An Expert Merchandise Financial Planning Guide

Total worldwide retail sales topped $28 trillion in 2022, marking a nearly 7% increase over 2021 and showing no signs of slowing through 2026, according to Statista. Merchandise financial planning (MFP) is critical for retailers that want to cash in on this bonanza. MFP can guide retailers’ decisions about budgeting and forecasting, inventory management, pricing strategies and customers’ omnichannel experiences to help them reach their financial goals. This article lays out several MFP approaches, its benefits and challenges, as well as how to create a plan for your own retail business.

What Is Merchandise Financial Planning (MFP)?

Merchandise financial planning (MFP) maps a retailer’s strategic financial goals to its merchandising, sales, channel and purchasing plans. At its most fundamental, MFP is about accurately predicting demand, stocking the right amount of inventory to meet that anticipated demand, and pricing merchandise so that customers will buy and the retailer will profit.

Key Takeaways

• Merchandise financial planning maps a retailer’s financial goals to fine-grained merchandising plans and decisions.
• The goal of MFP is to maximize profitability while optimizing investments in and management of inventory.
• Retailers can approach MFP from different levels of the business, as well as by product categories or specific products.
• MFP should take into account consumers’ omnichannel shopping preferences.

Merchandise Financial Planning Explained

Inventory accounts for a significant portion of a retailer’s budget. Expenses cover not just the merchandise but also transportation, storage, labor, shrinkage and depreciation. Merchandise financial planning helps the retailer manage and optimize its investments in inventory, ensuring that the right products are in the right place, at the right time, in the right amounts and at the right prices to maximize cash flow and profitability. And given the role of seasonality for many retailers, MFP should occur both preseason and in-season. By regularly monitoring and updating their MFP plans, retailers can respond to market trends and shifts in customer demand, maximizing their profit margins for their best-selling items, adjusting sales strategies for slow-selling products and planning promotions and markdowns as appropriate.

Types of Merchandise Financial Planning

Merchandise financial management is a key part of retail financial management and can be approached several different ways. Plans can emerge from the financial goals set up by business leaders or from input collected from different departments. Plans may also coalesce around specific merchandise or categories of merchandise. The following are the most common types of merchandise financial planning.

1. Top-Down Planning

   Top-down planning begins at the highest level of a retail business, where, for example, the owner or CEO/CFO establishes the business’s overall financial goals and targets. Then, goals are broken down and allocated to different divisions, departments or product categories. Merchandising plans that align with guidance from the top are then carefully designed to meet the executives’ goals.

2. Bottom-Up Planning

   The reverse of top-down merchandise financial planning, bottom-up MFP begins with store or product managers and others at the ground level who know their merchandise best and can assess their needs at the SKU level. This information is then rolled up and consolidated to guide the business’s broader financial objectives.

3. Key Item Planning

   Key item planning focuses on high-priority merchandise or best-selling seasonal goods, such as the hottest toys or latest electronics for the holidays. These items are often responsible for a high proportion of a retailer’s gross revenue. As a result, the retailer will want to make sure it has enough stock on hand to meet demand, though not so much that it risks overstocking or so little that it risks running out of stock, either of which can lead to financial loss.

4. Class or Category Planning

   With this MFP approach, retailers target specific classes or categories of products to inform their plans and forecasts. This process is often guided by a product merchandise hierarchy, which first groups retail products at the highest store level and then, step by step, winnows the information down to its most granular — for example, by department (womenswear and menswear), product category (tops and bottoms), product types (pants, shorts and skirts), styles (floor-length, knee-length and miniskirts), brands, colors and sizes. The primary purpose of a merchandise hierarchy is to support detailed reporting that drives smarter business decisions.

5. In-Season Open-to-Buy Planning

   In-season open-to-buy (OTB) planning is the dynamic process of managing and adjusting inventory, based on events happening within, rather than in advance of, the season. Even the best preseason planning can be stymied by events out of a retailer’s control, such as a supply chain disruption caused by a hurricane. In-season OTB allows the retailer to make the necessary adjustments to maximize its ability to (literally) weather the storm and minimize financial losses.

Merchandise Financial Planning Steps

Any plan worth its salt is backed by a methodical approach that offers the best chances of a successful outcome. MFP is no different, paving the way for better financial management, improved customer satisfaction due to better product availability and a more agile response to market changes. Here’s a breakdown of the six primary steps involved in MFP.

1. Analyze Historical Data

   The first step for the retailer is to understand both short- and long-term historical sales trends, not just by reviewing data at the top store level, but also with a deep dive into monthly or even weekly results per SKU, product category and department (mirroring the product merchandise hierarchy). Comparing actual results to what has been forecasted is also important for forward-planning purposes, as is the context of the data, so don’t just analyze raw numbers. If sales were stagnant, was there a bigger reason, perhaps, such as a rise in unemployment? Does that reason still exist?

