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Five Ideas to Help CEO’s Manage Inventory

HCS Consulting June 2005 Newsletter

This newsletter includes 5 suggestions for company owners, COO’s, and operations management to use in directing their company’s inventory management efforts. Implement these now and you should have improved inventory turnover by year-end.

  1. Manage inventory as a liability. We learned in Accounting 101 that inventory is treated as an asset when a company is preparing its balance sheet. But when managing inventory, do not think of it as an asset, 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 are doing 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 those 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 will not be needed.
  2. Expect inventory to fill the available space. I have walked through hundreds of warehouses in my career. Rarely do I find one that is not almost full, or with open space in the racks. Before you add warehouse space, especially “temporary” outside storage, challenge the organization to find a way to not take that step. If you still think it is necessary, call me and I’ll talk you out of it. 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% 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. I still wonder what would have happened had we painted the line down the middle!
  3. 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%, your MRP system is giving your people bad information. If you have Bills of Material and they are not 99% accurate, do not 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 count program. You will get much better results. The most common measure of velocity is turnover. Inventory turns are calculated with this equation:
    Inventory turnover =
    Annual cost of goods sold
    Average inventory in dollars
    If you have $1.0 million of inventory and have $4.0 million annual cost of goods sold, you are turning your inventory 4 times a year (4,000,000/1,000,000). Turn rates vary by industry and type of business. I have benchmark data for many categories if you want a point of comparison for your business.
  4. Reduce cumulative lead times. Your business processes each take a specific amount of time. If you can reduce the amount of time or do more processes in parallel rather than sequentially, you can reduce the total system’s lead time. What gets missed frequently is the point that you should have less inventory in your system as a result. For example, if the purchasing people can reduce the time it takes to issue orders to suppliers by 2 days using e Procurement techniques, 2 days worth of inventory should be permanently eliminated from your process. If new CRM software allows you to ship customer orders in 2 working days, rather than 4, take 2 more days of inventory out of the business.
  5. People make decisions, systems and data are just enablers. People who know the company’s objectives, plans, customers, etc. will better understand the impact of their inventory decisions. 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.

Thank you for reading this newsletter. If inventory is a critical issue for your company, I would be happy to discuss any of these suggestions with you. If you know of someone in your company or in another company that would find it of interest, please forward it to them. For more information regarding inventory management and purchasing, please visit my web site www.hshieldsconsulting.com. If you do not want to receive future newsletters, you may reply and indicate that.

©2005 HCS Consulting - All rights reserved.