Implementing Effective Inventory Management

Through the end of the 1980's, most software packages for distributors placed an emphasis on sales and accounting related modules. In the early 1990's, many distributors recognized that they needed help controlling and managing their largest asset, inventory. In response to this need, several computer software companies developed comprehensive inventory management modules and systems. These new packages include many new features, designed to help distributors effectively manage warehouse stock. But after implementing new software, many distributors don't feel that they have gained control of their inventory. These wholesalers continue to face many of the same challenges they experienced with their old systems:
" Stockouts and lost sales are common while warehouses are bulging with inventory
" On-hand and available-for-sale quantities in their computer systems aren't accurate
" The return on investment from inventory is not satisfactory
In some cases, the problem lies in the computer software. Some packages still do not have the necessary capabilities for effective inventory management. In other situations, a distributor is using a software package that is too complicated. His buyers don't have the knowledge, time, and/or skills to take advantage of the system's capabilities. But the most common reason distributors do not achieve their inventory management goals has nothing to do with the computer system they utilize.
Despite what many data processing salespeople will tell you, computers do not provide solutions to inventory management problems. Computers are tools. They must be used in the proper business environment in order to work effectively. This environment is comprised of several elements. All of them must be present in order for your new inventory management system to live up to its potential. If your system is not performing up to this potential, be sure you have implemented each of the following characteristics of good inventory management:
1. Protect your company against theft - Make sure that the only people in your warehouse belong in your warehouse. Pilferage is a larger problem than most distributors realize.
2. Establish an approved stock list for each warehouse - Most dead inventory is "D.O.A" (dead on arrival). Order only the amount of non-stock or special order items that your customer has committed to buy. Before adding an item to inventory, try to get a purchase commitment from your customer. If this is not possible, inform the salesperson who requests the item that he or she is personally responsible for half the carrying cost of any part of the initial shipment that isn't sold within nine months.
3. Assign and use bin locations - Assign primary and surplus bin locations for every stocked item. All picking and receiving documents should list the primary bin location (in either characters or a bar code). With correct bin locations on documents, order picking is probably the least complicated job in your warehouse. Assign inexperienced people to this task and your most experienced warehouse workers to receiving inventory and stock management.
4. Record all material leaving your warehouse - There should be appropriate paperwork for every type of stock withdrawal. Under no circumstances should material leave the warehouse without being entered in the computer. Eliminate "no charge/no paperwork" material swaps. Product samples should be charged to a salesperson's account until they are either returned to stock or charged to the customer.
5. Process paperwork in a timely manner - All printed picking documents should be filled by the end of the day. Stock receipts should be put away and entered in the computer system within 24 hours of arrival.
6. Set appropriate objectives for your buyers - Buyers should be judged and rewarded based on the customer service level, inventory turns, and return on investment for the product lines for which they are responsible.
7. Make sure every employee is aware of the cost of bad inventory management - Inventory loss through theft, breakage, or loss must be paid for with net profit dollars. If your net profit before taxes is 4%, it takes $2,500 in new sales to make up for a $100 merchandise loss!
8. Ensure that stock balances are accurate and will remain accurate - Implement a comprehensive cycle counting program. A good cycle counting program can replace your traditional year-end physical inventory.
9. Determine the most advantageous replenishment path for each item in each warehouse - Assign one of these "paths" to each item in each warehouse:
a. Distributive purchasing - The warehouse replenishes stock with a purchase order issued directly to the vendor
b. Central Warehousing - The stock of one warehouse is replenished with a stock transfer from a central warehouse
c. Cooperative Purchasing - Several branches "pool" their needs and issue one vendor purchase order in order to meet the vendor minimum order within a reasonable amount of time
10. Specify guidelines for setting the reorder method an other purchasing parameters to maximize inventory turns and minimize stockouts:
a. Minimum/Maximum quantities
b. Economic order quantities
c. Order up to a specific stock level
d. Safety stock quantities
e. Preseason buys
11. Document replenishment procedures:
a. Line buys
b. Non-stock items
c. Price-break purchasing
d. Preseason buys
e. Importing material
12. Establish customer service, inventory turnover, and return on investment goals for the following 24 months for each branch and major product line - After each month end close, compare the goals to the actual results.
13. Initiate an on-going dead stock and excess inventory control program - Excess inventory is usually considered to be any quantity of a product greater than a 12 month supply.
a. Transfer excess stock to a branch that needs the material
b. Return the stock to the vendor
c. Lower the price of items with excess inventory
d. Substitute surplus inventory for lower cost items that are still popular
e. Offer special commissions for the sale of surplus merchandise
f. Sell the excess inventory to a competitor
g. Donate excess stock to a non-profit agency
h. Throw it out, take the "write-off" for your financial statement, and free up room in your warehouse
14. Make inventory management considerations part of corporate strategic planning.
Implementing an information management system is a lot like painting a house. When you paint a house, the success of the job is dependent on the preparation of the surface before the paint is applied. Even if you use the most expensive paint available, if the surface has not been scraped and sanded, the paint will peal off. Likewise, the most expensive system will not deliver the results expected by a distributor unless it is operating in a business environment that ensures inventory accuracy.
If you would like to discuss any of the fourteen elements of good inventory management listed above, or have any other inventory management questions, please give me a call.

