, or turn rate, is calculated by dividing sales by inventory. For instance, if a company sells $20,000 and holds inventory of $12,000, its inventory turnover rate is 1.7. That means it goes through its inventory supply about 1.7 times for that period.
Identifying this number helps the architects of OTB plans understand the level of demand for each item in their inventory and how much of their OTB budget to allocate for each product sold.
Because products sell at different rates, most companies set individual turn rates for each category, which allows for a more accurate calculation of how much product you need for each SKU.
How to Calculate Your Open to Buy Budget
Like any effective budgeting tool, the OTB formula helps companies make reasonable predictions based on past performance while considering circumstances that might alter those expectations.
The formula creates a framework for best practices and aids those involved in the procurement process to see the month-over-month changes in sales volume.
Here’s the OTB formula:
OTB = planned sales + planned markdowns + planned end of month inventory – beginning of month inventory
Here are definitions of the terms above:
- Planned sales: The dollar amount of sales projected within a time period
- Planned markdowns: The total number of discounts planned during the sales period
- Planned end of month inventory: How much inventory is projected to remain at the end of the sales period
- Beginning of month inventory: The inventory total (in dollars) available for sale at the beginning of the month
- Planned OTB purchases: The dollar amount of expected purchases a store makes at the end of the sales period to replenish its inventory
Note that planned end of month inventory carries over to the next month as the new beginning of month inventory.
Here is an example of what an OTB calculation looks like:
OTB = $25,000 + $600 + $45,000 – $35,000 = $35,600
In this case, the projected OTB budget allocates for $35,600 of inventory purchases at the end of the sales period. By using this formula, businesses can obtain a stronger grasp of their inventory needs month over month.
How to Apply OTB Planning to Your Business
While larger businesses and corporations make longer-term OTB plans (quarterly, semi-annually, etc.), those running smaller operations with tighter budgets will find shorter-term plans more beneficial.
If you’re running a small business for which large spikes of sales during holiday periods are the norm (floral boutiques, video game stores, greeting card businesses, etc.), creating weekly OTB plans is likely the best route. Weekly plans help your purchasers understand which products need to be ordered at higher volumes more frequently during these periods.
Below is a sample OTB plan for how a small video game retailer might handle the holidays:
November | December | |
|---|---|---|
Planned Beginning of Month Inventory | $40,000 | $30,000 |
Planned Sales | $20,000 | $15,000 |
Planned Markdowns | $500 | $300 |
End of Month Inventory | $30,000 | $20,000 |
Planned Open To Buy Budget | $10,500 | $5,300 |
A longer term OTB plan for a family-owned art supply store might look like this:
January | February | March | April | May | June | |
|---|---|---|---|---|---|---|
Planned Beginning of Month Inventory | $35,000 | $25,000 | $20,000 | $18,000 | $28,000 | $22,000 |
Planned Sales | $30,000 | $35,000 | $19,000 | $27,000 | $40,000 | $25,000 |
Planned Markdowns | $800 | $400 | $250 | $450 | $100 | $500 |
End of Month Inventory | $25,000 | $20,000 | $18,000 | $28,000 | $22,000 | $30,000 |
Planned Open to Buy Budget | $20,800 | $30,400 | $17,250 | $37,450 | $34,100 | $33,500 |
No matter what kind of OTB plan your business uses, it’s crucial for purchasers to review all forecast amounts to make sure they are practical. While it’s important to look at current data and purchasing habits, it’s also beneficial to look at past sales figures to make estimates.
Bottom Line
Considering the changing retail landscape, it’s more important than ever to create accurate forecasts and tight budgets to stay afloat. With historic numbers of retailers closing every day, keeping your store stocked with the items your customers need the most will go a long way as global supply chains become less reliable.
In the end, open to buy planning is an essential tool in your arsenal.
