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Managing supply chain is increasingly a demanding task of satisfying the customer and the shareholders. Supply chain professionals worldwide have a daunting challenge of managing a global supply chain aligning with the business needs and financial downturn adds another dimension to the complex challenge structure. All agree that supply chain manager’s primary task should be apart from keeping customers or stores properly stocked and deliver the perfect order every time, they must balance the need for low costs, proper inventory levels and maximum service levels. They must ensure that supply chain management is an integral component of the company’s strategic direction and plan to create and maintain a competitive advantage.

Apart from the above-mentioned challenges and tasks of a supply chain manager, we have few more issues to tackle in the modern world and they are Globalisation; Terrorism; Product Proliferation; Scrambled Merchandizing and Customer Retention.  In order to balance all tasks and counter all challenges, we need a process and that is called Sales and Operations Planning.

Sales and operations planning (S&OP) is an integrated business management process developed in the 1980s by Oliver Wight through which the executive/leadership team continually achieves focus, alignment and synchronisation among all functions of the organisation. The S&OP planning includes an updated forecast that leads to a sales plan, production plan, inventory plan, customer lead time (backlog) plan, new product development plan, strategic initiative plan and resulting financial plan. Plan frequency and planning horizon depend on the specifics of the industry. Short product life cycles and high demand volatility require a tighter S&OP planning than steadily consumed products. Done well, the S&OP process also enables effective supply chain management (Source: WIKIPEDIA). S&OP is critical for any company that is targeting strong performance.

Let us understand global challenges faced by many organisations in different regions in order to understand how S&OP can help us to counter them.S&OP 1

As explained above more or less all regions in the world face some unique challenges such as demand for velocity improvement, faster and accurate order fulfilment, global supply chains, the pressure to reduce costs, and last but not least is to improve top line revenues.

Planning can be classified as two different methods, the first one deal with unconstrained planning.  This means typical material requirement planning, which answers the question of what is required to meet the demand without any constraints.  The second method is constrained demand planning.  This method with the help of a tool measures what can be produced with a given constraints and available resources.  Let us see who is good at unconstrained planning? EMEA and all other regions are doing very well both in responding to the unplanned event and also in an unconstrained environment. In my opinion, the most disappointing factor of the survey is that the best in class results in the case of responding to unplanned event or demand and conducting a gap analysis and initiating corrective actions indicate there is a lot of work on hand.

Constrained planning and the ability to respond to the unplanned demand in a timely manner indicate the S&OP 2level of supply chain flexibility and supplier collaboration, apart from manufacturing nimbleness.  Living with a problem and addressing the problem through gap analysis distinguishes the supply chain.  The world is the true classroom. The most rewarding and important type of learning is through experience,  there is only one thing more painful than learning from experience and that is not learning from experience.

But how many organisations are involved in going through the S&OP Process?  EMEA seems to be heading the group at a Macro level.  The S&OP success largely depends upon the SKU level measurement, all other regions are better compared to EMEA.  What is disappointing is that no other region is close to the best in class.  S&OP process is driven by the people and it is very critical that they understand the importance of the process and implement it effectively in order to drive the organisation in the right direction.  It is heartening to note that all other regions have done better than best in class in understanding the business systems and utilising them effectively.  Individual or functional (departmental) goals and objectives sometimes derail the S&OP process and that could result in heavy inventory and disappointed customers and shareholders.S&OP 3

It is needless to add that technology is very critical for the S&OP Planning and execution.  What is sad to know is that many organisations do not invest in specialised IT tools to drive the S&OP/Demand planning, they rely on ERP tools.  This was very clearly established by the survey undertaken by Aberdeen group. Demand forecasting in a retail and FMCG markets and within PUSH supply chain area is challenging due to product proliferation.  You need a specialised tool that could provide a variety of options and models with regard to your future demand.

