Wednesday, August 13, 2008

Target Inventory Investment

Budgets are good management tools. Unfortunately, few distributors maintain budgets and projections for what is probably their largest asset, inventory. It is critical to the success of your inventory management system, and your business in general, to develop a budget for the value of stocked inventory maintained in each warehouse. This budget is referred to as the "target inventory investment."
Target Inventory Turnover: Most hard-goods distributors earning gross margins between 20% and 30% would like to receive five to six inventory turns in a main warehouse, and ten to twelve turns in a branch location. But these optimal goals cannot be achieved overnight. A realistic "incremental" goal is to increase your current turnover rate by 1/10th turn per month. And as we will see, it will probably take three months, after you begin an effective inventory management program, to start to see results.

So, if the inventory of stocked products in your warehouse is currently turning three times annually, and your company initiated an effective inventory management program three months ago, you should try to achieve 3.1 turns next month, 3.2 turns the month after, etc. This gradual increase in inventory turns is usually the result of an aggressive, but achievable, program to reduce the quantity of unneeded material in your warehouse.
you've developed a target inventory investment. Now you have to decide what products will comprise this investment. Let's start by dividing your inventory into three categories:

Dead Inventory: Inventory with no sales or recurring transfers during the past 12 months.

Slow-Moving Inventory: Inventory that has had some movement, but less than one and a half turns a year. That is, you've sold the normal shelf quantity less than 1-1/2 times in the past 12 months.

Other Items: Items whose stocked inventory will turn more than one and a half times per year. That is, your "good" inventory.

Please note that depending on your specific market, "good" inventory might have to turn more than 1-1/2 times a year. For some companies, "good" inventory must turn 12 times a year. If you have questions about what your particular situation, please contact us.

If you need to reduce your overall inventory investment to meet your turnover goals, a good place to start is to look at the dead stock and slow-moving items that are stocked in your warehouse. Of course, there are some valid reasons to maintain an inventory of items that don't currently sell on a regular basis. But, you must realize that if an item doesn't sell, it doesn't directly contribute to generating the profits necessary for you to remain in business. It is an expense. And, like a new truck, a computer system, new shelving, your payroll, or any other expense, non-moving inventory must indirectly contribute to the current or future profitability of your company. How can it do this?

  • It might be a repair part or other item that you must have on hand to handle customer emergencies. That is, it contributes to your reputation as a reliable supplier.
  • It may be an item that you're fairly certain will sell in the future. You've invested in the product today, to receive profits in the future.

As with any other expense, you must control the amount of dead stock and slow-moving inventory you maintain in your warehouse. You can only afford so much of it. In the following discussion, we'll guide you in establishing a budget for the amount of this inventory that you can reasonably maintain.

Just one more note before we go on. You must separately categorize dead stock and slow-moving inventory for each company warehouse or location. An item might have a lot of activity in one branch, but be as "dead as the market for eight-track tapes" in another location.

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