OPEN TO BUY (OTB)
The Complete Guide
This is a complete guide to the OTB (Open-to-Buy) concept in retail, and a detailed step-by-step explanation of the entire process. The Open to Buy process is used to calculate how much inventory the business should buy.
You will learn about:
- Open to Buy (OTB) Definition
- Retail Buying Plan Template
- Open to Buy Budgeting Steps
- Importance of OTB
- Retail Buying Plan Considerations
Here we will talk about what OTB stands for and what the formula consists of
We will be covering in details :
- Open to Buy Definition
- OTB Outcome
WHAT IS OTB IN RETAIL
OPEN TO BUY DEFINITION
OTB stands for Open-to-Buy. It is the amount you need to buy products with, in order to achieve the set sales budget for a certain period, usually 6 months. It is calculated at cost and assigned to different product categories based on each category’s contribution to total sales.
Read Also: Category Management
IMPORTANCE OF OPEN TO BUY IN RETAIL & ECOMMERCE
OTB calculation is one of the most important tasks to master when starting a retail business. Failing to calculate the open to buy budget can be detrimental for the business, due to stock problems that will soon arise from improper planning. In fact, a lot of retail & ecommerce startups fail, mainly due to cash flow problems created by poor inventory management.
These businesses often buy too much inventory, relative to their sales, and fail to clear this inventory on time to be able to buy fresh new merchandise. They end up clearing the excess merchandise at deep discounts, which affects their profitability, their brand value, and their ability to sell at full price in the future.
Some businesses face the other side of the problem, i.e not having enough inventory. This affects their ability to deliver their sales goals, and pay their operating costs.
So, identifying the right amount of inventory to buy, is one of the most critical skills to master for any retailer.
HOW MUCH INVENTORY SHOULD I HAVE?
The amount of inventory you should start your retail business with, or keep on hand all-year round is determined by your forecasted sales. Once you have established your sales budget or forecast for the year, you will be able to calculate exactly how much inventory you need to deliver those sales, as well as to have enough stock cover, so that you don’t run out of stock and lose sales in the process.
The scientific method to calculate how much inventory you should have is the Open to Buy process. It takes into consideration your sales, margins and desired stock level, and applies a certain formula to determine how much inventory you should buy.
We explain the process in details in the below video, and the rest of this guide.
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WHEN DOES THE OPEN TO BUY BUDGETING HAPPEN?
WHAT IS THE OUTCOME OF THE OPEN TO BUY PROCESS?
If you perform the OTB calculation process properly, you will get the dollar amount for purchases for the next period (e.g. 6 months), segregated into product departments or categories.
Based on that amount, you can start placing your orders from your suppliers and plan them to arrive at different intervals during that period (6 months).
In this chapter we will list the exact steps to create a retail buying plan
We will be covering in details :
- Sales Budgeting
- OTB Calculation
STEPS OF OPEN TO BUY PLANNING
Here we will explain the steps of creating a retail buying plan for a 6 months period, and we will use an example of July 2020 to December 2020. This means we want to plan for the orders that we will place in order to arrive in the period from July 20 to Dec 20.
Buying Plan Steps
- Set your sales budget
- Define your margins
- Define your targeted inventory turns
- Get your opening stock at cost
- Calculate the buying plan
STEP 1 : SET YOUR SALES BUDGET
You start by setting the sales budget for your retail stores from the time of planning, up until 6 months after the period you are buying for. In the above example that is an 18 months forecast.
If you already do annual sales budgeting for your business, you will already have the sales budget for the first 12 months. For the next 6 months you can copy the budget for the same period from this year and apply any growth/de-growth you expect.
Note: We have a step-by-step sales & margin budgeting guide in the members areas
STEP 2 : DEFINE YOUR MARGINS
Define your realized margin for the sales you budgeted and forecasted in the previous step. This should take into considerations any markdowns you will carry during these periods.
STEP 3 : DEFINE YOUR INVENTORY TURNS
How many times do you plan to turn your inventory in a year?
This is used to define the closing stock level.
For example, if the business is targeting 2 turns per year, then the closing stock should provide a 6 months cover. If the targeted turnover is 3 times per year, then the stock cover should be 4 months, .. and so on.
For fashion, 3 to 4 turns per year are considered good, so maintaining 3 to 4 months cover is appropriate.
We keep an updated benchmarks list for inventory turns and other KPIs for different retail segments. You can use this as a benchmark for your business, based on which category your business belongs to.
* Our OTB excel template displays the forward stock cover separately for each month, so the planner can increase/decrease their purchasing amount accordingly. This also helps during the year while updating the sheet with actual sales data as the months roll in, to show the current stock cover and take corrective actions if needed
STEP 4 : GET YOUR OPENING STOCK AT COST
Your opening stock is the stock value (at cost) that you carry at the beginning of the period you are budgeting for. For our example here this would be at the beginning of July 2020.
If you were budgeting for a period that starts tomorrow, this would have been your current stock value (at cost). However; since we always budget for a period well in advance (usually 6 months ahead) this would mean calculating your opening stock well in advance.
