How to Turn Inventory Management into a Business Asset
When prospective buyers conduct a due diligence review of your business, and ask about your inventory control systems, how will your answer affect their offer?
When you are seeking additional credit from your banker, how will they value your inventory?
In the eyes of the buyer or the banker, your inventory may not have the same value that it did in the past.
This newsletter will provide you with four actionable suggestions on how to insure that your inventory has the most value to you and, when necessary, to prospective creditors or buyers.
The key metric for managing and valuing inventory is turnover or "velocity." We like the term velocity because it reminds us that inventory at rest is costing your company money. Inventory that is moving through your process - that is being picked, packed, etc. is potentially earning money. Turnover is defined as follows:
Inventory turnover = Average cost of goods sold / Average inventory
There are two ways to improve turns:
1. Sell more with same amount of inventory
2. When sales are declining reduce inventory at a faster rate than the sales decline
Inventory accuracy is critical to keeping your customers satisfied, for insuring your buying decisions are made correctly, and for demonstrating to your bank that your numbers are reliable. Annual physical inventories only guarantee accuracy for a brief time. Soon after you finish, your inventory counts can change. So, if your annual inventories only remain accurate for thirty days, you're operating with inaccurate data 92% of the time.
In addition to knowing how much inventory you have in stock, you also need to know where it is. If location accuracy is not 99+% in your warehouse, inventory decisions will cause disruptions in scheduling and customer service. The best way to develop and maintain location accuracy is a cycle count program.
Cycle counting is done on a regular basis, either weekly or daily depending on the size of the warehouse and the number of items. A cycle count team - one warehouse person and someone from either inventory control or finance - should count a selected group of items. Then they should reconcile the physical count with the computer record, book the adjustment, and do a root cause analysis. The benefit of cycle counting is that when you do it regularly, and address the root causes of errors, accuracy will improve.With cycle counting, inventory accuracy is improved, and prospective buyers gain confidence in the accuracy of your financial data because they see effective management systems and procedures in place.
A third element of effective inventory management is "chunking." Most companies measure 'turns' for the entire business and think they can mange inventory at the "macro" level. Don't stop there. Inventory decisions are made at the item and product family level of detail. You need to find the manageable "chunks" of inventory for your business - i.e. product lines, locations, customer specific, etc. When you can measure the turns for each chunk, you can make fact-based decisions about how much inventory to buy and hold.
A fourth important inventory management measurement is forecast accuracy. Forecast accuracy directly impacts the amount of inventory in your system and how many turns you can achieve.
While sales people may resist the idea of forecasting sales, they are certainly the best source of information regarding what their customers are likely to buy over the next 6-12 months. There is also some history regarding sales data except for your newest products and customers. Start measuring forecast accuracy, it may never be 90+%, but even small improvements can result in inventory reductions.
Cumulative Lead Time
Finally, identify your company's cumulative lead time - any permanent reduction in lead time should result in smaller inventories. Consider the lead time to purchase material from suppliers and your internal lead time to process orders, pick and pack, and the transit time to your customer. Can you find activities in your supply chain process that can be done in parallel, rather than sequentially, that will diminish lead time and inventories?
Velocity...Accuracy... "Chunking"... Forecasts... and Lead Time.
Sounds like a lot to do when you already have a full plate, but the fact is it's easy to implement and maintain these processes.
Better performance today, and a higher price tag for your business in the future.