2. Forecast Demand

   Demand Forecasting is the process of predicting customer demand for specific products and services, or categories of products and services, in the future. It involves analyzing historical sales, market trends, the economy, competitors, new target markets, the supply chain and any other factors that might influence demand, such as a marketing campaign that could potentially increase sales of a particular product category or SKU.

   Demand forecasting informs many important business decisions — including inventory planning, pricing, storage optimization and resource allocation — all of which can affect profitability and customer satisfaction.

3. Update Sales Targets

   Using data from the historical analysis and demand forecasting, and including input from internal managers, the retailer can update its sales targets for the coming season. It may also be helpful for the retailer to work with an outside consultant to gain greater understanding of what is happening on a macro level.

4. Set Target Profit Margins

   Profit margin is a critical business metric that reflects the percentage of profit derived from sales. Gross profit margin is the percentage left after the retailer’s cost of goods sold, or COGS, is deducted; net profit margin also deducts all of the retailer’s expenses and costs. By setting a target profit margin, the retailer can make strategic decisions about pricing, investments in inventory and promotional activities. As with the previous steps, setting target margins begins with a historical analysis of past performance. A competitive analysis is also critical, to see what the market can bear, as is consideration of anticipated markdowns or promotions that might have an impact on margins. The surest way to track profit margin is by using software that captures the data in real time and displays it on an easy-to-read dashboard.

5. Develop a Merchandise Inventory Plan

   Creating a merchandise inventory plan is one of the most important steps in the process of merchandise financial planning. The inventory plan lays out how a retailer will manage its merchandise to meet customer demand so as to not tie up cash in excess inventory and storage or, conversely, not have enough merchandise and lose out on sales.

6. Adjust as Needed

   The completion of an MFP doesn’t mean a retailer’s work is done. The last, but ongoing, step is to continuously track actual financial performance against the MFP and modify as appropriate. For example, if a supplier raises its price, the retailer may need to adjust its own prices to cover its increased costs and maintain a healthy profit margin. A change in customer demand could also lead to adjustments to the merchandise inventory plan.

Challenges of Merchandise Financial Planning

Merchandise financial planning is neither a quick nor a simple process. For example, achieving the right inventory levels is a constant balancing act that can easily be thrown off by unforeseen circumstances. Additional challenges involve data accuracy, lack of resources and changes in customer demand.

• Problems With Data Accuracy and Quality

  Accurate planning relies on accurate historical data. Errors in sales numbers, inventory counts or financial data can throw off forecasts and smart decision-making, resulting in lost sales, excess inventory and reduced profitability. This is why many retailers turn to software, which eliminates or greatly minimizes all of the issues that crop up with manual, error-prone tasks, such as data input and physical inventory counts.

• Lack of Resources

  Economic downturns, supply chain disruptions, political instability and other uncontrollable events can turn the best of merchandise financial plans upside down. Lack of resources, such as raw materials, can send prices skyrocketing, which increases a retailer’s COGS. That may lead to a corresponding need for the retailer to increase prices to cover its costs and still make a profit. Amid a tight labor market, adequate investment in skilled personnel, technology, training and other resources is also important for the successful implementation of a merchandise financial plan and, by extension, the overall financial success of the retail business.

• Fast-Changing Customer Demands

  In today’s retail environment, consumer preferences can shift quickly, especially in fashion and technology. Planning for the season or year ahead can be challenging when customer demand and trends are in flux. Successful retailers remain agile, invest in real-time data analytics and keep an eye on the pulse of customers’ evolving needs, all while ensuring that the foundational financial aspects of their business remain robust.

Benefits of Merchandise Financial Planning

Merchandise financial planning serves as a roadmap for retailers, guiding their inventory investments, demand forecasts, promotional strategies and financial performance. Three key MFP benefits are as follows:

• Reduced Inventory Costs

  Careful MFP strategies ensure that retailers have the right amount of inventory to meet demand, reducing instances of overstock and stockouts. This balance is critical for maximizing profitability and meeting customer expectations. But inventory costs include more than just capital expenditures. Transporting, storing, handling and maintaining inventory, known as carrying costs, can also slice into profits if not properly accounted for in MFP.

• Increased Sales

  By ensuring that popular items are in stock and that new trends become available in a timely manner, retailers can meet customer expectations, leading to increased loyalty and repeat business. And, when MFP aligns inventory with customer demand, there’s a higher likelihood of items selling at their full prices, reducing the need for unanticipated markdowns.

• Improved Profitability

  MFP is crucial not just for sales or inventory efficiency but because it also directly impacts a retailer’s profitability. By optimizing the merchandise mix, addressing pricing strategies and controlling costs, MFP can significantly enhance profit margins.

