Microsoft Dynamics NAV News & Tips
Making Hay While Clouds Loom Part 2: Analyzing and Reducing Inventory Levels

As discussed last month, it’s time to “batten down the hatches” but that’s not enough, it’s what you do under the hatches that will determine your opportunity when the economy recovers.

According to all of the pundits, cash flow is king right now. To maximize cash flow, we need to manage costs. According to Grant Thornton, in their whitepaper The Credit Crunch; A Practical Guide, their number two strategy (right after Cash is King) is a relentless control of costs. How well are you managing inventory costs?

To begin, let’s look at some benchmarking Aberdeen Group has provided for complex manufacturers* as a means to measure your own performance:

Definition of Class	Performance
Best-in-Class; Top 20%	20% reduction in inventory levels 98% inventory accuracy 97% complete and on-time shipments 96% manufacturing schedule compliance
Industry Average; Mid 50%	12% reduction in inventory levels 92% inventory accuracy 89% complete and on-time shipments 85% manufacturing schedule compliance
Laggard; Bottom 30%	3% reduction in inventory levels 82% inventory accuracy 76% complete and on-time shipments 70% manufacturing schedule compliance

*If you are not a manufacturer but would still like to compare your performance within your industry, please contact us and we will attempt to provide relative comparative data.

If you are in the Best-in-Class category - congratulations!

If you are not where you expected, the industry performance data can help you set new goals.

Your business management system(s) is a good place to look for performance answers and cost control improvement. Data for the following analysis should be easily obtained from your ERP application.

Inventory levels

Generic replenishment models such as min/max or simple reorder points have major shortcomings, and both of these methods will likely increase inventory levels unnecessarily given the current economy. In addition, the same model cannot be used across all product lines (unless, of course, you have excluded all others through close examination).

These simple rules will hepl you scrutinize your inventory:

• Relentlessly distinguish real inventory from bad inventory. Bad inventory doesn’t move. It sits in your warehouse and costs money. There are two easy ways to identify bad inventory - 1) calculate the number of annual hits (how often it is picked), or 2) even more revealing, determine the number of turns for each item. Identify the midpoint of either method for your items, then scrutinize the bottom half.

• Get rid of bad inventory. Consider asking your supplier to take it back for other, better selling items, or simply sell it at a discount to recover your costs and convert it to cash. The information provided by step 1 should give you insight as to when each “bad” item is sold, and potential solutions on how/when to order it from your suppliers if the item is truly necessary to complete your product lines.

• For the remaining items, determine the adjusted gross margin of each using the following equation:
  (Gross Profit – (Average Inventory * Carrying Cost Percent)) / Sales.
  This will give you a true profitability by item. The results might be surprising! Once again, scrutinize the results looking for the most and least profitable items.
  
  Be sure to apply this same calculation for inventory that is maintained only for a specific customer.

• Now that you have a better idea of what items are generating the most cash, determine your forecast accuracy of each using the following: (Absolute Value of (Usage – Forecast)) / Lower of (Forecast or Usage). This will give you your forecast error rate. In a study done by Effective Inventory Management, Inc., the mean forecast error was 682%! Best Practice companies had an error rate approximately 1/10 of this.

• As mentioned in last month’s article, forecasts that average over the last 6 months are probably overstating inventory given the current market. Tighten your forecasts by testing several methods and use the formula that results in the lowest forecast error.

These are but a few suggestions on how to analyze and reduce inventory levels, which is only the first metric of the Aberdeen Group study. For additional details or assistance on how to automate these steps, please contact Mike Packard at mikep@ics-support.com or 425-284-5426.

References for this article include Aberdeen Group, Effective Inventory Management, Inc., and Grant Thornton. Each of these organizations provides considerable information on the subjects of inventory cost reduction, best practices, and industry benchmarks, and we encourage you to visit them.

 

According to all of the pundits, cash flow is king right now. To maximize cash flow, we need to manage costs. How well are you managing inventory costs?