Controlling
Inventory
Controlling inventory
does not have to be an onerous or complex proposition. It is a process and
thoughtful inventory management. There are no hard and fast rules to abide by,
but some extremely useful guidelines to help your thinking about the subject. A
five step process has been designed that will help any business bring this
potential problem under control to think systematically thorough the process
and allow the business to make the most efficient use possible of the resources
represented. The final decisions, of course, must be the result of good
judgment, and not the product of a mechanical set of formulas.
STEP 1:
Inventory Planning
Inventory control requires inventory planning.
Inventory refers to more than the goods on hand in the retail operation,
service business, or manufacturing facility. It also represents goods that must
be in transit for arrival after the goods in the store or plant are sold or
used. An ideal inventory control system would arrange for the arrival of new
goods at the same moment the last item has been sold or used. The economic
order quantity, or base orders, depends upon the amount of cash (or credit)
available to invest in inventories, the number of units that qualify for a
quantity discount from the manufacturer, and the amount of time goods spend in
shipment.
STEP 2:
Establish order cycles
If demand can be predicted for the product or if
demand can be measured on a regular basis, regular ordering quantities can be
setup that take into consideration the most economic relationships among the
costs of preparing an order, the aggregate shipping costs, and the economic
order cost. When demand is regular, it is possible to program regular ordering
levels so that stock -outs will be avoided and costs will be minimized. If it
is known that every so many weeks or months a certain quantity of goods will be
sold at a steady pace, then replacements should be scheduled to arrive with
equal regularity. Time should be spent developing a system tailored to the
needs of each business. It is useful to focus on items whose costs justify such
control, recognizing that in some cases control efforts may cost more the items
worth. At the same time, it is also necessary to include low return items that
are critical to the overall sales effort.
If the business experiences seasonal
cycles, it is important to recognize the demands that will be placed on
suppliers as well as other sellers.
A
given firm must recognize that if it begins to run out of product in the middle
of a busy season, other sellers are also beginning to run out and are looking
for more goods. The problem is compounded in that the producer may have already
switched over to next season’s production and so is not interested in (or probably
even capable of) filling any further orders for the current selling season.
Production resources are likely to already be allocated to filling orders for
the next selling season. Changes in this momentum would be extremely costly for
both the supplier and the customer.
On the other hand,
because suppliers have problems with inventory control, just as sellers do,
they may be interested in making deals to induce customers to purchase
inventories off-season, usually at substantial savings. They want to shift the
carrying costs of purchase and storage from the seller to the buyer. Thus,
there are seasonal implications to inventory control as
well, both positive and
negative. The point is that these seasonable implications must be built into
the planning process in order to support an effective inventory management
system.
STEP 3: Balance
Inventory Levels
Efficient or
inefficient management of merchandise inventory by a firm is a major factor
between healthy profits and operating at a loss. There are both market-related
and budget-related issues that must be dealt with in terms of coming up with an
ideal inventory balance:
•
Is
the inventory correct for the market being served?
•
Does
the inventory have the proper turnover?
•
What
is the ideal inventory for a typical retailer or wholesaler in this business?
To answer the last
question first, the ideal inventory is the inventory that does not lose
profitable sales and can still justify the investment in each part of its
whole.
An inventory that is
not compatible with the firm’s market will lose profitable sales. Customers who
cannot find the items they desire in one store or from one supplier are forced
to go to a competitor. Customer will be especially irritated if the item out of
stock is one they would normally expect to find from such a supplier. Repeated
experiences of this type will motivate customers to become regular customers of
competitors.
STEP 4: Review
Stocks
Items sitting on the
shelf as obsolete inventory are simply dead capital. Keeping inventory up to
date and devoid of obsolete merchandise is another critical aspect of good
inventory control. This is particularly important with style merchandise, but
it is important with any merchandise that is turning at a lower rate than the
average stock turns for that particular business. One of the important
principles newer sellers frequently find difficult is the need to mark down
merchandise that is not moving well.
Markups are usually
highest when a new style first comes out. As the style fades, efficient sellers
gradually begin to mark it down to avoid being stuck with large inventories,
thus keeping inventory capital working. They will begin to mark down their
inventory, take less gross margin, and return the funds to working capital
rather than have their investment stand on the shelves as obsolete merchandise.