North America organisations are heavily wedded to legacy systems compared to other regions.  It is sad that a matured market such as North America depends on the legacy and old systems and lacks the emerging market’s capability.  Further, NA does not boast an integrated ERP solution in place. It is clearly evident that emerging markets are more adventurous in investing in technology which could lead to better planning, less inventory, improved customer service and increasing top line revenue with the attractive bottom line.

S&OP 4We have made an attempt to understand how the world is managing S&OP business process.  Before I sign off, let me spend few minutes to explain the current challenges of S&OP process globally.  The first challenge is to align the process to the business strategy; we have often seen both heading in the opposite direction. The business ownership for the process, it is quite common to see S&OP as a sub-function of Supply Chain with more emphasis on managing supply than the demand.  In my opinion, the biggest challenge is managing the change (fear of failure).  This is very commonly seen in constrained planning situations.  Many people believe that S&OP process is all about the forecasting the demand but very few understand that it is a process to align the operational excellence with business needs in the form of customer demand.  Many do not see the value of S&OP in containing the inventory carrying thus resulting in cost reductions.  In order to address this issue what we need is executive governance.  The executive team should understand the importance of S&OP process and drive it effectively.  It is quite common to see Management team is involved in approving the outcomes and not driving the outcomes.  It would be effective if executive management drives this process aligning with organisational goals.  Another commonly noticed challenge is the new product launch.  Any product launch should go through product lifecycle management (PLM) process and all elements of PLM process should be thoroughly reviewed before the launch, if not the S&OP process will not help in achieving the product success.  The last but not least is connecting the planning to the execution.  Many organisations are good at planning, when it comes to execution, to a great extent many are not successful.  S&OP is only a business process, in order to make it successful, business discipline is critical and governance is paramount.

Cartoon Source: Cayuga Partners

SOP

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In general supply chain innovations or improvements focussing on inventory optimization target either lead time reduction or cost savings and in some cases both.  The bottom-line for these concepts is to reduce or eliminate inventory and minimize the impact of inventory carrying costs on the P&L and to reduce the lead time.

If I were an entrepreneur involved in manufacturing, I would love to own inventory that is just required for that day’s production needs.  If I am big reseller I would like to buy material that is just required to meet day’s demand.  If I am a big buyer, I would prefer suppliers to carry inventory that is required by me.  The reason for all these demands is that Inventory costs money and its money to carry the same.  And that is the reason everyone would like to differ the inventory carrying.  Do we have solutions to meet this requirement within Supply Chain?  And that is the reason we are here to find out the solutions.

Some of the solutions that could answer the questions raised above include the following:

  1. Vendor Managed Inventory
  2. Consignment Inventory
  3. Inventory Financing
  4. Cross-Docking

Vendor Managed Inventory (VMI):

This is a very popular concept in Asia and majority of High Tech/IT manufacturers use this solution.  What is VMI?  The title indicates the meaning and objective of the solution.  The inventory that is required by the manufacturer is managed and maintained by the supplier at the back yard of the manufacturer. The objective of VMI is that by pushing the decision making responsibility further up the supply chain, the manufacturer will be in a better position to support the objectives of the entire integrated supply chain resulting in a sustainable competitive advantage.  This solution creates a transparent supply chain enabling supplier and buyer to avoid uncertainties in supply.  Centralizing and automating the replenishment decision also helps reduce the distortions in ordering introduced when there are several intermediaries that place orders in a supply chain.  The big change to supply chain is that VMI transforms push supply chain to pull supply chain thus avoiding wastages and uncertainties.

As you can see from the above graphical presentation, in a VMI environment three parties are involved.  The first one is the Vendor, the second one is the manufacturer or the buyer and the third one is the 3PL appointed by the buyer to store, manage and supply vendor material to the production line as and when required.  The buyer provides indicative yearly consumptions and allows the vendor to develop safety stocks and reorder points to ensure that the VMI hub never runs out of inventory.  One can notice the responsibility of inventory planning is shifting to the vendor instead of buyer.  This model also provides the certainty to the Vendor with regard to demand for their product.  This model is very popular in raw material supply environment.  However, this model can be customised to a finished goods environment.

