The first thing that most retailers do to increase store profitability is to try to raise sales revenues. They do this by advertising more, increasing their sales staff, expanding display space, enlarging the store, or running a sale.

Every one of these actions increase cost. There is also a not-so-obvious area of improvement that can increase profits without increasing overhead. If you're not turning your inventory at least three times and if you're not producing a GMROI (Gross Margin Return of Inventory) of at least $2, you're probably not turning your inventory rapidly enough. Over inventory is the culprit that adversely affects profits almost as severely as just plain "sloppy management".

There are so many direct and indirect expenses that are related to inventory. GMROI is the first indicator as to whether your net profits are satisfactory. It is a fairly well-accepted fact that the cost of carrying excess inventory can add up to 30-40% of the cost of the inventory, In other words, a store carrying an excess of $100,000 in inventory can expect a $30,000 to $40,000 annual excess in operating expenses.

Remember, you've got cost of money, cost of insurance, warehouse occupancy costs, additional handling costs and repairs caused by crowding. These costs are hidden in bits and pieces under many general ledger headings. If they were all gathered together under one account heading called "inventory carrying costs, the magnitude of the cost, and thus the seriousness of the problem, would be more readily seen.

All of the above are just the tip of the iceberg. The most serious cost of being overstocked relates to the fact that overstock almost always results in cash flow problems or a warehouse space problem that prevent a store from being able to stock good sellers in sufficient quantities to keep them in stock even half the time. It's an established fact that the 20% of a store's items that are cumulatively producing 80% of its gross margin are individually in stock only about 1/3 of the time. If we were able to reverse that ratio...instead of 1/3 of the time in stock and 2/3 out, keep them in stock 2/3 of the time and only out 1/3, thereby doubling in stock days... sales would theoretically be 80% higher. They wouldn't actually be 80% higher, because when stores are out of stock of good sellers, they are successful in selling substitutes some of the time. If this figure is divided by 8 to be conservative, thus assuming 10% lost sales due to good-seller stock-outs, the cost of good-seller stock-outs in a store doing $1,000,000 a year could amount to $100,000 in sales and approximately $25,000 in net profit after variable expenses.

Stores who find themselves overstocked, oftentimes take excessive, short term markdowns in their attempt to raise cash and this alone in a store doing $1,000,000 a year can amount to over $10,000 in excessive markdowns.

The owner of a $1,000,0000 store carrying $100,000 over-inventory could be 'spilling more than he or she drinks" due to: excess carrying costs; loss of profits from good sellers out of stock; and excessive markdowns.

Here are the answers to the problem. Since everyone knows that most stores produce 80% of their gross profit on 20% of their selection, make it a point to identify the items that fall into these two categories. Make a special point of staying in stock in the items that are selling rapidly and create an orderly methodology of regularly marking down slow movers to get them out of stock. Make an effort to turn those slow movers into cash and put that money into stock of the fast movers. Regular and orderly incremental markdowns will move out your slow sellers rather than holding them for a once or twice a year parking lot sale where you give the goods away because you only have one shot at it.

Be sure you're making at least $2 GMROI before you start expanding your business on a slippery foundation. In other words you should be making a gross profit of at least $2 on every $1 in inventory. That relates directly to the old fundamental of a 40% margin and a three time turn.