Inventory Cost: Post Cost of Unplanned Inventory

How much of your cash is tied up in inventory? For many companies, simple response will be “a lot”. Not planning for inventory will always lead to inefficiencies, without regard to if you are keeping too much inventory or too little.

If you are keeping too much inventory, there are several reasons it isn’t a good idea:

1. Too much of your money is tied up in inventory. Even with the low-interest rates of today, money in bank is better thank money tied up in inventory.
2. Cost of storing and securing inventory adds up. Cutting down on inventory could reduce the need for space ($), need for security ($), need for maintenance like heating, cooling, etc ($), and there is no spoilage ($$$).
3. Makes your number look bad than they need to be. Your inventory turn over would be low (inefficiency), return on asset will be low (underpricing your company), and makes other metrics looks not so pleasing.

On the other hand, too little inventory have its own set of problems.

1. Lost sales because there isn’t sufficient inventory to meet orders. Perhaps the worst but don’t let feel of lost sales lead you to overstock.
2. Unhappy customers because of back-orders or long wait time to receive purchases.

So what is the game plan to avoid both sets of problems. It boils down to a strategy of tying your sales process and your procurement and managing processes.

1. Foremost, understand and track your lead times. If inventory is available, how long does it take to fulfill, ship and ensure products are received by end clients? How long does it take to receive parts, sub-components or merchandise-for-resales? This is the starting point.
2. Forecast, forecast, and forecast. It is important to forecast what sales volume will be in the near term (we will cover forecast in the near future.) Overtime you should become very precise in your ability to forecast near term demand.
3. Know your industries cycles. If you have a period of higher sales, plan for it.
4. Keep a narrow buffer for just in case. And emphasis here is on “narrow”.
5. Actively manage procurement. Many companies make large purchase so that they reduce number of purchase that have to be made.

There are several well documented methods for both forecasting and managing inventory purchase. My favorite is on Economic Order Quantity, but it might not be suitable for smaller organizations.

In short, not planning for inventory could easily result in hidden costs and missed opportunities for your business. Strategize, systemize, and execute.