Open-to-buy (OTB) is an inventory management strategy and formula businesses use to create buying budgets for specific periods of time. It takes into account expected beginning-of-month and end-of-month inventory, planned sales, and planned markdowns. Basically, an open-to-buy budget tells retailers how much they can spend on inventory at some future date, whether it be the holiday season or the month of May.
Key Takeaways:
- Open to Buy (OTB) is a formula retailers use to determine how much to spend on inventory
- OTB prevents over-buying and helps manage cash flow
- Use OTB in conjunction with other metrics like demand and sales forecasts and inventory turnover for a complete picture
With open-to-buy planning, retailers can forecast and spend proportionately to sales, meet demands for popular products, and prepare for seasonal surges. By helping retailers keep track of on-hand inventory compared to what is actually needed, open-to-buy planning reduces excessive spending and minimizes waste.
Use our free open-to-buy template below to make six-month or ten-week purchasing plans that will keep your business on track.
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Open-to-Buy Budget Formula & Calculator
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 in the future. The formula creates a framework for best practices and helps you detect month-over-month changes in sales volume. Use the calculator below for your OTB budget:
You can also calculate it by hand using this formula:
Open to Buy = planned sales + planned markdowns + planned end of month inventory – beginning of month inventory
- Planned sales: The dollar amount of sales projected within a time period
- Planned markdowns: The total amount of discounts planned during the sales period in dollars
- Planned end of month inventory: The dollar value of the inventory that is projected to remain at the end of the month*
- Beginning of month inventory: The dollar value of the available inventory for sale at the beginning of the month
*Note that planned end of month inventory carries over to the next month as the new beginning of month inventory.
Although the formula is generally expressed in months, you can use it to calculate open-to-buy purchases for a longer period, as in our example below.
Say you want to create an open-to-buy plan for the holiday season (November to January) at your clothing store. You anticipate heading into the season with $7,000 of inventory. Last year you made $78,000 in sales during this time. This year, however, your customer base has grown and your business is making slightly more, so you anticipate making closer to $90,000. Additionally, you plan to mark down summer items valued at $3,000 by 20% ($600), and you anticipate having about $5,000 of inventory in stock once the holiday period is complete. With all this, your OTB calculation would be:
Open to Buy = planned sales + planned markdowns + planned end of month inventory – beginning of month inventory
Open to Buy= $90,000 + $600 + $5,000 – $7,000
Open to Buy= $88,600
Based on your predictions, you should spend $88,600 on inventory for the holiday season to ensure you have enough items in stock but are not overspending and ending up with waste or sacrificing your bottom line.
You can make your open-to-buy plan as granular or as macro as makes sense for your needs. Simply apply the same formula to a single product to make predictions on a per-product basis.
Open-to-Buy Planning & Inventory Turnover Rate
Open-to-buy budgets measure multiple factors, but one of the most important things they gauge is your inventory turnover ratio. 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.
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.
Because products sell at different rates, most companies set individual turnover rates for each product category or individual item, which allows for a more accurate calculation of how much product you need for each stock-keeping unit (SKU).
How To Apply Open-to-Buy Planning to Your Business
While larger businesses and corporations make longer-term open-to-buy plans (quarterly, semi-annually, etc.), those running smaller operations with tighter budgets should use shorter-term plans.
For businesses that see large seasonal spikes, create open-to-buy plans for each week. This will ensure you stay on top of seasonal flows and also help your buyers understand which products need to be ordered at higher volumes more frequently during busy periods.
Below is a sample open-to-buy 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 open-to-buy 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 open-to-buy 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.
Understanding your inventory and making accurate projections is a key part of open-to-buy planning, and it all comes down to good inventory management. Make your life easier with a fully integrated POS system with inventory controls, so that you can get automated reports, insights, and real-time data on your inventory.
Pros & Cons of Open-to-Buy Planning
Open-to-buy planning is an inventory management process used widely across the retail industry for a reason—it’s an effective way to make predictions about the future of your store and how you should allocate funds. The OTB predictive strategy, however, does have its drawbacks and you should be aware of them before you apply OTB planning to your business. Let’s take a look at its pros and cons:
- Flexible, reactive planning structure: Most businesses have weekly or monthly open-to-buy plans. This allows you to make adjustments as conditions change and update your budgeting plan without being locked into an annual or quarterly plan.
- Keep the right amount of stock on hand: When done well, open-to-buy planning allows you to anticipate how much stock you should have on hand based on your anticipated sales. This means you will be able to avoid stockouts, excess stock, or aging inventory and keep your customers happy.
- Detect patterns and trends: Because open-to-buy planning looks at specific periods of time and uses past sales data to make predictions, you can detect seasonal trends and patterns that will help you make even better decisions for your business.
- Avoid overspending: Open-to-buy planning splits up your spending into time periods, telling you what money is appropriate to spend and when. This means that you can avoid overspending—only buying in accordance with your budget. In turn, this ensures that you have adequate funds for future purchases.
- Smart cash flow allocation: With open-to-buy planning, you can see just how much money you can reasonably spend on inventory alone. This helps you remain cash flow positive, ensuring that your budget will have room for other things, like marketing or overhead costs.
If you want to learn more about the other aspects of budgeting a retail business, you can check out our guide on how to budget a retail business.
- Need to supplement with other data: While your open-to-buy will set you on the right track, it will not give you the full picture of your business or inventory. To make truly data-driven budgets, you also need to consider other metrics, like your sales forecast, inventory turnover rate, and margins and markups.
- Not good for store staples: For products that are permanent staples in your store, open-to-buy planning is likely not the best way to make buying budgets. Open-to-buy planning says that you should buy $X of the item at a certain time, however, there are instances when it is better to wait until there is a shipping or volume discount to buy in greater bulk—but your open-to-buy plan won’t help you determine this.
- Best suited for companies with lots of SKUs: For companies with a few SKUs, open-to-buy planning might be more work than it is worth. If you don’t have many products, you can often make buying predictions simply by viewing past inventory and sales data.
- Little wiggle room: While your open-to-buy plan will give you a hard and fast number to use to make budgeting decisions, it does not leave room for error. In general, you will want to shave a few dollars off of your open-to-buy prediction in case an unexpected situation arises.
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.
