Some of the questions we will review in this document may seem very fundamental. That is the point. With over 25 years of assisting clients with the implementation of inventory and distribution software, I can assure you there might be one in 100 clients that know the answer to all seven of these questions. While software can solve a multitude of woes, it cannot be installed in a vacuum, assuming that all inventory problems will magically be resolved. The difficult part of implementing inventory software is gaining a full understanding of the inventory environment so the software can be configured properly. This can only be accomplished when you are able to answer the following questions about your business.
Designing and implementing a plan for inventory locations is crucial for a distributor. Obviously, arranging inventory by fast moving to slow moving in relation to your shipping and receiving area is foremost. However, certain single inventory items may need to reside in more than one row/bin location due to large volumes or physical size. Developing a clear ‘map’ of fast moving/slow moving items in conjunction with primary and secondary locations is critical. All warehouse employees must know and understand the purpose and value of inventory management and consistency.
This will also insure that inventory is more likely to remain in salable or usable condition. “Misplaced” inventory exposes you to back-orders or missed delivery dates with customers. Lost inventory can have financial effects with bankers, taxes, and cash flow.
It sounds simple – any inventory package can tell you this. But again software cannot solve all problems. Controls and processes that define the movement of inventory are actually more important. Can your inventory be moved without proper documentation – whether it be transfer, receipt, shipment, or return? If the business process is not monitored and enforced, software will not correct this problem. While physical inventories can correct on-hand balances, this is a costly investment for a situation that can be controlled with most any reputable inventory tool coupled with enforcement by management. Management must ensure that all personnel will adhere to inventory management protocols.
According to many experts in the field, on the average a company’s inventory carrying cost is about 25% of its average annual inventory investment. Knowing how to measure this and applying it routinely can help quickly point out issues that may be occurring in your warehouse, inventory stocking levels, and overall management decisions. Costs that should be included in the calculation are inventory risk costs like obsolescence, damages, pilferage, and undocumented usage – the largest component.
Of course storage space, labor, and material handling equipment will need to be included in the calculation, as well as inventory service costs like insurance and taxes. Without this knowledge, you can’t properly optimize your inventory management system, which means you can’t make informed decisions about establishing the right inventory levels.
Inventory turns over a specific period of time is calculated by the following formula:
Inventory Turnover = Cost of Goods Sold / Average Inventory
This measure tells you the number of times your inventory is sold or used during a specific time. The number that is calculated has to be put in context. A higher inventory turnover ratio indicates that inventory does not languish in the warehouse. On one hand, too little inventory in stock can lead to lost sales if product is not there to meet customer demand. This can also lead you to be caught flat-footed if there is a sudden spike in demand. A lower ratio can mean that you have a lot of capital tied up in inventory or that you have done a poor job forecasting demand. You should benchmark your ratio against your industry’s standard.
For you to meet your customer service commitments, your supplier’s on-time delivery performance is critical. Analysis should obviously include required delivery dates, but also purchase order acknowledgement, back-orders, errors, communication, and product quality. Appropriate lead-times must be in place for measurement to be taken. These lead-times must take into consideration “customary” size and time of orders.
An ABC analysis provides you a mechanism for identifying items that will have a significant impact on overall inventory cost, while also providing a tool for identifying different classifications of stock that will require different management and controls.
Typically:
“A” items represent 20% of individual stock items that accounts for 70% of the annual consumption value.
“B” items represent 30% of individual stock items that accounts for 25% of annual consumption value
“C” items represent 50% of individual stock items that accounts for 5% of annual consumption value.
The answer to this question allows you to focus on the inventory items that are really important.
The question that usually bounces back to me on this one is “What does this have to do with inventory?” Well, everything. Ultimately your business thrives or fails based on sales. Understanding the true value of your customer allows you to put the management of your inventory into perspective. This can be calculated with the following formula:
(Average Value of a Sale) X (Number of Repeat Transactions) X (Average Retention Time in Months or Years for a Typical Customer)
Once you know how frequently a customer buys and how much they spend, you will better understand how to allocate your resources in terms of customer retention programs and inventory management controls you’ll need to keep your customers -- and keep them happy.