Merchandise Financial Planning and Omnichannel Merchandising Strategy

Pandemic-related lockdowns caused an undeniable shift in consumer shopping behavior. In 2020 alone, ecommerce sales escalated 43%, or $244.2 billion, according to the Census Bureau’s “Annual Retail Trade Survey.” Now past the thick of the crisis, many consumers have embraced a hybrid shopping approach that includes physical stores, online stores, mobile apps and social media platforms, along their paths to purchases. Smart retailers bake this reality into their merchandise financial plans to provide a consistent, seamless customer experience that ensures that customers can transition smoothly from one channel to the next and pick up where they left off.

MFP for an omnichannel environment requires complete visibility into inventory across all channels. Every additional channel increases the complexity of inventory management and demand forecasting — processes best left for technological solutions, such as inventory and financial management software. Retailers must also take into account the interplay between channels and plan accordingly. For instance, an email promotion for printer ink could drive customers to the retailer’s physical store, website or mobile app.

That said, no matter how many sales channels a retailer employs, its ultimate objective remains the same: to optimize its inventory investments, meet customer demand and achieve its financial goals.

Turn Your MFP Into a Financial Blueprint With NetSuite

NetSuite provides retailers with all the tools they need to manage their businesses, including inventory and financial management. NetSuite for Retail is an integrated solution that supports multiple sales channels, locations and brands, with real-time visibility into key data about inventory, financials and customers’ buying behaviors, among other insights that inform merchandise financial planning. By seeing which items are flying off the proverbial shelves, which ones are gathering dust and which might benefit from a promotional nudge, retailers are better able to adjust their inventory and pricing strategies and, ideally, continue to enjoy strong profit margins.

Anyone who has ever taken a vacation understands the planning process. First come the biggest decisions: Where do you want to go and can you afford it? Then, it’s time to figure out how you will get there, what to pack and which fun activities to schedule. These considerations, among others, are analogous to merchandise financial planning. The better a retailer can predict demand, the more likely it will meet its stated financial goals, improve profitability and enhance its customers’ omnichannel shopping experiences. MFP helps retailers align their financial goal “destinations” with the many important elements that will help them get there, including budgeting, inventory assortment, how much merchandise to keep in stock, pricing and more.

Merchandise Financial Planning FAQs

What is a merchandise financial plan?

A merchandise financial plan (MFP) maps a retailer’s financial goals to inventory purchasing and management. At its most fundamental, MFP involves sales and demand forecasting to ensure that the retailer has stocked the products its customers want, at the right price.

What are the 7 elements of the merchandise planning process?

The merchandise planning process comprises seven elements that work together to help retailers reach their financial goals. They are sales forecasting, inventory management, open-to-buy (OTB) planning, assortment planning, allocation/replenishment, pricing strategy and performance analysis.

What are the 6 P’s of merchandise planning?

The 6 P’s of merchandise planning are:

• Precision: Gathering quantitative evidence and deriving precise insights from it.
• Perspective: Identifying overarching trends and putting them in context.
• Profit: Maximizing profit margins through inventory optimization.
• Planning: Always thinking ahead.
• Persistence: Striving to get desired results.
• People: Working well with stakeholders in other departments and functions.

What is the merchandise planning process?

The MFP process involves five distinct steps: analyze historical data, forecast demand, set target margins, develop a merchandise inventory plan and adjust as needed.

What are the most important factors to consider when setting financial targets for merchandise?

When setting financial targets, retailers should start by reviewing historical sales and profitability data to identify trends and patterns that can guide them forward. It is also important that they consider the state of the economy, seasonal fluctuations, the competitive landscape and any other external factors that could have an impact on their costs, pricing strategy, sales and profitability.

How can retailers use historical data to improve their demand forecasting?

Retailers can leverage their historical data to help predict future demand for merchandise, based on an analysis of sales data, inventory performance, customer behavior, seasonal trends and external events beyond the retailer’s control, such as an economic downturn or natural disaster. Accurate data is the foundation of effective demand forecasting. With the emergence of advanced analytics tools and machine learning algorithms, retailers can be more confident in their ability to anticipate demand with greater precision.

What are the best practices for developing a merchandise plan?

Here are five best practices for creating an effective merchandise plan:

1. Analyze historical data and current market and consumer trends.
2. Update sales targets.
3. Forecast demand.
4. Set target margins.
5. Regularly review and improve.

How can retailers monitor and adjust their merchandise plan as needed?

Retailers need to proactively monitor and adjust their merchandise plans to ensure that the plans remain aligned with market dynamics and business objectives. By constantly monitoring key performance indicators and being prepared to make adjustments in real time, retailers can make sure their merchandise plan remains effective, maximizes sales, minimizes stockouts or overstocks and aligns with the dynamic nature of the retail industry.