Identifying accurate minimum and maximum stocking quantities are what we’ve found to be the best way for service companies to manage having the right amount of inventory on hand. The minimum quantity should include the safety stock that you want to have on hand to protect you from running out of stock. Your maximum quantity should not exceed the bin capacity for that product and should represent the budget of product you are willing to stock at that time. It is important to review these quantities as time passes. For example, if you are constantly running out of a particular item, the minimum/maximum quantities should probably be adjusted.
Just the same, when cycle counting the slower moving items and you notice a bin with too much product in it, adjusting the min/max quantities lower will make sure the next time that product comes up to buy the order amount will be lower.
Long lead times are not a problem, inconsistent ones are. If you know a product consistently takes 4 weeks to get after ordering, you’ll know when to order. If a supplier is shipping product the same day one time…and four weeks at other times, what will happen to your customer service? Your inventory turns? Find out from your suppliers how long it will take to receive material and then use that for your ordering system. Your vendor choices will greatly determine your own internal efficiencies so take that into consideration when figuring your true cost of inventory.
Recognize the true cost of inventory. If you buy a product for $1.00 and sell it for $2.00 you made a 100% profit…right? In spite of what some of your employees might believe, a company incurs costs other than what the vendor (and transportation, if applicable) when buying and maintaining a product in inventory. These costs can be divided into two categories: the cost of ordering the material and the cost of handling the inventory in your warehouse. If we add these costs to the amount you actually pay for the material, we get the total cost for the material:
Unfortunately many companies overlook the “hidden” cost of ordering and many believe they are buying from the lowest cost supplier when in fact it is costing them much more than buying that product at a higher invoice price but a lower overall cost. You must account for the processing time for the initial purchase order, the expediting time until the product hits your door and processing the invoice for payment. Total ordering costs include identifying what needs to be ordered, placing the order (fax, phone or barcode scanner direct), reviewing the vendor confirmation, checking for correct costs and quantities, confirming delivery dates and receiving the product all the way to the designated bin location. Also included is the processing of payment by accounts payable processing the paperwork, creating and mailing a check and filing the paperwork. Obviously, any inaccurate shipments, defective material, bad quality products, unlabeled products or questionable invoice pricing will increase the cost to order for that particular service company because of the vendor incompetence.
There are formulas available to help compute companies’ overall cost to order and for also each vendor to determine whether or not their pricing is indeed the best. The average cost to order for most service companies is around $6.00 per purchase order line item but companies using bar coding or other types of electronic purchasing and payment average around $3.00 or half the amount that other companies have.
Inventory carrying costs include such things as warehouse or truck space, taxes, insurance, obsolescence or shrinkage, material handling and the cost of money, which include opportunity cost. Adding the above costs and dividing it by your average inventory value will get you your total cost to carry percentage. For most companies this amount comes to around 35% but companies utilizing organized systems that take full advantage of designated bin locations and efficient space utilization often average less than 30%.
So back to our example of a $1.00 purchase and $2.00 sell price for an item, the true profit would have depended on how many other products and line items would have been purchased along with that part. For example, if that item were the only thing purchased from that vendor, the cost to order would have been extremely high. Alternatively, if it was ordered along with 50 other lines items and was one of 500 of that product purchased on that line item, the cost to order and carry would have been much, much lower.
So do yourself and your family a favor by working with a progressive supplier that you trust in bringing your company up to date with effective inventory control solutions that will allow you the peace of mind and money to spend your time on that beach, in that boat, on that golf course or in that park seeking the greater satisfactions of life!
