This article was written by Ted McDaniel, SCORE Orange County Management Counselor
In these tough business days, each of us has to be aware of all costs connected to the business. I don’t need to explain why. However, how many times have you as a manager walked through the plant or store and noticed the same items in the same place as before? You then review the financial reports and notice the large amount of cash tied up in inventory -- and many of you stop right there. After all, inventory is needed to make the sales and perform the services that are the life blood of your business. If the inventory level doesn’t appear to be too far out of line, you don’t look too closely. But you may be missing the full picture!
The cost of inventory is usually a major item in most businesses. Let’s look at some controls:
1. How big should the inventory be? A fair test would be to find out how many times your inventory turns in a year. The more it turns, the better it is being utilized. One way to measure turnover is by comparing it to sales. For example you have $500,000 in sales and $100,000 in inventory, you have five turns a year. (You have to be careful here since too high a turnover rate might indicate too many “stock-outs,” which represents another problem!)
2. Strict accounting rules require that the average inventory is compared to cost of goods sold. This requires more effort on your end since cost of goods sold must be developed and will depend on your type of business. Good business software (such as QuickBooks) will be very helpful in developing these figures and their ancillary reports. In any case you most know the facts! Making decisions on the basis of faulty data is a sure ticket to failure.
3. Preparing and analyzing inventory costs and turnover and cost of goods sold will not expose another common inventory problem: old and/or obsolete inventory gathering dust on your shelves. The cost of that inventory continually carried on your books steals money from you each and every day! You bought it, yet it just sits there. That money could be used for other more productive purposes. Remember, it’s not only the cost of the product but the space it occupies and the fact that it prevents you from spending those dollars for things that would help you grow your business. This problem is common in many businesses, however it’s not often addressed effectively! To help eliminate this problem, there are a variety of methods that work toward solutions. A simple one is to determine how long a product had been in house. You can code each item when it arrives. For example you can use a number according to the month (1 for January 2 for February, etc) followed by a hyphen and then the year. Therefore, inventory that arrived in February, 2010 could be coded 2-2010. Not only is this helpful information but it will make it obvious in a hurry which inventory isn’t working for you. If your inventory aging analysis shows that your inventory as a whole turns 5 times a year, and the item you’re looking at has been on the shelf for a year and a half, you know you need to take some action is required to get rid of it!
4. One of the most common inventory control techniques being used is the product identification code. Most of us know this as the “bar code””or Universal Product Code (UPC). You see it on items at your grocery store, etc. UPC systems are constantly being upgraded and reevaluated. If you want to use UPC to control your inventory, you will need a bar code scanner that will interface with your accounting or inventory software. Virtually all of the popular software programs are equipped to do this, because use of UPC codes is very pervasive in today’s business world.
The point of all of this is to make it easier for you to keep good business records and be able to produce the reports you need to make good decisions. If you haven’t implemented systems like this, I recommend you do so right away.