Open to Buy (OTB) is a foundational financial control mechanism used by retailers to manage inventory investment. This system provides a systematic approach to merchandise planning, preventing a store from overspending on stock that may not sell. By aligning purchasing with sales expectations, OTB ensures a business maintains optimal stock levels to meet customer demand. OTB is designed to maximize sales opportunities while minimizing the financial risks associated with excess inventory.
Defining Open to Buy
Open to Buy represents the dollar amount a retailer can spend on new merchandise within a specific time frame, typically calculated monthly. It is a calculated budget figure that determines the purchasing power available to a buyer to achieve their inventory goals and sales projections. The OTB calculation ensures that inventory levels remain balanced, meaning there is enough stock to support expected sales without creating an unmanageable surplus. This budget is dynamic, changing throughout the period based on actual sales performance and any unanticipated markdowns taken.
The calculation identifies the gap between the inventory a store needs and the inventory it currently has or has already committed to buying. Retailers use OTB to maintain a healthy stock-to-sales ratio, which measures how much inventory is on hand compared to how much is being sold. A positive OTB indicates the retailer has funds available for new purchases, while a negative OTB signals an overstocked position that requires corrective action.
Why Open to Buy is Essential for Retail Success
Effective use of Open to Buy planning directly supports sound cash flow management by controlling the outflow of capital for inventory purchases. By setting a precise spending limit, the tool prevents the common pitfall of overinvesting in stock, which can tie up working capital and strain financial resources. This financial discipline is a primary factor in maintaining the operational stability of a retail business.
OTB also plays a significant role in maximizing profit margins by mitigating the need for excessive markdowns. Overstocked inventory often forces retailers to discount goods heavily to clear space, directly eroding profitability. Conversely, the system helps minimize lost sales opportunities that arise from understocking, ensuring that popular items are available when customers are ready to buy them. Maintaining this optimal balance between supply and demand is a direct benefit of adhering to the predetermined OTB budget.
Key Components of the Open to Buy Formula
The calculation of the Open to Buy figure requires several specific inputs that reflect both sales expectations and current inventory status.
Planned Sales represents the anticipated revenue for the period, serving as the foundation for how much inventory will be required to support those transactions. Planned Markdowns are the anticipated reductions in price that a retailer expects to take on merchandise during the month due to promotions or clearance. These are included because marked-down items reduce the inventory value and must be accounted for in the budget.
Planned End-of-Month (EOM) Inventory is the desired dollar value of stock remaining at the end of the planning period. This figure is set to support the sales goals of the following month, ensuring a seamless transition of inventory levels. Beginning-of-Month (BOM) Inventory is the actual dollar value of the stock physically present in the store or warehouse when the period begins. Committed Orders represent the value of stock that has been purchased from vendors but has not yet been received.
These variables are integrated into the formula to provide a holistic view of inventory needs. Planned Sales and Markdowns represent the inventory that will leave the store, while the EOM dictates the desired ending balance. The BOM and Committed Orders represent the inventory already secured, making the OTB the purchasing gap that must be filled.
How to Calculate Open to Buy
The standard equation used to determine the Open to Buy figure aggregates the inventory needed and then subtracts the inventory already available. The formula is expressed as: OTB = (Planned Sales + Planned Markdowns + Planned EOM Inventory) – (BOM Inventory + Committed Orders). This structure ensures that the final purchasing budget precisely targets the difference between the necessary stock and the current stock.
To illustrate this calculation, consider a scenario for a retailer planning for the month of March. The retailer sets Planned Sales at \$50,000, anticipates Planned Markdowns of \$5,000, and targets a Planned EOM Inventory of \$120,000. At the start of March, the BOM Inventory is valued at \$130,000, and the retailer has Committed Orders totaling \$10,000.
Plugging these figures into the formula, the required inventory is (\$50,000 + \$5,000 + \$120,000), which totals \$175,000. The available inventory is (\$130,000 + \$10,000), totaling \$140,000. Subtracting the available inventory from the required inventory yields an OTB of \$35,000 for the month. This \$35,000 represents the exact dollar amount the retailer can spend on new merchandise to hit all their planned targets.
Applying Open to Buy to Purchasing Strategy
Once the Open to Buy figure is calculated, buyers use this dollar amount as a tangible budget for placing new orders with vendors. The total OTB is typically allocated across different product categories or departments based on their individual sales performance and inventory needs. For example, a buyer might assign a larger portion of the OTB to a high-performing category like footwear and a smaller portion to a slower-moving category like outerwear. This allocation process ensures that purchasing efforts are strategically focused on areas that generate the highest returns.
Retailers often employ a concept known as a rolling OTB, which means the budget is continuously adjusted based on actual performance rather than being fixed for the entire month. If a store’s actual sales exceed the planned sales mid-month, the OTB figure automatically increases because more inventory was sold than anticipated. Conversely, if sales fall short or markdowns are higher than expected, the OTB decreases, signaling a need to slow down purchasing to prevent overstocking. This constant reconciliation provides buyers with real-time purchasing guidance.
The OTB figure guides not only the dollar amount of purchases but also the timing and mix of inventory acquisitions. Buyers utilize the budget to decide which vendors to place orders with and how deep to buy into specific styles, colors, and sizes. By adhering to the OTB limit, the purchasing team maintains financial control and ensures that every dollar spent on inventory is aligned with the overall merchandise plan.
Limitations of Open to Buy Planning
The effectiveness of Open to Buy planning depends heavily on the accuracy of the initial sales and markdown forecasts. If the sales predictions are significantly inaccurate, the resulting OTB figure will be flawed, leading to either overstocking or stockouts. A steep, unforeseen drop in customer demand, for instance, can quickly render a calculated OTB budget obsolete, requiring immediate and often difficult adjustments.
OTB planning can also introduce rigidity into the purchasing process. The fixed budget may make it challenging for buyers to capitalize on unexpected buying opportunities, such as a vendor offering a deep discount on desirable merchandise. This structure is difficult to manage when faced with unforeseen supply chain disruptions or sudden shifts in consumer trends that require quick inventory reactions. The system works best when market conditions are relatively stable and predictable.