Inventory may not be at the top of your mind. But if you have a business that relies on inventory to generate a significant part of your revenue, managing it well can make all the difference to your bottom line, as well as to customer satisfaction.
While inventory sits quietly on your balance sheet as an asset, it also ties up cash flow and takes up space. And some of it may be going obsolete while you are busy selling the rest of it.
Let me share some thinking that may change the way you look at and manage your inventory, to the benefit of your customers and your business.
First, I see inventory as an expense, even while it sits on the balance sheet as an asset. That's because you really only need it at the moment a customer demands it. Up until that point, it is just tying up valuable resources.
How a business manages inventory, then, is directly related to customer demand, which, admittedly, is unpredictable at the best of times. You don't want excess inventory, but you also don't want to run out and miss out on making sales and meeting customers' expectations.
How well you fulfill customer demand is often referred to as your service level. If you ship every product, all the time, as soon as it is ordered, you have a service level of 100 per cent. This may be a reasonable goal for a company such as McDonald's Corp., with thousands of stores contributing data to robust systems on what demand is likely to be from day to day and season to season. But it may be impossible for your local plumbing-supplies store.
An independent plumbing-supplies store trying to achieve a 100-per-cent service level will probably run out of cash and space trying to stock every part at levels capable of responding to any possible peak in demand.
So, instead, such small businesses focus on keeping bestsellers in stock and have the shortest lead time possible for special orders or responding to larger-than-expected demand.
Lead time is key when analyzing your inventory. Lead time is simply the amount of time it takes to get a product into the hands of your customer, through the supply chain from which you procure it (your vendor's delivery time).
If your supplier ships to you in three days, you can respond quickly to unexpected customer demand and, as such, carry less inventory. If your vendor is far away and the lead time is closer to 90 days, your inventory will be much higher because your response time (your ability to pivot on changing customer demand in quantities and items) is much, much slower.
Another metric that is highly important is frequency. I am a big fan of buying less more often. Buying less quantity more frequently allows you to keep your inventory low, improves cash and space resources and, most important, improves your response time to changes in demand volume and styles.
On the surface, buying less more often has a significant downside – transportation costs. However, my experience has taught me that this extra expense, small in relation to your total purchasing cost, is more than compensated for by the extra gross margin you make on your selling price when you are able to turn on a dime relative to changes in customer demand.
And that's not to mention the money you save in financing the inventory, storing and insuring it. Besides, the less inventory you have at any given moment, the less risk you have for inventory obsolescence and the discounting or waste that comes with it.
Last, I avoid getting drawn into buying more than I would normally need just because a supplier has a discount, sale or special. Often, a supplier is offering a limited-time pricing discount because it has too much inventory and needs to turn it back into cash.
I would be very analytical when it comes to buying too much inventory get a better price – you'll want to be sure that the discount will compensate for the extra costs of carrying excess inventory, or that passing on the savings to your customer will increase demand enough for you to move through the inventory quickly.
This is just skimming the surface about enhancing inventory-management skills, but I hope you can already see that paying closer attention to inventory is a profit opportunity for your business and a customer-service benefit to your clients.
Special to The Globe and Mail
Chris Griffiths is the Toronto-based director of fine tune consulting, a boutique management consulting practice. Over the past 20 years, he has started or acquired and sold seven businesses.
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