A rising tide will float all boats. But when the water level drops, the heavy boats will hit the rocks first and suffer the most damage.
The same is true of inventory levels. High sales growth can hide waste and a growing inventory problem below the surface.
You need inventory to keep your business running smoothly. If the right inventory is not available, you may miss sales opportunities. But it is also a risk. Too much inventory adds carrying costs and it risks becoming obsolete, damaged or lost before it’s sold.
In fact, aging inventory often adds between 10% to 20% more to the purchase price of goods due to financing charges, storage and handling fees. Bad inventory management can also create a gap in cash flow as supplier invoices come due while there is no immediate sale for the goods.
Three indicators to maintain optimal inventory levels
The optimal scenario is to turn inventory into cash as fast as possible, while making sure supply is balanced with sales demand.
There are three key indicators of a healthy balanced level of inventory.
- Service level—Is the inventory item available for sale when required?
- Fill rate—What quantity of an order was filled against what was ordered?
- Inventory turns—How many times per year has the company turned over its entire inventory. Once you have calculated inventory turns you can compare your business to your industry using the free BDC tool.
Four steps to improve your inventory management
If you realize there is a need to improve inventory management in your company, use these four steps to begin problem solving.
1. Assess the situation
Using the indicators mentioned above, identify where the issues are occurring and ensure you have the right inventory levels to meet sales demand (service level and fill rate).
2. Identify excess or aging inventory
Identify which inventory items have been in your business for over 90 days.
These items are often excess or aging inventory. People may have lost sight of these items and have moved them to the back of the warehouse, top racks or hidden storage areas: “Out of sight, out of mind.”
Tagging these items and making them visual reminds us that we have an opportunity to turn these items to cash:
- They can they be returned to a supplier
- We can identify a new customer for this material
- They can be repurposed into useable items or discounted, considering we may have already assumed a 20% carrying cost
Propose an action plan with your sales and purchasing team to concentrate efforts on finding potential buyers.
3. Look for the root cause of the problem
Next, find out how why service levels are not met or how the extra inventory was collected in the first place.
- Is the low service level related to supplier lead times or purchasing methods?
- How did aging inventory become a problem? Did customer preferences change? Did we simply order too much?
Examine the reasons to help guide actions that will prevent the same mistakes from happening in the future.
4. Apply best practices and involve your team
Apply best practices such as “just-in time inventory” to predict how much inventory you will need to meet sales demand by using historical sales data, forecast, and supplier lead times. This data will help you determine the right level of inventory necessary to ensure you can meet customer requirements without burdening your cash flow.
Establish a clear target for optimal inventory levels and share it with your team. You’ll also need your team’s input to find ways to achieve the target.
Deliver what your business needs
It’s impressive to see what good inventory management practices can do for a company with the right focus.
I recently completed a project with a major industrial supply company that was able to transform aging inventory into millions of dollars in cash, in the process also freeing up shelf and floor space. Within the first 90 days of the project, two complete rows of racking and shelving were vacated and three million dollars worth of dead stock was converted to cash.
Digging into the underlying issues causing the inventory problems, we also improved processes to deliver what the business needs while saving time and resources. Improved purchasing processes and tools helped the company negotiate better prices and delivery from their suppliers to better meet sales demand.
Are you looking for inventory management solutions at your business? Contact us.
BDC experts work everyday to ensure Canadian entrepreneurs have the right systems, parameters and processes in place to ensure effective inventory management practices.