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Are You Inventory Rich and Cash Poor?

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Article Summary: Poor buying practices, supplier performance issues and insufficient attention to lean inventory practices are among the major causes of having too much inventory and too little cash.

View all articles by David McMahon


Poor buying practices, supplier performance issues and insufficient
attention to lean inventory practices are among the major causes.

A contract manufacturer turns inventory 3.6 times. A furniture retailer turns inventory 4.1 times. A wholesaler turns inventory 4.4 times. What do these firms, in different businesses, have in common? They carry too much inventory. While where they each have the extra inventory may differ—raw, WIP or finished, they have too much money tied up in inventory.

From accounting and financial views, inventory is an asset, a positive, for businesses. Inventory is a buffer against uncertainty. The cycle time from when inventory is needed until it is received, sold and paid for is an important contributor to company success and longevity. The longer the cycle time is, the larger the amount of inventory that will be carried to balance against uncertainty.

Inventory turns are important. Think of it this way. The above firms are being paid every 90 days. That is essentially, what four turns really means. No one would want to get a paycheck that infrequently. That is a lot of capital tied up earning nothing while it sits unsold and an incredible float on capital. So why do businesses operate that way and accept such performance?

 

Inventory has a “limited shelf-life”. Over time the sales value of excess inventory decreases. “Dogs” and “also-rans” build up (see David McMahon’s excellent articles in the December/January and March/April issues of FURNITURE WORLD) causing less than optimal profitability and inventory yield. In addition to the capital issue, excess inventory can have a large negative impact on operations. Over-full warehouses cannot have efficient layouts. Out of date and crowded conditions make order-picking tedious, time consuming and labor intensive. For retailers who do cycle counting, excess inventory is counted too often. That’s another waste of time and labor. Many retailers who base their warehouse and distribution center needs on inflated inventory levels incur higher than necessary building and associated costs. These issues have been well covered in past FURNITURE WORLD articles.

WHAT CAUSES EXCESS INVENTORY?
Businesses do not decide to carry too much inventory as part of a strategic plan. Inventory increases creep in... it is not a deliberate business decision to tie up too much capital in inventory. The reasons for excess inventory vary but some of the common ones are:

Loss of sales fear. The fear of not having an item to sell is often stronger than the fear of not being able to sell the item. Couple this with the fact that sales forecasts are often overly optimistic, resulting in a troubling situation.

Price deals. Furniture retailers take advantage of lower prices for volumes in excess of what they need or will use in a reasonable time. Some deals may seem that they are “too good to pass up” even if it is likely that these items will sit in inventory for much longer than a best seller. Before you go off to Las Vegas or High Point, put a note in your pocket to remind you that economical purchases may actually be uneconomical.
Write-offs. Businesses are hesitant to write off inventory and take the hit on their profit and loss statements.

No measures. Some firms do not aggressively measure and manage inventory, inventory turns, inventory aging or inventory velocity. Many in our industry give inventory less than adequate recognition. Make sure that items are at least tracked by vendor and category.
Limited inventory planning. Planning is not based on demand management or similar technologies. Instead, it is more of an intuitive activity. Long lead-times for items, especially those imported, compounds the problem.

Supplier performance. There is no system in place to track and manage the performance of suppliers even when they fail to ship or deliver more than 25% of purchase orders on time. Furniture retailers who find themselves in this situation must build-in extra time to receive their orders and carry extra inventory to compensate for supplier delivery issues.

No process. Buying and ordering inventory are transactions initiated in response to a real or perceived need. Problems arise when there are no company-wide strategic processes for customers; sourcing or tactical process for sales and operations planning. Cost boosting procedures, such as expediting shipments or ordering excess inventory are indicators of inadequate processes.

One approach fits all. Inventory strategy should be segmented to reflect differences in item profitability and turn velocity. Firms end up carrying too much inventory when they apply a single strategy to “best sellers” (“A” and “B” items) as for slower turning (“C” and “D”) items.

Home furnishings retailers rarely have too much inventory for just one of the above listed reasons. This reflects a lack of underlying priority, process and control.