Note: If you are using the Open to Buy excel sheet, you don’t need to perform the below calculation manually. You will enter the beginning inventory for Jan 2020, and afterwards the opening and closing stocks will be calculated automatically, based on the sales figures and intakes you provide.
To manually calculate the opening stock, check the example below:
You are now in Jan 2020 and want to budget for July 2020 to Dec 2020. You will need to get the opening stock for July 2020.
This will require you to extract the current stock on hand that you have (at Jan 2020) and then subtract from it any stocks that you will sell from Jan to June 2020 and add to it any stock that will arrive between Jan to June 2020.
Current stock level (Jan 2020) at cost = 100,000$
Sales from Jan to June are 200,000$ at 60% margin
COGS from Jan to June = 200,000 $ x (1-0.6) = 200,000 x 0.4 = 80,000 $
Receiving (orders) that will arrive in March 2020 at cost = 20,000 $
Opening stock at July 2020 = 100,000 $ – 80,000 $ + 20,000 $ = 40,000 $
STEP 5 : CALCULATE THE BUYING BUDGET
THE OPEN TO BUY FORMULA
Opening Stocks + Intakes (Purchases) - Sales = Closing Stocks
This Open to Buy formula accounts for markdowns by calculating sales at cost (COGS). Opening Stocks, intakes and closing stocks are also calculated at cost value, not retail value.
Once you have defined your sales, margins and opening stocks in the previous steps, you will plug those numbers in one of the Open to Buy tools we discuss below, to calculate your total buying budget.
You will then use this budget to start placing your orders that should arrive during the budgeted period (e.g between July 20 to Dec 20). If you already have placed any orders that should arrive during this period, you will simply take this out of the budget that you have and order with the remaining amount.
The stock cover that you have defined above (covered period) means that, at the end of the budgeted period (say Dec 2020) you will have enough stock to trade until the end of the covered period (e.g until end of June 2021), even if you haven’t received any more orders after Dec 2020. This is supposed to be a safety net for your business to always have forward cover, so that your stores will never have empty shelves.
OPEN TO BUY TOOLS
RETAIL BUYING PLAN EXCEL TEMPLATE
This is the retail buying plan excel template for multi-department calculation of an open to buy budget.
OPEN TO BUY EXCEL
The template includes monthly sales and intakes, and is expandable to include more departments/ categories. The sheet also automatically calculates the forward stock cover for each category, every month, so you can increase/decrease your purchases based on the stock cover you want to target for each category.
You can use this excel sheet to create a 6 month merchandise plan, 6 months in advance. The total months on the sheet are 18 months, and we show you exactly how to fill it in the PDF attached to it. We also provide separate demo sales, margin & inventory data for you to practice using it.
The retail buying plan template is a very useful tool that is used throughout the year, and not only at the Open to Buy planning time. Once you have ordered your inventory, you can start tracking actual sales and intakes every month in the sheet, and this will allow you to always be on top of your inventory. You will be able to spot any stock build-ups quickly and take actions (like markdowns or delaying orders) on time. You will also be able to see if your stock level is becoming too low for some categories, and adjust your buying accordingly.
TERMINOLOGY OF THE OPEN TO BUY TEMPLATE
Opening Stock: The amount of stock (at cost) you have at the beginning of the period.
Forecasted/Actual Intake: The stocks you are receiving, whether already ordered or still to be ordered.
Forecasted/Actual Sales: Actual or budgeted sales for that month/period
Closing Stocks: Stocks (at cost) at the end of the period
Forward Cover: How many months your current stock on hand will cover your sales.
ONLINE OPEN TO BUY CALCULATION TOOL
The second option to calculate your retail buying budget is our online Open to Buy calculation tool, which is a quicker, easy to use, step-by-step tool for retail & ecommerce store owners to calculate their buying budget by department/category or class.
The OTB tool supports up to 6 product segments (departments/categories/classes) in one process and can be used multiple times for more segments. It operates on a period basis (not monthly), so you can choose this period to be 4 months, 5 months, 6 months,..etc, based on your entered data.
It will take you through the process step-by-step and give you at the end the buying budget segmented by the segments you entered at the beginning (e.g if you want department level, enter department sales.. if you want category level enter category sales… and so on). You then use these amounts to start placing your orders.
In this chapter we will discuss considerations linked to Open to Buy budgeting.
We will be covering in details :
- Time Considerations
- Critical Issues
- OTB Accuracy
OPEN TO BUY COSIDERATIONS
WHY 6 MONTHS OPEN TO BUY PLAN?
The reason for choosing 6 months as a default period for a retail buying plan is because usually collections are segregated into Spring/Summer and Autumn/Winter and manufacturers usually require orders to be placed 6 months in advance, so that products will be available at your stores at the right time to launch the season. That’s why it is better to have a rolling 6 months budget ready at all time.
Also when you have your OTB for a 6 months period ready, you can place your orders based on their order lead time, not necessarily 6 months in advance.