Markdowns are an important part of the working capital cycle. Even though the
margins on markdown sales are lower, turning these items into cash allows you
to purchase other, more current goods, where you can make the margin you
desire.
Keeping an inventory fresh and up to date requires
constant attention by any organization, large or small. Style merchandise should
be disposed of before the style fades. Fad merchandise must have its inventory
levels kept in line with the passing fancy. Obsolete merchandise usually must
be sold at less than normal markup or even as loss leaders where it is
priced more competitively. Loss leader pricing strategies can also serve to
attract more' consumer traffic for the business thus creating opportunities to
sell other merchandise as well as well as the obsolete items. Technologically
obsolete merchandise should normally be removed from inventory at any cost.
Stock turnover is
really the way businesses make money. It is not so much the profit per unit of
sale that makes money for the business, but sales on a regular basis over time
that eventually results in profitability. The stock turnover rate is the rate
at which the average inventory is replaced or turned over, throughout a
pre-defined standard operating period, typically one year. It is generally seen
as the multiple that sales represent of the average inventory for a given
period of time.
Turnover averages are available for virtually any
industry or business maintaining inventories and having sales. These figures
act as an efficient and effective benchmark with which to compare the business
in question, in order to determine its effectiveness relative to its capital
investment. Too frequent inventory turns can be as great a potential problem as
too few. Too frequent inventory turns may indicate the business is trying to
overwork a limited capital
base, and may
carry with it the attendant costs of stock-outs and unhappy and lost customers.
Stock turns or turnover, is the number of times the
"average" inventory of a given product is sold annually. It is an
important concept because it helps to determine what the inventory level should
be to achieve or support the sales levels predicted or desired. Inventory
turnover is computed by dividing the volume of goods sold by the average
inventory. Stock turns or inventory turnover can be calculated by the following
equations:
Stock Turn = Cost of Goods Sold
Average Inventory at Cost
Stock Turn = Sales
Average Inventory at Sales Value
If the inventory is
recorded at cost, stock turn equals cost of goods sold divided by the average
inventory. If the inventory is recorded at sales value, stock turn is equal to
sales divided by average inventory. Stock turns four times a year on the
average for many businesses. Jewelry stores are slow, with two turns a year,
and grocery stores may go up to 45 turns a year.
If the dollar value of a particular inventory
compares favorably with the industry average, but the turnover of the inventory
is less than the industry average, a further analysis of that inventory is
needed. Is it too heavy in some areas? Are there reasons that suggest more
inventories are needed in certain categories? Are there conditions peculiar to
that particular firm? The point is that all markets are not uniform and
circumstances may be found that will justify a variation from average figures.
In the accumulation of
comparative data for any particular type of firm, a wide variation will be
found for most significant statistical comparisons. Averages are just that, and
often most firms in the group are somewhat different from that result.
Nevertheless, they serve as very useful guides for the adequacy of industry
turnover, and for other ratios as well. The important thing for each firm is to
know how the firm compares with the averages and to deter- mine
whether
deviations from the averages are to its benefit or disadvantage.
STEP 5:
Follow-up and Control
Periodic reviews of the inventory to detect
slow-moving or obsolete stock and to identify fast sellers are essential for
proper inventory management. Taking regular and periodic inventories must be
more than just totaling the costs. Any clerk can do the work of recording an
inventory. However, it is the responsibility of key management to study the
figures and review the items themselves in order to make correct decisions about
the disposal, replacement, or discontinuance of different segments of the
inventory base.
Just as an airline cannot make money with its
airplanes on the ground, a firm cannot earn a profit in the absence of sales of
goods. Keeping the inventory attractive to customers is a prime prerequisite
for healthy sales. Again, the seller's inventory is usually his largest
investment. It will earn profits in direct proportion to the effort and skill
applied in its management.
Inventory quantities must be organized and measured
carefully. Minimum stocks must be assured to prevent stock-outs or the lack of
product. At the same time, they must be balanced against excessive inventory
because of carrying costs. In larger retail organizations and in many manufacturing
operations, purchasing has evolved as a distinct new and separate phase of
management to achieve the dual objective of higher turnover and lower
investment. If this type of strategy is to be utilized, however, extremely
careful attention and constant review must be built into the management system
in order to avoid getting caught short by unexpected changes in the larger
business environment.
Caution and periodic review of reorder points and
quantities are a must. Individual market size of some products can change
suddenly and corrections should be made.
