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Managing Inventory: Lower Operating Costs "Just In Time"


If you sell or make products, inventory is critical. After all, without inventory, what do you have to sell? Or make? While some businesses use order fulfillment services that capture and process orders, most companies need at least some inventory on hand to ensure products are readily available.

The problem is determining correct inventory levels. If too little inventory is on hand, delays and even lost sales result, creating customer frustration. If too much inventory is on hand, you pay:

  • interest on purchased finished products or materials
  • storage costs
  • handling costs
  • potential damage or loss
  • obsolescence or spoilage
  • insurance (and it’s not cheap)
  • taxes on unsold goods.

With too much inventory on hand, cash is tied up and can’t be used for other business activity, which is not good. Managing inventory directly improves cash flow and the company’s bottom line.

The goal of inventory management is to ensure quick turnaround, minimize cost and maximize customer satisfaction. Determining the right inventory levels is based on several considerations.

Effective Lead Time

Lead time is a major factor in determining how much inventory to keep in the warehouse. Some products sell quickly. Some materials are used more frequently in production processes. Not all products and materials are used at the same rate, and not all can be replenished at the same rate.

The first step in managing inventory is to determine frequency of sale or use, and the time typically required to restock an item. In simple terms: how many of these do I sell a month, and how long does it take me to get more?

Creating an effective balance is critical to maintaining sales and operations while minimizing inventory costs.

Inventory Buffers

Buffers are the difference between smooth operations and grinding to a halt when products or materials are tapped out. Even though past history, future sales and production forecasts help indicate optimum inventory levels, most businesses create an additional buffer to handle short-term spikes in activity.

The size of the buffer depends on the business; 5% additional inventory could be enough for all but the most unexpected circumstances. Balance the cost of the buffer with the cost and need for that on-hand inventory.

If an item costs $5,000, and a supplier can deliver that item in two days, maintaining a buffer may not make good business sense. On the other hand, if a business is based on volume sales, then a larger buffer makes sense so that no sales are lost due to lack of inventory.

Minimum Requirements

An effective, inventory management system includes:

  • identifying and sourcing reputable suppliers who can deliver on time and in quantities needed
  • pre-established stock levels
  • periodical reviews to adapt to changes in production capacity, sales trends and market forces
  • triggers that signal purchases or purchase delays when item or material price levels rise or fall dramatically

Use customer relationship management (CRM) software to track sales and inventory needs. CRM is also essential to develop sales and inventory projections.

Reduce Inventory Costs

Take inventory management to a higher level as the need for effective management increases, usually based on past sales and accurate sales projections.

Ask suppliers to help. Many suppliers will manage inventory, create just-in-time systems, and even provide items and materials on consignment. That’s a supplier who wants to keep you happy, and one to keep in the Rolodex.

Create best practices and apply these techniques across the supply chain. Multi-location companies often use localized inventory management practices. Adopting the best methods for inventory control not only streamlines and standardizes processes, but it also reduces costs of operation.

Adapt operating practices to inventory goals. Production of large quantities increases the need for raw materials and inventory levels. Adjusting production schedules saves on total inventory costs and increases productivity when items are "handled" less frequently.

Dispose of obsolete stock. Often, unused products or materials sit for years simply because it "feels" wrong to throw them away. Sell at a discount, or even discard obsolete stock. Doing so reduces costs over the long term and frees up space for productive inventory.

Reduce inventory review time. Some companies take a physical inventory once a month and then place orders based on that inventory. As a result, they may be forced to maintain higher stock levels because a long review time lengthens lead time to acquire new products or raw materials.

A shorter inventory review cycle creates faster order cycle times and typically reduces the level of inventory needed on hand.

Optimize ordering processes. Purchase orders that take days to work through a distributor’s or supplier’s bureaucracy increase order lead times.

To maintain control and speed up the process, set order "limits" that don’t require multiple management approvals. This way, re-order cycle times are shortened, while your company still maintains tight financial and management control over the purchasing process.

Analyze customer needs. Some customers, for example, those in the construction business, don’t need all materials when the initial order is placed.

If customers use products over time, delivering a portion of an order immediately and the remainder on demand, allows for less total inventory and lower inventory costs. The key, of course, is to ensure the lead time for ordering and receiving additional material is short enough to meet customer requirements.

Make inventory management a key performance indicator. Most companies work hard to achieve their goals. When inventory management is a key performance indicator for an entire department or business, employees are less likely to sacrifice smart inventory control strategies in favor of more "personal" goals, like achieving productivity targets at the expense of creating excess finished goods inventory.

What’s the bottom line with inventory management? It’s your company’s bottom line. The fewer materials or finished goods in inventory, the lower the cash demands.

To improve cash flow, optimize inventory levels and dramatically reduce the cost of keeping excess product in storage.

With inventory, less IS more.

Business - Accounting Industry

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This article contains general information only. Sunflower Bank is not, by means of this article, rendering accounting, financial, investment, legal, tax, or other professional advice or services. This article is not a substitute for such professional advice or services, before making any decisions related to these matters, you should consult a qualified professional advisor.