Thursday, 26 April 2012

Why Inventory Control Matters

It takes a while to learn some lessons in business.  Eventually I learned that inventory control is really important.  Inventory control is not sexy.  But inventory control can make or break your enterprise.  Here are my top 10 reasons why inventory control matters...

1.   Inventory = cash

Inventory is not a business expense, it is an investment.  When you are buying inventory, you are trading wealth in the form of cash for wealth in the form of stuff.  Inventory is not tax deductible.  To the tax man these two pictures look the same.

2.   Warning: Volume Discounts!

If we buy twice as many we get get a lower price.  But if we buy twice as many then we will have less cash in the bank, less cash to pay salaries, less cash to invest in new equipment and less cash for research & development and advertising.  What is the cost of this cash?  Think 30% per year.  If you can save 30% and use up the inventory within a year, then it might be a good idea.

3.   Bring inventory in too soon and your cash is all tied up

Timing is everything, you want the inventory to arrive just in time.  Items should be scheduled to arrive when they will be needed, not before, not after.  This minimizes the space used for inventory, this minimizes the cash tied up in inventory.  Often blanket orders can be placed with a supplier that enable you to get a volume price based on your annual requirement but with deliveries that can be scheduled though out the year.  Tie this together with 60 day payment terms and things are starting to look good. 

4.   Bring inventory in too late and you lose customers

A store with low inventory is not a good store.  A manufacturing operation without raw material is an operation that is running at a very low level of efficiency.  Ultimately customers will go elsewhere to find the products they need.  Because customers always want products RIGHT NOW!

5.   The tax man thinks inventory and profits are the same thing

Inventory is not an expense, it is an investment.  Your profit for the year, in the simplest terms possible, are as follows;
Profit = Sales - Purchases + Change in Inventory

The taxman and auditors take your change in inventory for the year very seriously.  This is why they want you to do a physical count at the end of every year.  If you use your inventory control system for all of your inventory transaction and your sales and purchasing then you will be in a great position at the end of the year to quickly verify your inventory (perhaps counting only the top 80% of the value, which often equals only 20% of the items).

6.   Don't increase inventory to cover up for a bad inventory control system

A poor inventory control system will eventually lead to angry customers waiting for products and this will lead to angry bosses. Fortunately, there is a handy quick fix, order piles of inventory so everything is always on hand.  Unfortunately this just burns up cash and wastes money.  A far better solution is to invest in a sensible inventory control program that keeps track of all your inventory, sales and purchases and lets you know when it is time to order something.  (OfficeBooks is a good choice for that).

7.   Turns, Turns, Turns

There is more than one way to measure inventory.  The first is value, what is the total value of all my inventory?  Simple.  This is a good number to know but it doesn't capture how well you are managing your inventory.  A more interesting number is turns.  Inventory turns are the number of times (usually per year) that your inventory is replaced.  Surprisingly it can be calculated by;
Inventory turns = cost of good sold / average inventory

So if the cost of everything I sold this year was $1M and my average inventory is $500,000 then my inventory turns are 2.  Our goal is to maximize this number.   If we can increase inventory turns to 2.5 then our average inventory has dropped $400,000 and we just put $100,000 into our bank account.  If your inventory turns are less than 1 then stuff is hanging around for over a year. 

8.   More ways to waste money; Holding Costs

There are hidden, insidious costs to inventory.  These are called holding costs.  These include; counting inventory, protecting inventory from theft and damage, insuring the inventory, storing inventory, moving inventory.   Inventory takes up expensive floor space, it must be counted by people, it must be protected from damage and very frequently it must be handled and moved to make room for more inventory.  Inventory in your facility can be damaged, dropped, scratched and stolen.  So you need to buy insurance for your inventory.


9.   Use computers to monitor inventory 

Computers are great at monitoring things, and inventory levels are easy for computers to monitor provided all of the sales orders, purchasing and work orders are done on the same computer system.  Setting inventory minimums (mins) and  economic order quantities (EOQs), allows computers to make good recommendations on what actions should be taken to keep the inventory at your target levels.  

10. Use people to think and take Action

I like to have a person in the inventory control loop.  People make good decisions if they have good data.  9 times out of 10 computers could correctly issue purchase orders and work orders without any human intervention but that 1 time out of 10 can really hurt.   Maybe there is bad data or information that the computer is unaware of.  That's why we designed OfficeBooks to be semi-automatic. The system 'flags' the user to buy things or make things.  The user is really just doing a sanity check before clicking the buy button.  Does this make sense?  Does this price seem sensible?  Do we really need this inventory?  Is the minimum set properly?  Can I put this on a blanket order?  People are creative and thoughtful.  Computers are fast.  Best to combine their talents.

Good Luck with your Inventory Control!

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