A favorite subject of executives in corporate boardroom meetings is inventory. In bad times or when sales are slacking, many company leaders would tend to scrutinize inventory strategies to maximize cash flow. In better times or when sales are growing, some executives would tend to place inventory strategies on the backburner while they focus on delivering against higher demand.
Many firms recently have found that it is best to manage inventories when sales are increasing because there is often a need for greater investment in product supply to support surging demand. Executives, of course, would want to ensure the investment is spent prudently in the form of having just enough inventories: not too much in unnecessary cash tied up and not too little in having not enough stock that may lead to lost sales.
When it comes to managing inventories, several ideas are worth considering:
Eliminate slow and non-moving items
Slow-moving items are those in which sales for a period have significantly dropped against the historical average (with seasonal effects factored in) while non-moving items are those with no sales at all for the same period.
During times of high sales growth, faster inventory turnover of best-selling products may mask the dormancy of slow- and non-moving items. There have been instances where the losses from selling slow-moving items via promotions or high discounts can wipe out the gains from best-selling items. Hence, executives need to be vigilant in their monitoring of inventories.
Review inventory policy
Firms should review the movement of items and how long they are in storage especially when sales are growing. Some items may sell faster than expected thus requiring higher stock levels. Items that don’t sell as fast would naturally require less supply or inventory.
Some firms use the ABC classification of inventories where more expensive items are maintained at lower quantities than those which cost less. ABC analysis is based on the Pareto principle or the 80/20 rule that suggests 20% of items represent 80% of total revenue.
Each item class may be classified into a set of processes:
- A items – 20% of items with 80% of total revenue, requires a tight control and accurate records.
- B items – 30% of items with 15% total revenue, may need less tightly controlled and accurate records.
- C items – 50% of items with 5% total revenue, may need the simplest controls possible and minimal records.
As much as this may seem to make logical sense, ABC inventory management clashes with the thinking of keeping higher inventories of fast-moving items and less for slower-moving products. ABC preaches keeping inventories at minimal working capital value but without consideration of availability against demand.
Many companies attempt to over-simplify inventory policy by fixing a stock level based on sales. For example, a firm may declare that inventories of all items will be fixed at one-month sales. Demand patterns per item normally do not follow a regular cycle, however. Sales would always vary and inventories as a result would swing either towards over-stocking or out-of-stock.
Successful inventory managers recognize that inventories are meant to ensure firms will be able to deliver steadily to customers in recognition that supply and demand have levels of uncertainty.
Some firms have too many products. Others have too few. Whatever the case, firms who constantly review their product lines and plan what to sell and make often have a competitive edge in cost and delivery. In other words, a firm should dynamically manage its products.
Some companies plan the number of items to sell statically, that is, they review infrequently such as once a year, thinking that it isn’t economical to plan more often. In this scenario, a firm would be slow to react if actual demand for certain items isn’t manifesting against expected forecasts. Inventories would build-up, which in turn would cause adverse effects on a company’s financial condition.
Aim for value contribution
Many executives view inventory management as a non-value adding activity. That may sound logical as inventory in itself does not appreciate or contribute value. A sharp manager, however, can turn how inventories are managed into one that would add competitive value.
For example, inventory managers can focus on higher inventories of raw materials instead of finished goods, which would result in an outright reduction of working capital as raw materials are of lower cost than finished goods. At the same time, having more raw materials could allow for more flexibility in scheduling which items to produce against actual demand.
Inventory management is a critical activity whether the firm is experiencing sales growth or not. Especially when firms are investing support for revenue growth, managing one’s inventories is essential in ensuring that that investment is well-spent and yields positive financial results.
Jovy Jader is a Managing Director and a Supply Chain Management Consultant at Prosults Consulting LLP. Email at email@example.com.