Here are five suggestions to use in directing your company’s inventory management efforts. Implement these now and you should see improved inventory turnover by year-end.
- Manage inventory as a liability. We learned in Accounting 101 that inventory is treated as an asset when a company prepares its balance sheet. But when managing inventory, treat it as a liability, a big cash-absorber that can cause severe cash flow problems. As you walk through your warehouse or manufacturing areas and see dust-covered excess and obsolete inventory in the back corner, imagine how nice it would be to convert it to cash.The people who do your planning and buying activities need to recognize the inventory implications of their decisions. An effective tool for monitoring the impact of those decisions is a Purchase Commitment Report. This report is developed by adding up the value of your open purchase orders and displaying the totals in monthly buckets. So in June, your report would give you the open order totals for purchased material due in July, August, September, etc.If you compare these totals to your sales projections, you have one element of a good cash flow forecast. Also, if the open order total for a future month exceeds the sales forecast (use cost of goods sold if available), your inventory is going up that month whether you want it to or not. The Purchase Commitment Report gives you information that allows you to avoid bringing in inventory that won’t be needed.
- Expect inventory to fill the available space. I’ve walked through hundreds of warehouses in my career. Rarely do I find one that isn’t almost full, or with open space in the racks. Before you decide to add warehouse space, especially “temporary” outside storage, challenge the organization to find a way to not take that step.We did an interesting experiment at Helene Curtis when we needed additional space for manufacturing. We painted a line down the floor of our incoming material warehouse (it was full), and said that all the space on one side of the line (20 percent of the total) was needed for a new production line. Our people accepted the challenge and made the necessary adjustments in planning and execution to free that space up.
- Measure accuracy and velocity. Good inventory management starts with measurements, not software. Record accuracy is a measure of how well your “book” inventory matches the actual count by item and location. If your record accuracy is not at least 95-98 percent, your system is giving your people bad information. If you have Bills of Material and they’re not 99 percent accurate, don’t be surprised when your manufacturing manager complains about not having the parts needed for production. If you rely on physicals to maintain inventory accuracy, consider initiating a cycle account program. You will get much better results.The most common measure of velocity is turnover. Inventory turns are calculated with this equation:
Turnover = Annual cost of goods sold
Average inventory in dollars
If you have $1 million of inventory and have $4 million annual cost of goods sold, you’re turning your inventory four times a year (4,000,000/1,000,000). Keep in mind that turn rates vary by industry and type of business.
- Reduce cumulative lead times. Your business processes each take a specific amount of time. If you can reduce that time or do more processes in parallel rather than sequentially, you can decrease the total system’s lead time. You should have less inventory in your system as a result. For example, if the purchasing people can reduce the time needed to issue orders to suppliers by two days using e-procurement techniques, two days’ worth of inventory should be permanently eliminated from your process. If new CRM software allows you to ship customer orders in two working days, rather than four, take two more days of inventory out of the business.
- People make decisions; systems and data are just enablers. People with the proper training will usually make good inventory decisions. As the company owner or CEO, if you ensure that people understand the principles of inventory management and are trained to use the systems in place, you can begin to raise the bar, lower your inventory and improve cash flow.
Vistage Associate Herb Shields is president of HCS Consulting, based in Northbrook, Ill.