WHAT CAN BE DONE?
Carrying excess inventory and the problems that result do not have to be accepted as a way of doing business. Some options furniture retailers use successfully to reduce this creeping menace include:

Establish Strategy and Process. Develop a strategy and a process to manage inventory. This must come from the top down within your company. Without sustained executive commitment, this will be a frustrating endeavor. Some of the essential elements to include in a plan to eliminate excess inventory should be:

  • Measure inventory. You have to know where you are and where you are going. Develop metrics to track inventory velocity, aging and turns.
  • Implement lean across the company. Excess inventory and additional time are waste and add no value to the product (see The FURNITURE WORLD Articles, “Lean Logistics - Supply Chain Management” Parts 1-3 posted to the Operations Article archives on www.furninfo.com). Many departments can create non-value time and inventory. Lean is very similar to supply chain management with its emphasis on pull for product movement. Lean is a key tool used to identify and reduce unnecessary inventory.
  • Look at the entire supply chain. While assessing the total supply chain, distinguish the inbound supply chain from the outbound supply chain in designing and implementing the strategy. Otherwise, the cycle time and resultant inventory are blurred. Also, develop multiple transport and stocking programs to reflect the segmentation of inventory. Firms that have supply chain management as part of the core competency and strategic focus perform better in controlling inventory across the supply chain.
  • Segment inventory by velocity and by profitability. Unbundle it to understand where inventory exists, why it exists and how it occurs.
  • Make inventory part of the overall company direction with regard to its role in serving customers, and contributing to sales and profits.
  • Implement a sales and operations planning program that ties to both customer and sourcing strategies.
  • Compress time. Uncertainty and inventory buffers increase with time. Reduce the time period that starts with the need for inventory and ends with the time it is sold. This is especially important for critical items and for imports that require long transit times. Compression should occur both internal and external to the company.
  • Develop reliability. Vagaries in the supply chain compound uncertainty and increase inventory. Fostering reliability throughout the supply chain is an important focus for those who are interested in reducing uncertainty and inventory levels.
  • Be creative. Find what works for your company. Do not imitate what others do. Do not be restrained by existing company practices and “rules” that were developed for reasons that are long forgotten.

Distribution network. The location and size of your warehouse facilities was likely decided years ago.  After an initial, long overdue review, your company should review its distribution network every five years or so to make sure that the location and number of facilities is optimal with regard to cost and level of service. Being out of stock often reflects how inventory and replenishment is directed--as a process or as a series of ongoing transactions.  A process crosses the organization reflecting time, efficiency and demand planning.  Replenishment is essentially a procedure (placing purchase orders).  Procedures are used when there are no processes in place or if processes are flawed or out-of-date.  Lean and supply chain management share a bias against excess time and inventory, aka "waste".  Also warehouses often include "dogs", old, out of date inventory -- another sign of waste.

Supplier performance. Make supplier performance evaluation a key part of your inventory management and of the sourcing strategy. Manage purchase orders. There is much more than low-prices to be considered in any good vendor selection and review process.

Effect of global sourcing. Long transit times across the Pacific and other trade lanes affect the inventories that firms may carry. Analyze the impact of such sourcing and determine how to address the inventory impact.

Outside assistance. There are two options here. There is the one-time help that can be provided by a supply chain management consulting firm. There is also the ongoing approach that can be provided by a 4PL or 3PL to manage the inbound or outbound supply chain. The 4PL should be a neutral party whose focus is supply chain management and does not bring a possible “conflict of interest” as a supplier of freight or warehouse services. 3PLs and 4PLs that can “see” the supply chain, not just freight or pallets, can be valuable partners.

CONCLUSION
Increasing inventory turns and velocity is critical to business profitability and survival. Reducing inventory and preventing buildup of unnecessary inventory is not a quick fix. It takes time to develop inventory problems and it takes time and effort to solve them. In addition, it is easy to slip back into the same old bad inventory practices. A lasting solution requires constant focus and determination.


Thomas Craig is President at LTD Management, an independent management consulting firm in the supply chain management and logistics industry. Mr. Craig has strategic and tactical real world experience in domestic and international logistics, transportation (ocean, air, trucking, rail, intermodal), warehousing, information technology, outsourcing, third party logistics (3PL), globalization and supply chain management for North America, Asia, and Europe. Clients include manufacturers, retailers, wholesalers and 3PLs. LTD has extensive experience with all types of logistics service providers--domestic transport (all modes), international transport, 3PLs (both domestic and international), warehouses, freight forwarders, and supply chain software. Prior, Mr. Craig worked at General Electric, 3M, and Abbott Laboratories. He has authored articles for US and foreign print and online publications and has been invited to speak at conferences throughout the world. See more articles on supply chain management on www.furninfo.com. Questions can be directed to Tom Craig at tcraig@furninfo.com.


David McMahon is a Certified Management Accountant and Consultant with PROFITconsulting, a Division of PROFITsystems. Questions about this article, or to request a similar analysis on your financial statements contact him at Davidm@furninfo.com or call 8oo-888-5565.

View all articles by David McMahon

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