While inventory management directly benefits your business and your customers, it’s also critical to ensuring that your manufacturing and your raw materials supplies are efficiently managed. When you run out of raw materials, it’s costly and adversely affects your ability to supply your customers demand.
Calculating inventory turns
By having the number of inventory “turns “ optimised (times you sell through your inventory) it ensures you will earn the best possible return. Too few turns mean products age in inventory, so they’re less likely to be sold at the full retail price. Plus, they take up space. Don’t think of inventory as a product on your shelves. Think of it as money laying there dormant, that could be in your pocket.
It is important to calculate yearly inventory turns. First, determining the Cost of Goods Sold (COGS) over the past year. Divide your COGS by your average inventory on hand. That’s the number of inventory turns you had over the past year. Here’s a simple example: say your COGS over the past year is $300,000.
Your current inventory is valued at $60,000. Calculate inventory turns as:
$300,000 ÷ $60,000 = 5 inventory turns over the past year.
If you want to calculate the average number of days required for inventory to turn, divide 365 by your 5 inventory turns to get 73 days. This is the average time it takes to turn your inventory.
How many inventory turns should you have?
Though it varies by industry, generally acceptable turn rate is between five and 10 inventory turns per year. A figure in this range indicates you’re keeping your inventory at a reasonable level. It typically means that you are buying the right amount of inventory at the right time to cover your normal demand. Using our example, although at any given time your inventory may be higher of lower, you will always have, in stock or in the pipeline, a supply adequate to cover the next 73 days.
Both high and low inventory levels are bad
When your inventory turns are low you have to begin to think about what you are going to have to do to liquidate slow-moving items. You all know that liquidating means turning something material into cash. The primary object of liquidating old inventory is to turn it back into cash to buy more stock that will turn over faster.
Profit happens when you generate more cash than you spent to acquire your inventory. It’s unfortunate that you typically use the term “liquidate” only when a business is trying to sell dead or slow moving stock or going out of business.
An excessively high number of inventory turns indicates that your business is likely running out of products too quickly. Meeting customer demands becomes unreliable. This can happen as a way to cope with limited production capacity at your business or at a supplier’s.
It could mean that something in the market has created unusually high demand, a situation that is out of your control. Like a media mention of your key product at holiday time. Or, it could mean that you are not purchasing adequate quantities. This can be a sign of a business being cash-poor.
How to maintain the optimum inventory level
The correct amount of time it should take you to turn over your inventory depends on what industry you’re in. Groceries (low cost and often perishable), for example, need a higher turnover rate than luxury automobiles (high cost and expected to last a long time).
Inventory turns aren’t glamorous, but they are metrics that provide vital clues about the health of your business. It is unfortunate that too many small businesses tend to not to monitor inventory turns, relying on their ‘gut feelings’. Unfortunate because inventory turns are something that is totally under your control and can have a direct impact on cash flow and profit.
Think of it this way: You have cash in the bank and you have cash on your shelves in the form of the product. If you are short on cash in the bank but have lots of it tied up in the product on your shelves, you need to convert what is on the shelves into cash. The bank won’t let you deposit your inventory into your bank account.
Establish a critical parts list for customers and your business
In establishing the critical parts to keep on hand, first, think about the customer. What are the critical parts they will require to ensure your product can keep working? Identifying critical parts for your products can greatly enhance your customer’s experience. There is nothing more frustrating for customers when they have to wait for simple parts that are holding them up.
There are several elements involved in determining the status of critical repair parts in plant and equipment maintenance and operations. Some of these parts are essential to the operation of production equipment in a manufacturing plant. Other parts do not have such a severe impact on production. When it comes to office supplies, you don’t want to be running out of printer toner when you are desperate to deliver a sales quotation.
To determine what parts need to be held on site as critical or insurance spares. An analysis is conducted to rank the probability and severity of impact on the production process or employee safety if the equipment were to fail and the ability of the production process to run effectively.
When spare parts and equipment assemblies are identified as critical, the second phase of the decision process begins. That is deciding on the amount of inventory to keep on hand related to a suppliers ability to supply on demand. Alternative suppliers should also be considered and ranked behind your main supplier.
Use your critical parts list to mitigate risk
A risk analysis that evaluates the lead time from the time the order is placed with the supplier until receipt of the item on the site, is important. This affects the decision to stock the part as critical inventory. The reliability of the supplier to meet the expected lead time for the part should also be a part of the risk analysis. Suppliers providing critical spare parts should go through a certification process and be under contract to mitigate unexpected lost production time and delayed deliveries.
When parts availability is limited to a single supplier, the question needs to be asked, “What is the financial status of this supplier?” If there is a possibility that the supplier could go out of business, the decision might be to buy what is available and hold the parts in inventory to mitigate that risk.
When parts are obsolete or the manufacturer is no longer producing these specific parts. The decision might again be to purchase the available parts and hold them in inventory as a hedge against possible equipment failure.
Where critical parts are involved with a particular product, some businesses provide the customer with a pack of critical parts. This can be a real customer service, particularly if the customer is in a regional, or remote area.
Planning your inventory
Inventory planning is the practice overseeing and controlling the ordering, storage and use of components that you use in the production of the items you sell. It is also the practice of overseeing and controlling the quantities of finished products ready for sale. This might include demonstration stock, floor stock and lay-bys. Why not use the ‘one-page business plan’, to start planning your inventory management, https://goo.gl/OpxiUR.
Integrate inventory management with your business model and supply chain
When one of your suppliers runs out of raw materials. It’s costly to them and adversely affects their ability to supply you the products your customer’s want and need. Ensure your inventory management is closely linked to your business model and supply chain. The more integrated and the better planned and managed these two things are the more efficiently and profitably the business will operate.
