This past weekend here in the Northeastern US, we were confronted with a blizzard bringing record snowfall totals. How do unexpected weather events like this impact inventories? Grocery stores saw milk, bread and eggs flying off their shelves just days before the storm; apparently many people planned to weather the storm by eating French toast. Hardware stores saw rock salt selling out and an increase in demand for snow blowers, shovels, and generators. Good inventory management includes the idea of planning for those unexpected surprises. Here are some ideas from an article about inventory challenges, “Overcome the 5 Biggest Inventory Turnover Challenges”.
Inventory turnover is a measure of the number of times inventory is sold or used in a time period such as a year. The equation for inventory turnover equals the cost of goods sold (or net sales) divided by the average inventory.
As an example for a company where the cost of goods sold in the past year was $815,000 and at the end of this period, the inventory was valued at $163,000.
We use the inventory turnover formula:
$815,000 cost of goods sold / $163,000 closing inventory = 5.0 turns per year
The inventory turnover ratio helps operations managers better understand how frequently their stock levels will turn and also helps financial advisers or buyers better understand how often replenishment stock should be ordered to avoid stock outs.
5 Inventory Turnover Challenges to Overcome
- Inventory seasonality: Some goods have higher customer demand than predicted due to certain weather such as unusually wet or cool summers. For instance, the HVAC industry will often see Heating and Cooling system demand vary based on these trends. This should be accounted for in inventory stocking policies and plans for the year. While some seasonality such as holiday sales can be planned for, how do you prepare for aberrations like a blizzard? Or what happens when those items don’t move due to an unusually warm winter with less snow?
- Obsolescence: Outdated stock often cannot be sold and for most distributors, inventory that has sat for more than 12 months is likely considered “dead” or an obsolete inventory Dead inventory has a corresponding negative effect on the balance sheet, where it has to be written off or given away at a cost to the company. Tracking demand patterns of inventory items helps identify excess and dead inventory over time.
- High carrying costs:If a business has excess inventory, either sales are lower than forecasted or stock holding levels have been poorly planned and managed by operations or affected by unanticipated weather. Buying in bulk from suppliers can also tie up capital in stock and lead to too much inventory being on hand, leading to poor cash flow. Keeping inventory levels lean can offset unnecessary carrying costs.
- Carrying slow turning, high cost products:Having slow inventory turnover ratios for expensive stocked items will lead to more working capital committed to inventory costs and possibly a greater risk of inventory obsolescence. ABC Analysis or ABC Classification can be used to avoid carrying high cost, slower moving items. Wholesale distributors should consider if the extra cost to “rush” order high cost items from their supplier is actually less than the cost of keeping these items in inventory.
- ABC Analysis: Utilize Pareto Analysis(the 80/20 rule) for inventory that is classified into A, B and C groups, with ‘A’ being the most frequently demanded items. Detailed attention is focused on these important items to ensure items with high customer demand are always in stock to avoid stock outs or back orders. ABC analysis is also used to help warehouse managers place inventories in the optimal location within the warehouse to ensure efficient order fulfillment saving labor costs.
So what are some of the inventory challenges of seasonality on your inventory? How did you survive the “big storm’? I’d like to hear what you find beneficial when planning for the unexpected in your business!
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