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12.22.06
Are You Inventory Rich And Cash Poor?
 By
Thomas Craig
A contract manufacturer turns inventory 3.6 times. A retailer turns inventory 4.1 times. A wholesaler turns inventory 4.4 times.
What do these firms, in different businesses, have in common? They carry too much inventory. While where they each have the extra inventory may differ-raw, WIP or finished, they have too much money tied up in inventory.
From accounting and financial views, inventory is an asset, a positive, for businesses. Inventory is a buffer against uncertainty. The cycle time from when inventory is needed until it is received, sold and sales payment is received is very important to company success and longevity. The longer the cycle time is, then the larger the amount of inventory that will be carried to balance against uncertainty.
Inventory turns are important. Think of it this way. The above firms are being paid every 90 days. That is essentially, what four turns really means. No one would want to get a paycheck that infrequently. That is a lot of capital tied up earning nothing while it sits unsold and an incredible float on capital. So why do businesses operate that way and accept such performance?
Inventory has a "limited shelf-life". There is a window of opportunity to sell the product. Once that window closes then the sales value of it decreases and the profitability and inventory yield are not maximized. In addition to the capital issue, excess inventory influences service and operations. Unnecessary freight costs were expended to bring the products in. The inventory works against having a good warehouse layout to reduce order picking. It adds to labor costs. If the company does cycle counting, then such inventory is counted too often and is a wasted time effort. Too much inventory can also mean having a distribution center larger than is really needed to store the extra items. So the cost and service impact is large. There is also restricts agility to adjust quickly to changing conditions.
WHAT CAUSES EXCESS INVENTORY? Businesses do not decide to carry too much inventory as part of a strategic plan. Inventory increases creep in; it is not a deliberate business decision to tie up too much capital in inventory. The reasons for excess inventory vary but some of the common ones are:
*Loss of sales fear. The fear of not having an item to sell is stronger than the fear of not being able to sell the item. So a hedge factor to carry more items and more inventories is necessary. Also, sales forecasts can be overly optimistic.
*Price deals. Companies take advantage of lower prices for volumes in excess of what they need or will use in a reasonable time. But it is "too good of a deal to pass up" even if it sits forever in inventory. Economical purchases may actually be uneconomical.
*Write-offs. Businesses are hesitant to write off the inventory and take the hit on the profit and loss for the year.
Continue reading this article.
About the Author:
LTD provides logistics consulting for strategic and tactical needs. The scope of capabilities is broad--supply chain management, outsourcing, transportation, warehousing, inventory management, and more for both domestic and international needs. Clients include retailers, wholesalers/distributors, manufacturers, logistics service providers and 3PLs.
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