The success of any retailer or product-based company relies on stocking the right inventory at the right time. With a defined purchase budget for each sales period, it’s important to identify the exact inventory that will meet customer demand.
Open to buy planning is a strategy that can help meet that demand by helping companies calculate the number of products they need to purchase. While it’s useful for all types of businesses, open to buy is particularly helpful for retailers that carry a wide range of inventory or specialize in seasonal products.
What is open to buy?
Open to buy (OTB) is a financial budget used to plan retail inventory purchases. It accounts for several factors, including beginning-of-month and end-of-month inventory, planned sales, and planned markdowns, to determine how much merchandise a retailer should purchase for a given period.
Note that OTB only calculates the right amount of merchandise a retailer should purchase, not the specific type of merchandise to purchase.
In its simplest form, OTB shows the difference between how much inventory is on-hand and how much is needed. By comparing current inventory levels with what’s expected to sell, OTB serves as an inventory management strategy that helps companies meet customer demand while reducing excess spending.
OTB planning can be applied to all levels, including all inventory types, specific product categories or departments, or even a single item.
How to use the open to buy formula
The OTB formula is based on previous inventory performance and future sales predictions. As such, the formula’s results cannot be taken as exact figures. They’re estimates to use as a framework in your inventory plans, as well as a way to detect any changes in product sales month-over-month.
As a financial budgeting tool, OTB can be calculated in dollar amounts or product units. However, dollar amount is the preferred method — either product cost or retail value — as it eliminates any pricing variation.
The following formula is used to calculate open to buy:
Open to buy = Planned sales + Planned markdowns + Planned end-of-month inventory – Planned beginning-of-month inventory
The OTB formula references the following terms:
- Planned sales: The dollar amount of retail sales projected within the given period
- Planned markdowns: The dollar amount of all discounts or price reductions planned within the given period (includes any temporary or permanent markdowns that lower the original selling price)
- Planned end-of-month inventory: The dollar value of all inventory that’s expected to remain at the end of the month (planned ending inventory carries over as the following beginning-of-month inventory)
- Beginning-of-month inventory: The dollar value of all the inventory that’s expected to be available for sale at the beginning of the month
Let’s look at an example of how the open to buy formula would work for a retail store during the month of December.
Say the retailer expects to have $40,000 worth of inventory at the beginning of the month. Based on previous sales data and demand forecasts, it anticipates total sales of about $95,000 in the next month.
The store also holds an annual holiday promotion where all Christmas items are discounted by 20%, for a total planned markdown of $5,000. At the end of the month, the retailer expects to have $10,000 worth of inventory.
In this case, the retailer's OTB equals $70,000, using the calculation below:
$70,000 = $95,000 + 5,000 + 10,000 – 40,000
4 Benefits of open to buy planning
Open to buy planning is used in retail merchandise planning across every industry. It’s a simple and straightforward method to determine how much of a product should be purchased to generate the most profit. By informing your inventory purchase decisions, OTB brings a number of benefits.
Achieve optimal inventory levels
Investing in the right inventory is a top priority for retail businesses. Too much spend ties up cash flow and can leave you with aging inventory or deadstock, while insufficient merchandise can lead to stockouts or lost sales. OTB helps you find the optimal on-hand stock levels based on clear calculations and collected data.
Maintain inventory flexibility
Rather than planning the amount of inventory for the entire quarter or year, OTB is usually applied to shorter weekly or monthly periods. This gives companies more flexibility to adapt their inventory to unexpected market changes or customer demand.
For example, a retailer that commits to a yearly purchasing plan will need help to respond to faster trend cycles. Companies that use OTB, on the other hand, have more flexible retail strategies and can quickly adapt their product selection to capture profitable, time-sensitive opportunities.
Reduce overspending
In addition to being an inventory management strategy, OTB is also a financial budget intended to optimize cash flow. Retailers are able to determine actual product purchasing costs, which they can then compare against their budget allocation.
By calculating product purchases for shorter time periods, rather than a lump annual spend, OTB avoids overspending and ensures sustained inventory investments for future purchases.
Identify and respond to trends
With shorter planning cycles and insights from historical sales plans, OTB helps retailers pinpoint when trends start to rise and fall. Reviewing inventory turnover rates and promotions on a weekly or monthly basis allows for a more granular view, and enables companies to capitalize on smaller trends.
When open to buy planning isn’t a good fit
Open to buy planning is recommended when selling seasonal or trend-based products, such as fashion accessories or apparel. The strategy is less effective for a store’s staple items, like bottled water at a grocery or mattresses in a home goods store.
Staple items typically sell at the same rate throughout the year, without much fluctuation, and should always be kept in stock. In most cases, companies are better off with a supply chain that automatically purchases their core products in bulk to decrease per unit costs and increase profit margins.
OTB planning may also not be worth the time and effort for retailers with few SKUs. Calculating and replenishing the amount of stock at high frequencies requires detailed work, and is likely unnecessary for fewer products. In these cases, setting automated reorder points with a best-in-class solution like QuickBooks Enterprise is often a better option.
How QuickBooks supports open to buy planning
QuickBooks Enterprise offers real-time inventory visibility and automations that reduce manual errors and inventory carry costs to improve cash flow.
QuickBooks Enterprise comes with 14-built-in retail-specific reports that you can customize to pull essential data and make better decisions. This functionality offers instant visibility into key metrics, automatically displaying all the information to calculate your OTB. Plus, Enterprise can also generate all necessary purchase orders for upcoming sales periods from the same dashboard.
Final thoughts
Open to buy planning is a trusted strategy that helps retailers determine the ideal quantity of products to purchase. Drawing from previous sales numbers, inventory levels, and upcoming promotions, the formula clearly shows how much inventory is needed to meet market demand as efficiently as possible.
Implementing an OTB strategy not only keeps inventory purchases within budget, but also reveals upcoming trends and increases your company’s ability to respond quickly to market trends.
