Why Practice Inventory Control?

Every company that is trying to get its grips around what they have talked about Inventory control. Companies that are trying to understand what they need to meet their demands are looking into Inventory Controls.  The concept of Inventory Control is straight forward.  Knowledge of what you have and what you can sell.  Additional controls are used to make sure that this information is correct, accurate, and actionable.

From an accounting standpoint, Inventory controls are critical in understanding business costs.  Goods sitting in inventory carry a cost.  The labor required to put that item away in the warehouse and to count it periodically also carries a cost associated with it.  Rarely recorded are equipment usage and resource execution.  These operations have a cost related to them.  To properly calculate the true cost of an item you need to capture all of the resource, time, and equipment costs.  Examples of this are tasks like picking, prepping, and item consumption (Manufacturing or sales).  Capturing the associated wear on the equipment used is also necessary.

But, do we really need to practice inventory control?  We’ll consume inventory as soon as we can.  A rush order (at a premium cost) will resolve any stock-out situation.  These simple thought processes may work for small operations, but as you grow these processes can signal the demise of a growing company.

Business Requirements for Inventory Controls

Inventory Contol verifies the on-hand value of assets

Inventory Control Practices meet the following business requirements:

• Accuracy of Inventory Valuation for Investors and Lien Holders
• Research and analysis of processes to push cost-saving initiatives
• Minimization of process downtime due to stock-outs
• Managers wanting visibility and understanding of their operations
• Workforce Management

Although all 5 reasons are valid, experience has shown that 80% of the time you will encounter the first two reasons as the impetus for the implementation of the processes.  Executive management is looking for ways to improve the operations budget and the profit margins for their company and the Inventory carrying costs is usually the second-highest number on their Balance sheet (Resource Overhead is usually the first).  Major investors like venture capitalists and financial institutions will want to audit the Inventory on-hand reporting to make sure that the numbers are accurate and that there are not some misleading business practices in place.  The stronger the inventory control system, the more accurate these numbers are and in turn the shorter the investor audits can last.

A company that is always “In Search of Excellence”[1] or steadfast in the beliefs of “Six Sigma”[2] will hold a manager to Key Performance Indicators (KPI’s) that are based around productivity and cost reduction.  They will also want to make sure that their management personnel is “Champions of Change.” This is critical to the cause of improved practices or else the processes will remain stagnant and resistant to new philosophies and overall change.

Inventory Control: Why Carry Inventory?

In a perfect world, the material would be consumed onto a work order or into a process batch as soon as they are received onsite.  Likewise, Finished Goods would be sold and shipped out to a customer as soon as the manufacturing operation is complete.  These practices would optimize costs and reduce the need for having Inventory on-hand, however, this is rarely the reality.

Factors that contribute to the need to carry inventory and practice Inventory Control:

Manufacturing Operations and Material availability:

• Many manufacturers will run a 24/7 production schedule. (24 hours a day, 7 days a week)
• Materials will only arrive in the facility between the hours of 9am and 5pm, Monday thru Friday.
• To meet the Inventory demand during the hours where materials are not actively arriving at the facility additional inventory must be stored.

Supply/Demand planning constraints with Inventory Control:

Cost Efficiency Constraints:

1. 1. 1. The optimal profit margin requires more Raw Materials need to be purchased
      2. Finished Goods need to be produced at a specific pace to achieve the optimal piece rate or cost per item.

Build up Supply in anticipation of upcoming demand.

You have a sales order for a large number of goods.  They all have to ship together on a specific date.  To meet that demand, you must build up the supply over time.

For example; 6000 goods are ordered to be shipped in 6 months. The production rate is 250 widgets a week.  To meet the demand, production needs to start 24 weeks before the agreed shipment date.  The 23 weeks leading up to the shipment date will resort in additional inventory on-hand. (1 week of production subtracted from the shipment date)

Changes in Customer Demand

Changes in Customer demand may lead to an excess of supply. Customers will cancel or delay orders at any time. Manufacturing is already underway. It is cheaper to store the goods than to scrap them.  The goods will be shipped once a new order is placed.

Changes to a manufacturing schedule:

Manufacturing equipment can go down unexpectedly and cause a break in the production plan. This may cause a change in manufacturing line runs and the need for materials to be consumed. During such a “downtime” another product line will get started instead.  This is down to maximize resource efficiency.  To perform ad hoc changes in production, excess raw materials will need to be on-hand. The produced goods will also need to be stored.

Conclusion

As you begin to fully understand the needs to properly carry, track, and control inventory; your company’s capabilities will grow.  As you grow, the next steps will be to add additional controls. An example of an additional control is a Cycle Count.  A Warehouse Management (WMS) Solution is also the next progression.  In order to get there, you will need to assess if you are ready.  A simple checklist is available in my post 5 Questions to See If You are Prepared for a WMS Solution.

[1] “In search of Excellence” a Book by Robert H. Waterman Jr. and Tom Peters

[2] Six Sigma: https://www.isixsigma.com/new-to-six-sigma/getting-started/what-six-sigma/