In my work with my SME clients, the one thing that has always perplexed me is the way the owners give importance to their “Inventory”. Many think inventory is just one more step involved in the business. I have observed that at least 20% of inventories at any point in time are either non-moving or obsolete or damaged or missing. Many business don’t even write off these inventories leading to their accounts department showing nice profits in excel sheets which do not reflect in the bank account.
I coach my clients to see inventory as ‘CASH’. Seeing inventory as CASH changes the entire perspective when dealing with inventory. The moment you see inventory as cash, you would ensure that it is safe and secure, it is counted everyday, pilferages are tracked, you would take all steps to ensure that inventories do not become obsolete and you would ensure that you can liquidate inventory at will…all as you would do with cash.
And because we have to ensure that inventory is liquid, it should be maintained at the right levels ensuring they are not in EXCESS while being just right to ensure timely delivery to customers. And this is one area where I have seen that there is hardly any strategy or planning that go in to inventory management and organisations thus suffer from crores of funds blocked in inventory way beyond acceptable limits.
In this blog, I will talk about two main reasons why organisations suffer from funds blocked in Inventory
Reason #1- Not knowing what is the Ideal Inventory
Many SMEs suffer from EXCESS INVENTORY which are sometimes far in excess of the ideal. The worst part is that there is hardly any awareness of what should be the IDEAL INVENTORY.
If only SMEs know and are able to compute “ideal inventory” on a continuous basis, the menace of money blocked in inventory can be completely eliminated and avoided. To know what is the ideal inventory, the organisation needs to compute two very important parameters:
a. The time the customer is willing to wait to receive the goods after placing the purchase order OR in short Expected Delivery Time (EDT)
b. The time the organisation would need to make the finished goods from scratch i.e. placing PO and receiving all raw materials, time taken to do quality controls, production time, packing and ultimate delivery to the customer OR in short the Total Lead Time (TLT)
Where the Expected Delivery Time (EDT) exceeds the Total Lead Time (TLT) then the company need not maintain inventory of finished goods or raw materials. These are products which are generally made-to-order or where the design or quality is so good that the customer is willing to wait patiently
Where the Total Lead Time(TLT) exceeds the Expected Delivery Time (EDT), then the organisation needs to maintain inventory of finished goods and depending on the procurement lead time, even raw material inventory needs to be maintained.
A comparison of these two parameters (to be done for each finished goods) will give the “ideal days of inventory” an organisation should hold for both finished goods and raw materials. Once the ideal no of inventory days is arrived at, we can arrive at the goods based on the expected sales per day arrived at based on past sales and forecasted sales.
The formula for arriving at this is little complex and involves computation using Bill-of-Materials, average sales, lead time involved in procurement of every raw material and certain other factors. Good news is that help is not far away.
SMEs can engage expert consultants to get the right formula and employ good business intelligence tools to run these complex computations day-in and day-out.
Below is an example of an organisation which is maintaining higher than ideal inventory and how business intelligence solutions coupled with help from consultants can help in locating the excess inventories. RED color indicates excess and GREEN is the ideal inventory
Reason #2 – Producing in excess of what can be sold
In order to maintain a lean inventory which is ‘just right’, organisations need to produce/ procure only that much which can be sold. Many organisations (especially ones who are on the Made-to-stock (MTS) model) produce inventory based on intuitions of their business owners or at best based on sales projections that happen at the beginning of the year. Once the production plan is finalised, no one reviews it with market reality of how the sales have been performing.
In the following representation you can see how this organisation continues to produce inventory though its sales had flattened.
It is to be noted that the “sales team” by nature do not come back to the management in time about the market reality as they are either hopeful of making good the shortfalls or fear strong feedback from the management. Thus by the time an organisation realises that their sales is not going in the right direction, a lot of inventory gets piled up. I have seen this in many organisations where there are crores of money lying as dead stocks where management does not know what to do with them.
In order to avoid this situation, the organisation should ensure that procurement and production plans are kept aligned with the actual sales trend that they see in their business. The plans should be reviewed monthly by the management. They should set up early warning systems which alert the management about the excess production and procurement trends.
Large companies deploy analytics solutions which recommends the production and procurement plan automatically based on sales trends an forecast numbers and also sends warnings where they are out of line. I highly recommend SMEs to adopt strong business intelligence and analytics solutions to help them in ensuring that they procure and produce in the right quantity.
While there are other reasons for high inventory, these are the two big elephants in the room and just getting these right by following the principles I mentioned will ensure that crores of money lying blocked in inventory can be released and added to the bank balance.
Signing off till we meet in again in my next blog