One small change can have an enormous impact! Recently, a network switch failure led to the breakdown of the baggage-screening system at Phoenix Sky Harbor International Airport when the software system that scans for explosives went into a continual reboot cycle and resulted in more than 3,000 checked bags missing their flights! One small glitch = many angry and disgruntled clients.
The same can be said for inventory management. If one small problem occurs, your business can quickly be in a world of trouble! Have you ever considered what could happen if your largest client who relied on you having an item in stock came to you and not only were you out of stock, but the vendor was back-ordered? Of course you have! In fact, many companies carry excess stock to avoid just such a catastrophe. But what about the ripple effect of “leaning” toward overstocking numerous items to avoid a potential lost sale from your less critical clients? The weight of these “small” errors can quickly take your business down, if you let it!
What is the ripple effect on inventory? How can “small” ripples grow to destroy your bottom line profits, or even threaten the life of your business?
Dead and Excess Inventory
Most companies underestimate the amount of dead and excess inventory in their business. While most guess it to be less than 10 percent, when a valuable inventory software like Cutwater is used, we find that the actual amount is anywhere from 20-30% or even more! That alone is more than a ripple but a strong wave, but then consider that holding costs represent an additional 20%! So for a company who has $500,000 of inventory cost, its cost of carrying or holding the inventory would be estimated to be $100,000 per year! When you consider the total cost of purchasing items, warehousing, handling, and accounting for depreciation, a ripple can soon become a tsunami!
When you buy a product for resale, you anticipate making a profit over and above the purchase price. But what happens when that item loses value, either because it has not sold and its market price has fallen below what it was purchased for. The item isn’t worthless but it is no longer valued at its original purchased price. The difference between the purchase price and the current price is the write-down amount. Any inventory write-down must be reflected as an expense on an income statement. Retailers can easily understand this; snowblowers and snow shovels have great value in the winter, but need to be drastically marked down when spring arrives!
At some point, a business will recognize that a portion of inventory no longer has any value and the value must be written off. Before this occurs, there are some steps that can be taken to salvage some value as outlined in the whitepaper “10 Ways to Get Rid of Dead or Excess Inventory”. A Write-Off is far more damaging to a company’s bottom line than a Write-Down which is why most businesses are hesitant to give up hope on actually selling something that in reality will NOT be sold.
Inventory = Working Capital?
Isn’t inventory considered working capital? Working capital is calculated as follows:
Working Capital = Current Assets – Current Liabilities
When inventory is considered an asset, it is then considered part of the working capital. However, the longer an inventory item is sitting on the shelf and not performing its intended purpose of being sold for profit, it becomes a liability and therefore becomes what we call “non-working” capital. The ripple widens with possible financing costs, interest paid on a purchase, and lost interest when your cash becomes inventory. Having access to liquid cash is critical for a successful business where it can be used to properly compensate employees, up your marketing efforts, streamline operations, and invest in the “right” inventory that will generate more profits. A shortage of cash can be a ripple with ever widening circles!
We often fail to consider costs related to stocking inventory such as rent, utilities like lighting and heating, security and building upkeep, not to mention warehouse employees. The cost of servicing your inventory includes theft protection, insurance against workplace accidents, and abiding by all sorts of government regulations including taxes which must be paid on the levels of inventory kept on hand; the higher the inventory, the higher the taxes! And if you have large amounts of inventory that need to be tracked, inventory management systems or applications may be needed to ensure no inventory goes missing.
The Costs of Stock-Outs
The cost of being out of stock can be quantified by lost sales or lost customers, but may be more difficult to calculate in terms of customer satisfaction levels. When there is insufficient inventory on hand to complete an order, you pay the price with emergency shipping fees and increased time spent contacting suppliers and improving ordering processes which takes your employees away from more productive aspects of your business.
The Most Important Ripples
A small problem OR more importantly a small solution related to your inventory can have a ripple effect on almost every aspect of your business, either positively or negatively. Some ripples are easy to quantify, while others may be more difficult to measure. There are tools to help provide valuable insights into your inventory. Inventory right-sizing through such tools can have a large, sustainable impact on your business!
Another important “ripple” is to consider how your life can have a ripple effect on the lives of others. You can have a great impact on this world with just one small act of kindness or love! If you’ve ever had your bag lost by an airline, you know the power of a little “mistake”. And if just a smile or a “hello” from a stranger has changed your outlook, you know it too!