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Danger Lurks in Your Inventory
Inventories have a way of
growing. The justification is usually that ‘if we don’t have it we can’t
sell it’, so a connection is made that translates as ‘the bigger the
inventory we have, the more sales we’ll make’. If only it were so.
Inventories are usually made up of many types of stock. There are
fast-moving and slow-moving products. There are products with a high
profit margin and products with low profit margins. Some products are in
demand and other products past their peak. To simply look at an
inventory as having a single ‘value’ can be very misleading.
At the bottom end of the inventory process is a warehouse full of dead
items past their prime and can’t be sold for anything like their cost of
acquisition. It’s truly amazing how much of this ‘dead’ stock is
retained on the books at cost price and lingers in the warehouses of so
many companies, adding to the value of their inventories but doing
nothing for their sales.
An inventory is a dangerous thing. If it’s not properly managed it
becomes the equivalent of money that’s depreciating at an increasing
rate and can actually drop below zero value. Be aware of the danger and
don’t let this situation develop.
How important is inventory as an asset? It’s probably the largest asset
of most SMEs, but it’s by no means the most valuable asset in the
business. The most important assets are those that turn the inventory
into cash – the sales team, the marketing and the business’ customer
relationships. That’s what keeps the business ticking over, not just a
bloated inventory waiting to be sold.
Some businesses manage to trade quite profitably without an inventory of
their own. ‘Just in time’ manufacturing processes created a whole new
outlook on parts inventories that made maintaining huge stockpiles of
components obsolete and saved manufacturers a lot of money. This line of
thinking can be successfully applied to just about every inventory
situation.
This taught businesses the importance of accurate sales forecasting –
knowing what the demand for a product would be and when it would arise.
Orders for components could be placed according to the projected demand
and the need to retain year round inventories was eliminated.
Most proprietors at least know their sales volumes and would no doubt
like to retain them. The catch is how can they do this and at the same
time operate with a reduced inventory? If every item in the inventory
turned over at the same rate this might be a problem, but a careful
analysis of what’s in any inventory will find some fast movers as well
as some items that have a much slower path to customers.
Go through the inventory in detail. Look at the age of what’s in stock
as well as how quickly each item turns over and the search will soon
find some real opportunities to cut down on the number of items there.
It’s also possible to discover some items in the inventory that haven’t
moved for so long they’re virtually obsolete. So it’s not just the total
value of an inventory that’s important; it’s what it consists of
bit-by-bit.
Now look at the profit margins the business earns on each item in the
inventory. Relate this to the turnover rate for each item and some
surprising facts will emerge. Finding items that turn over slowly and
generate low profit margins should ring a huge alarm bell that perhaps
these products can be either dropped from the range or sourced from
suppliers ‘on demand’.
Inventory on its own doesn’t sell itself. Certainly a business wants to
be able to provide its customers with fast-moving, high margin items
with the least possible delay, and that’s where the focus should be. In
most SMEs the ‘80/20’ law applies to the products they sell – 80% of the
turnover comes from 20% of the products. It makes sense to have those
20% of products dominate your inventory and find alternative ways to
handle the less-important 80%.
If an organization’s inventory is made up mostly of those ‘80%’ products
it’s time to do some housecleaning. All they’re doing is depreciating
from year to year and that capital could be better employed in selling
more of the 20% products. Even if items in the old inventory will
someday be moved, wouldn’t it be better to let someone else have the joy
of buying and stocking them? Liquidate them and free up the capital for
more productive uses. They can always be repurchased when and if
required.
Always remember that an inventory represents cash just sitting there.
It’s not cash in the bank; it’s cash that’s been invested and on which
needs to generate a return. Everything in an organization’s inventory
has a cost attached to it – just acquiring and warehousing it can be
expensive, and the longer it’s unsold the higher the costs become.
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