CASH into INVENTORY or INVENTORY into CASH?!

A manufacturer may turnover inventory 3.6 times, a retailer can have 4.1 turns and a wholesaler or distributor can show turns of 4.4.  What these companies, albeit, in different types of industries, have in common? TOO MUCH Inventory!  Where they may carry it – raw materials, work-in-process or in finished goods – is not necessarily the point.  The point is they have too much money tied up in inventory.

From an accounting outlook, inventory is an asset – a buffer against uncertainty.  The complete cycle time of inventory, when needed, when received, sold and sales payment is received is vital to a company’s success. The longer the cycle time, the larger the amount of inventory will be carried against that uncertainty.

Inventory turns are important.  While the turns mentioned in the opening paragraph look good on the surface it is important to understand that turns should be compared to rate of days paid.  In other words, when the company receives payment for the goods. The above firms are getting paid every 90 days. Would you like to get paid only every 90 days?  This leads to a large capital investment of inventory earning nothing at a large carrying interest rate.  Why do many companies still operate in this manner and accept this kind of performance?

In addition to the capital or carrying issue, excess inventory influences service and operations. Unnecessary freight costs were incurred to bring products into facility.  Other costs like manpower hours, warehouse put-away and larger warehouse space than is needed are increased.  A cycle count program, which is based on Pareto’s Law and ABC analysis, will continually count these items to the company’s detriment.  

A business does not automatically or deliberately decide to have too much inventory on-hand as part of their forecasting plan.  The reasons for excess inventory are many but some of the more common ones are the following:

1     Loss of sales fear: this is the fear of not having an item to sell as opposed to not being able to sell the item.  This is where companies will put in a hedge factor into their inventories.

2      Price deals:  Many companies purchase due to “great” price deals. Buy in excess of what is needed or will deplete in a reasonable time frame due to a price they could not pass up. Is it still a good deal when it sits in your inventory forever?

3      Write-offs: Firms are hesitant to write off the inventory and take a hit to their profit and loss for the year.  

4      Metrics to measure: there are no metrics or key performance indicators implemented to measure and manage inventory – inventory turns, days in inventory, inventory aging and inventory velocity and no “ABC” analysis.

5      Supplier performance: suppliers are not managed even the ones who fail to ship on time or less than a pre-arranged percentage of the purchase orders. Extra time and extra inventory are built into the system to compensate for delivery issues. 

These are only a few of the reasons for excess inventory. Inventory buildup is not the result of one cause but many create the overabundance of inventory.  These causes reflect the lack of priority, processes and control of the inventory.

Excess inventory is not an acceptable situation and needs to be eliminated as quickly as possible. There are some options to carry this out:

1     Strategy and process: develop a process and procedures to manage inventory. Sustainability for this must come from the C-level management, otherwise a frustrating endeavor.  Included in this, is the development of performance metrics for inventory (some mentioned above), implement lean to add value-added processes, study the entire supply chain from inbound to outbound and make inventory part of the company direction as it pertains to customers, sales and profits.

2      Distribution network: determine the optimal number of DC’s for today’s business. 

3      Supplier performance: ensure it is a key part of the inventory management and sourcing strategy.   There is more to vendor selection than just low prices.

4     Effect of global sourcing:  long transit times across the oceans affect the inventories – in costs – that companies carry. 

 Increasing inventory turns and controlling lead or cycle time is vital to a firm’s profitability and long term growth.  However, reducing inventory and preventing excess inventory does not happen overnight.  It took a while to realize the inventory overage, so it will take a fair amount of time to correct.  This action will require focus and diligence.

JIT versus JIC: An Inventory Dilemma

Just-in-Time opposed to Just-in-Case

As manufacturers are reaping the benefits of Lean and Lean Six Sigma or other continuous improvement processes within their facilities the importance of eliminating waste still hold sway.  So the question now facing these manufacturers is this: 

Has the time come where Just-in-Time inventory levels need to be changed to Just-in-Case levels?  With the present and at least near future volatility of the economy this may prove to be the case.  The answer lies within each company’s own supply chain and decided upon based on each company’s individual requirements.

Inventory is considered one of the seven (7) wastes in a lean manufacturing environment.  It is any material over and above what is required for use in the process.  The JIT environment basically works much like this: a piece per process > one piece delivered > one piece processed > one piece shipped.  Any and all inventory on hand after this process can be viewed as waste. 

There is no such thing as the ideal situation and it’s quite impractical.  Thus, inventory is carried within the facility.  In practice just about every company carries inventory of some magnitude.  And thus many issues ensue – excess storage requirements, carrying costs, increased material handling and obsolescence. The real concern should lie within the raw materials inventory levels as finished goods and sub-assemblies are in company’s control – based upon customer service levels and on-time delivery rates.  

Over the past several months many small companies have shuttered their businesses.   Much of this occurred when a primary supplier shutdown operations and damaged your delivery performance.  

Under these circumstances perhaps it is time for the remaining small manufacturers to take a good hard look at their suppliers and ask the following questions:

1-      How well do you know your first, second and third tier suppliers?

2-      Are any of them at risk of closing their doors and catching you off guard?

3-      Have you looked at their financial health?

Maybe the time has come to get to know them better.  Harks back to making your suppliers your business partners.  The slightest change or disruption upstream can cause a major effect downstream.   It might be a good idea to carry a few weeks inventory to protect the company until the risk potential with this supplier can be evaluated.  Perhaps a visit to this third tier supplier would be in order to avoid higher future costs.

Start this process by reviewing some of the more vulnerable suppliers.  For example: if you are in the automobile industry start by checking the health and stability of suppliers you share with the North American automakers.  

In any industry, in order to implement JIC, and to determine how much and type of inventory need to carry these questions require honest answers:

1-      How difficult will it be to source replacement parts?

2-      How long does it take to get customer approval to move the tooling?

3-      How much testing is required if a new supplier is needed in an emergency?

4-      How long can you delay in shipping to your customers before it affects relations?

5-      How much space will be required to carry enough stock in case of emergency?

The answers to these questions will point the way to determining the on-hand inventory levels.  In addition, with good strategy and procedures it should also help to determine which components are at the greatest risk.  

Please keep in mind that JIC could be a temporary solution to a temporary problem.  It is extremely expensive to carry JIC inventory for every part, so the decision needs to be made as to which parts are the most critical.  Be aware, the carrying cost may increase exponentially, at least in the short run.   Consider JIC an insurance policy but when the crisis is over re-think the policy and return to JIT and LEAN.