While inventory may only be a small part of your business, good inventory planning can have a big impact across many of your business activities. Have you ever watched an employee cringe when a customer enters your business? Because they don’t believe the goods the customer wants will be available.
Financing your inventory
Today, enterprise software gives you the tools you need to connect and manage your entire business. From financial and supply chain management and from inventory, manufacturing to operations and marketing. The modern software provides you with the insight you need to make smart decisions at an affordable investment. Most software is modular, so you can start with what you need and easily adapt as your needs change.
Inventory financing is a form of asset-based lending that allows you to leverage your inventory. This can help improve your cash flow and provide funds to pay for business expenses or to purchase additional inventory. This type of financing is useful if you are unable to get longer credit terms from suppliers, or you need the cash for other purposes.
Negotiate your supplier terms and conditions.
Negotiating the right deal with your suppliers doesn’t necessarily mean getting what you want at the cheapest possible price. You may want to negotiate other factors such as delivery times, payment terms or the quality of the goods. There’s a range of key considerations you need to bear in mind when setting objectives for purchase negotiations.
Points in negotiations might include
- Suitability of their supplies so you can provide the best value for customers.
- Price is important so you can maintain adequate margins.
- Value for money needs to be consistent and reliable.
- Availability is critical because you don’t want to be out of stock.
- Type of agreement required by both parties must be clear and enforceable.
- The supplier relationship with your competitors so they don’t compromise.
- Payment terms and conditions need to be flexible to meet market conditions.
- After-sales service and maintenance arrangements because you don’t want to be caught short.
- Possible dealings with your customers need to be clearly understood and respected.
- Returns policy should be clearly defined to avoid conflict.
- Quality must match your customer’s expectations.
- Logistics considerations so unnecessary costs are not incurred.
Before you start to negotiate, draw up a list of the factors that are most important to you. Decide what you are, and aren’t prepared to compromise on. Most business owners would view a good deal as one that meets all their requirements.
Take a careful look at your cash flow budget, a good supplier might be able to extend terms to help you through a difficult trading period. If you want to do more business with the supplier in the future, you should aim to strike a deal that both parties feel comfortable with.
There are many other factors to consider, such as whether you want to do business with a particular supplier again. Both sides should conclude a negotiation feeling comfortable and happy with the agreement. Negotiations can be unsuccessful if either side feels forced into a corner.
Be careful with returns from customers.
You can ask about their preference of a free repair, replacement or refund. But they are not always entitled to a refund. For example, the consumer guarantees do not apply if the customer received what they asked for but simply changed their mind. They could have found it cheaper somewhere else, or decided they did not like the purchase or had no use for it.
You need to have a very clear written policy statement of customer returns. However, you know your good customers and customer service should be a high priority.
Use your inventory to improve growth potential
Effective inventory management is at the core of supply chain management excellence. While it sits at the intersection of demand and supply many businesses have a poor understanding of inventory management practices. In fact, it is really only in the last decade that the direct link between inventory management efficiencies, cash flow and the customer experience, have finally been recognised.
If you are worried about finding new customers, try using your inventory as a magnet. Customers will seek you out if they know you have the right inventory immediately available and they will quickly spread the word. What inventory items do you have, or could have, where you could dominate your local market with the breadth and depth of the products.
When I was in the farm machinery business, we used our spare parts inventory as a point of difference. Our business was grossly overstocked but we managed an order fill rate above 90%. This gave our customers the confidence to buy our machinery over the competition. They used to come from hundreds of kilometres away, bypassing several of our competitors.
I recall visiting a retail shop in a very small remote country town of about 1,700 people. This shop had tens of thousands of dollars worth of expensive model trains in stock. I couldn’t work out how he justified such a large inventory until he told me his customer base extended across a several hundred kilometre radii containing several hundred enthusiasts.
There is an argument for holding excessive inventory and introducing new lines and ranges as it can greatly improve your customer service. And it is this kind of leadership that can improve your business leadership through better customer experiences.
Logistics and warehousing
Computerise your inventory management, warehousing and logistic are no longer considered to be ‘rocket science’. Make your inventory easy to find, putting common parts and critical parts where you have quick access. It may pay to have separate inventory of critical parts and parts for production.
Colour coding your storage bins will certainly help because it makes it easier to locate items.
Logistics and warehousing are integral parts of your supply chain. The first thing you should do is to think about the solutions to be used strategically. This is an area where a lot of time and money can be saved with good efficient inventory management. Improvements in logistics involve the management of the flow of inventory items between the point of origin and the point of consumption in order to meet the requirements of customers.
Being able to do this better and faster can give you a distinct competitive advantage. If you can measure all the processes involved, your competitive advantage will show quite amazing returns on your investment. It was Dell Computers who came out with their build-on-demand process, where they are able to keep a zero balance inventory.
This means they don’t purchase parts until an order is received. It is a way to greatly reduce overheads since you don’t need to warehouse parts or overstock parts you may not end up using.
Computerization and automation have changed the nature of work with logistics and warehousing. Specialised and higher-level computer skills, problem-solving and analytic skills, and more sophisticated contract management practices are driving a more integrated approach to inventory management. There is nothing like losing a good customer to focus attention on what needs to be done.
“When you can’t control what’s happening, challenge yourself to improve inventory management as a way to improve your customer experience and competitive advantage”. Peter Sergeant
“There are two ways to extend a business. Take inventory of what you’re good at and extend out from your skills. Or determine what your customers need and work backwards. Even if it requires learning new skills. Kindle is an example of working backwards”. Jeff Bezos