Why Is Inventory Turnover Important?
...it measures how hard your

How hard is the money you have invested working for you? You’ve probably been asked that question several times by stock brokers or "investment counselors." No, I’m not going to try to sell you mutual funds. This article isn’t about how you are managing your personal investments. Instead, we are going to look at the performance of your company’s largest asset: inventory.

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The Concept of Inventory Turnover
Say you sell $10,000 worth of a product (at cost) each year. Total revenue received from sales of the product is $12,500. If we bought the entire $10,000 worth of the product on January 1st, at the end of the year we would have made a $2,500 gross profit on an investment of $10,000.

But do we have to buy the entire $10,000 worth of the product at one time? What if we bought $5,000 worth of the product on January 1st. Then, just before running out of stock, we bought an additional $5,000 worth of the product with part of the revenues received from selling the first shipment. At the end of the year we’ve still sold $10,000 worth of the product, still made $2,500 gross profit, but on an investment of about $5,000.

Could we make the same gross profit on an even smaller investment? What if we were to buy $2,500 dollars worth of material. Sell most of it. Buy another $2,500 dollars worth of the product. Sell most of that shipment and then repeat the process two more times before the end of the year. The annual gross profit of $2,500 is now generated with an investment of about $2,500.

Which investment option is better? Selling $10,000 worth of a product (and making $2,500 gross profit) with an investment of $10,000, $5,000 or $2,500? The best option is $2,500. Investing $2,500 (rather than $10,000) frees up $7,500 that can be used for other purposes... such as stocking other products that have the potential of generating additional profits.

Every time we sell an amount of a product, product line, or other group of items equal to the average amount of money we have invested in those items, we have "turned" our inventory. The inventory turnover rate measures the number of times we have turned our inventory during the past 12 months. Here is a list of the turnover rates from our example:

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The Inventory Turnover Formula

Inventory turnover is calculated with the following formula:

Cost of Goods Sold from Stock Sales during the Past 12 Months
Average Inventory Investment during the Past 12 Months

There are several things to keep in mind when calculating turnover rates:

Only consider cost of goods sold from stock sales which are filled from warehouse inventory. Non-stock items and direct shipments are not included. Sure, these sales are important, but don’t involve your warehouse stock (i.e. your investment in inventory).

The cost of goods sold figure in the formula includes transfers of stocked products to other branches and quantities of these products used for internal purposes such as repairs and assemblies.

Inventory turnover is based on the cost of items (what you paid for them) not sales dollars (what you sold them for).

Inventory turnover depends on the average value of stocked inventory. To determine your average inventory investment:

Calculate the total value of every product in inventory (quantity on-hand times cost) every month, on the same day of the month. Be sure to be consistent in using the same cost basis (average cost, last cost, replacement cost, etc.) in calculating both the cost of goods sold and average inventory investment.

If your inventory levels tends to fluctuate throughout the month, calculate your total inventory value on the first and fifteenth of every month.

Determine the average inventory value by averaging of all of inventory valuations recorded during the past 12 months.

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Turnover Goals
As you determine your inventory turnover goals, consider the average gross margin you receive on the sale of products. Most distributors who have 20% - 30% gross margins should strive to achieve an overall turnover rate of five to six turns per year. Distributors with lower margins require higher stock turnover. If your company enjoys high gross margins, you can afford to turn your inventory less often.

A turnover rate of six turns per year doesn’t mean that the stock of every item will turn six times. The stock of popular, fast moving items should turn more often (up to 12 times per year). Slow moving items may turn only once, or not at all.

Finally, calculate inventory turnover separately for every product line in every warehouse. This will allow you to identify situations in which your inventory is not providing an adequate return on your investment. To improve inventory turnover, consider reducing the quantity you normally buy from the supplier. Inventory turns improve when you buy less of product, more often.

You have limited funds available to invest in inventory. You cannot stock a lifetime supply of every item. In order to generate the cash necessary to pay your bills and return a profit, you must sell the material you’ve bought. The inventory turnover rate measures how quickly you are moving inventory through your warehouse. Combined with other measurements such as customer service level and return on investment, inventory turnover can provide an accurate barometer of your success.

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