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Business education

How to cut your inventory costs Add to ...

Optimizing inventory levels is one of the biggest challenges that entrepreneurs face. It’s not easy to balance customer demand with the right level of inventory.

“Most business owners know that keeping inventory costs down provides a significant competitive advantage,” says Stephen McDonald, Senior Consulting Manager at BDC in Charlottetown, Prince Edward Island. “However, day-to-day challenges often make it hard to focus on the best ways of doing that.”

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Properly managing inventory starts with the right information. This includes data regarding high-value items in stock, inventory turns, carrying costs and which suppliers offer the most attractive logistics and financial terms.

However, accumulating that information is not always easy. That’s particularly true for smaller businesses, which cannot afford to maintain sophisticated reporting systems and are thus forced to resort to periodic counts and visual estimates. “Most companies conduct detailed inventory counts at year end for financial statement purposes,” he says. “But that is not always enough. The information can get dated quickly.”

Know your ABCs

McDonald suggested a few ways that entrepreneurs can bring down inventory costs. One common technique is for managers to roughly group their inventory into A, B and C categories in order to figure out where to best allocate resources.

“A” items are high-cost and process-critical items that comprise 80% of many companies’ inventory value, but usually only 20 to 30% of the inventory quantities. This category deserves the most attention in terms of tracking due to their high inventory value.

“Efforts to improve inventory levels should be focused on A items with SKUs (stock-keeping unit) of high inventory values,” McDonald says. “In many cases, conducting accurate and timely cycle counts of these goods will enable businesses to cut the dollar value of their inventory levels by between 40 and 50%.” Less important are B and C items that are necessary for the business to stock, but which generate medium or low inventory value.

Keeping track of which suppliers are willing to provide “just-in-time” shipments is also key to controlling inventory. Companies need to understand at what point in the process inventory items are needed and work with their suppliers to have these delivered as needed.

Companies can understand their processes better by using value stream mapping to determine the best time to receive inventory items. This allows companies to reduce their work in process and inventories and will lead to improved cash flow.

“You should encourage suppliers to make deliveries as close as possible to the date you need them,” McDonald says. “In fact, the perfect situation is when you can arrange for your suppliers to ship goods to your customers directly, where practical.”

One of the hardest decisions for many entrepreneurs is whether to invest the time and resources required to implement and maintain, up-to-date computerized inventory control systems.

Often that decision depends on a business’s growth stage. However, the high cost of carrying extra inventory should make gaining full control a priority.

That process starts when managers insist on getting optimal inventory-related information.



Content in this section is provided in partnership with the Business Development Bank of Canada. BDC provides entrepreneurs with financing, venture capital and consulting services. To find out more go to BDC.ca.

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