For example, you can have a distributor that ships your products once you order them, and they arrive within a week or two. In this case, you will utilize the already planned budget for that category and order 2 weeks before you need the products in your stores.
Also having a 6 months rolling buying budget ready all the time means you only have to do this exercise twice a year.
However; we do recommend revisiting your Open to Buy plan regularly and updating it with actual sales as the months start rolling, so you can rectify if you are not meeting your sales budget or if you are making much more sales than planned.
For example: If you are far behind your sales budget and still have some orders not placed you will be able to reduce those orders based on the current sales trend and avoid an overstock situation later on.
If you do not start rectifying the problem within the season, by clearing the extra stocks regularly or adjusting your buying, your OTB for the following 6 months will be automatically lower because your closing stocks will be high.
This means less Open to Buy budget to buy fresh stocks for the coming season and this will affect your sales.
DOES THE 6 MONTHS PERIOD START TOMORROW?
No, it doesn’t.
When we say we will plan for 6 months, we don’t mean starting from next month. Your next month’s buying budget should have already been set 5 months back.
If we are in January now, we should already have our buying budget planned until June.
Now, we start planning for the 6 months from July to December. So by the time you finish your OTB plan, you will have your buying set for actually the whole next year.
This is because for some products you will need enough time in advance to order them, esp. if you are dealing directly with manufacturers.
WHY IS OPEN TO BUY SO CRITICAL IN RETAIL?
Having the wrong retail buying budget means your business could be:
- Overstocked: you will end up with very high inventory at the end of the season
- Understocked: you will not have enough inventory to achieve your sales budget
WHY IS BEING OVERSTOCKED A BAD THING?
When you have too much stocks you will not have sufficient cash flow to order new products for the coming seasons, as your cash is tied to the existing stocks, hence your turnover will become slower.
Read Also: Cash Flow Management: 6 Actionable Tactics
It costs to actually hold stocks, so if you are overstocked you will be paying unnecessary costs for warehousing and handling your products.
This is why if you sell on Amazon FBA they will ask you to take back your stocks that have not been sold or they will write it off. You will be baring the cost of that too.
Amazon FBA sellers usually want to reduce their inventory storage fees, long-term storage fees and removal fees to improve their profitability. This is done by calculating a right buying budget that is connected to their forecasted sales.
Read Also: How to Reduce Amazon Storage Fees?
When you are overstocked, you will have to sell at low margins to clear merchandise. This will affect your profitability.
Read More: P&L Management: The Complete Guide
WHY IS BEING UNDERSTOCKED A PROBLEM?
You will miss your sales budget if you don’t have enough stocks to sell. You will start selling out of your best selling items first, but this will exacerbate the problem because it is those items that drive the traffic to your stores in the first place, so you will end up losing even more sales.
Besides missing your sales targets due to out-of stock situations in many of your SKUs, there is another problem with being understocked. When customers come and find you don’t have the products available and they start facing this issue frequently, they will slowly start shifting to your competitors.
At the end of the day, customers want their needs met. They don’t really bother who will meet their needs. It is your job to attract them to you and serve them, so you can get their repeated business.
This particular problem of losing marketshare to competition can be very costly to fix. You will have to spend more on customer acquisitions to win back customers that you already had them in the first place, instead of winning even more customers and growing your business.
DO I HAVE TO BE 100% ACCURATE?
Because your stock situation is dependent on your sales performance overall and also the performance of different departments within your stores, it is hard to be 100% accurate on your planning. Usually 5% deviation (up or down) is considered a good result in retail OTB planning.
As we’ve said, it is a very critical process, but also it can easily be mastered if practiced regularly.
This is also why we stress again on the fact that OTB planning is an ongoing process. You are advised to keep revisiting and updating your plan with actual sales figures as the months roll in, so you can take any action needed before it is too late.
It should also be noted that having a proper OTB budget is closely tied with having a proper sales budget. If your sales forecasting /budgeting turned out to be completely off, then automatically your OTB plan will also be far from reality. That’s because components of the OTB are purchases and sales.
In all cases, the more you practice budgeting & planning, the better your future forecasts will be.
Practice creating an Open to Buy (OTB) budget on simulated data, using our tools and templates.
Included in Premium Plus Plan
- Open to Buy Online Calculator
- Open to Buy Excel Template
- Practice with Simulated Data
PRACTICE OPEN TO BUY
Master the Open to Buy calculation process by practicing on simulated data and using our online tools and templates to create a budget.
We show you where the data is extracted from and how to use the two different methods to get the same result.
You can use the same data working sheet to prepare your own data for your business every time you use our online tool or OTB excel to calculate your own buying plans in the future.
By becoming a premium plus member, you will also learn how to:
- Set a retail sales budget for multiple stores
- Set the right prices for each category
- Plan your initial margins based on your markdowns
- Measure & analyze the productivity of your inventory by category or product
- Create a full financial plan for your business (Sales + OTB + P&L + Cash Flow)
- Learn from real-life case studies how to solve specific retail problems