Can Inventory be a Real Business Asset?

 

When prospective buyers conduct a due diligence review of your business, and ask about your inventory control systems, how will your answer affect their offer?  When you are seeking additional credit from your banker, how will they value your inventory?  Your inventory may not have the same value in the eyes of the buyer or the banker that it did in the past.  I discussed this subject recently with Bill Finn, Executive Vice President of Highland Park Bank and Trust, a Win Trust Financial affiliate.  He and I agreed on four actionable suggestions that will insure that your inventory has the most value to you, and when necessary to prospective creditors or buyers.

 

The key metric for managing and valuing inventory is turnover or “velocity.”  We like the term velocity because it reminds us that inventory at rest is costing your company money.  Inventory that is moving through your process - that is being picked, packed, etc. is potentially earning money.  Turnover is defined as follows:

 

Inventory turnover = Annual cost of goods sold/ Average inventory

      

There are two ways to improve turns – sell more with same amount of inventory or when sales are declining reduce inventory at a faster rate than the sales decline.

 

Inventory accuracy is critical to keeping your customers satisfied, for insuring that buying decisions are made correctly, and for demonstrating to your bank that your numbers are reliable. Annual physical inventories only guarantee accuracy for a brief time. Soon after you finish, your inventory counts can change. So, if your annual inventories only remain accurate for thirty days, you’re operating with inaccurate data 92% of the time.  The best way to develop and maintain location accuracy is a cycle count program.

 

Cycle counting is done on a regular basis, either weekly or daily depending on the size of the warehouse and the number of items.  A cycle count team – one warehouse person and someone from either inventory control or finance - should count a randomly selected group of items.  Then they should reconcile the physical count with the computer record, book the adjustment, and do a root cause analysis.  The benefit of cycle counting is that when you do it regularly, and address the root causes of errors, accuracy will improve. With cycle counting, inventory accuracy is improved, and prospective buyers and creditors gain confidence in the accuracy of your financial data.

 

 

 

A third element of effective inventory management is “chunking.”  Most companies measure ‘turns’ for the entire business and think they can mange inventory at the “macro” level.  Don’t stop there.  Inventory decisions are made at the item and product family level of detail.  You need to find the manageable “chunks” of inventory for your business – i.e. product lines, locations, customer specific, etc.  When you can measure the turns for each chunk, you can make fact-based decisions about how much inventory to buy and hold.

 

A fourth important inventory management measurement is forecast accuracy.  Forecast accuracy directly impacts the amount of inventory in your system and how many turns you can achieve. 

 

While sales people may resist the idea of forecasting sales, they do know what their customers are likely to buy over the next 6-12 months.  There is also some history regarding sales data except for your newest products and customers.  Start measuring forecast accuracy, it will never be 90+%, but even small improvements can result in inventory reductions.

 

 

Velocity…accuracy… “chunking”… forecasts...  Sounds like a lot to do when you already have a full plate, but the fact is it’s easy to implement and maintain these processes.  Bill Finn mentioned that banks will view prospective borrowers who can demonstrate good inventory management practices more favorably in the loan approval process.  Banks may be willing to loan more against “good” inventory as compared to overstocks, obsolete, etc.  And, good inventory management will free up cash for the business, even if you are not looking for additional credit.