Some of the benefits of VMI:

  1. At K-mart, customer service measures have gone form the high 80s to the high 90s.  Inventory turns on seasonal items have gone from 3 to between 10 and 11, and for the non-seasonal items form 12-15 to 17-20.
  2. ACE Hardware, the large hardware cooperative, has seen fill rates rise 4% to 96% in the past few years.
  3. Fred Meyer, the 131-unit chain of super-centres in the Pacific Northwest, reduced inventories 30% to 40%, while sales rose and service levels increased to 98%.  This was due to a VMI program implemented with two key food vendors.
  4. Grand Union, a New Jersey-based grocery retailer with more than 100 stores and three DCs, improved inventory turns by close to 80% and achieved 99% service levels.

Source: Fernando del Cid, Roger Gordon Brian Kearns, Paul Lennick, and Andreas Sattleberger.

The Consignment Inventory:

This is something similar to VMI with subtle difference.  In this case there are only three parties involved, that is the buyer and the seller.  Under this model, Inventory owned by the supplier is held by the buyer and the ownership of goods transfer to the buyer only at the point of consumption.  Consignment stock arrangements are usually put in place to assure continuity of supply to the customer or to reduce the customer’s working capital or both. While much of the benefit is to the customer, the supplier also benefits because the customer is tied to his product, he does not have to hold stock, and has more freedom in choosing when to manufacture or procure additional supplies to replenish the consignment stock.

Having worked in mining industry, I have seen many suppliers dealing with mining products enter into an consignment inventory agreement with the mining companies to supply inventory to the mining companies on consignment basis and generally billed at the end of the month when consumption is accounted.  This allows suppliers to tie the buyer to their product and the buyer is assured of continuous supply without investing in the inventory carrying and avoids the cost of inventory carrying which could be up to 25% per annum.

Some of the risks associated with consignment inventory model includes,

  1. Increase in overall inventory carrying with in supply chain.
  2. The pressure to reduce inventory is indirect.
  3. Due to lack of inventory planning by the buyer could lead to obsolete inventory for the supplier.
  4. Suppliers are likely to incur extra costs by carrying out stock audits on customer’s premises.
  5. A very high quality of stock rotation and record accuracy is required to be maintained by the customer’s employees when dealing with the suppliers’ inventory.

Inventory Financing:

 In short, finance provided to the borrower against the inventory as collateral. Inventory Financing companies are willing to finance against the inventory/purchases up to 70% to 90% of their value with a repayment period of 120 days. This allows the buyers to choose their suppliers based on their products, prices and service, rather than on the credit availability they offer.

In the present e-commerce environment where “cash to cash” cycle is shrinking for the big players, it is also imposing a financial stress on the smaller players who happened to be suppliers.  In order to understand the cash to cash term well, let me quote the definition provided by SCOR, “Cash-to-Cash Cycle Time is a continuous measure that is defined by adding the number of days of inventory to the number of days of receivables outstanding and then subtracting the number of days of payables outstanding. The result is the number of days of working capital your organization has tied up in managing your supply chain.”

More and more organizations are looking for solutions to differ inventory ownership.  The vendor managed inventory, JIT delivery are the examples of operating without carrying inventory.  These solutions may work well for the buyer but what about the seller who may be a small player.  This means that the suppliers are made to wait long to convert inventory into cash.  In case of JIT delivery solution, the supplier has to carry inventory at his facility which results in increasing storage and operational expenses and in case of VMI the suppliers are expected to pay the 3PL charges.  This kind of challenging expectations makes the suppliers non-competitive. This could only lead to ill-will among the suppliers and result in high cost of material, poor quality or even could lead to bankruptcies.

In an attempt to lessen this cash burden on the smaller suppliers, some of the service providers and Bankers are providing several trade-financing alternatives.  These alternatives could be driven at the behest of the major client of the 3PL, in which case the credit rating of this entity is used to compute the cost of money to the smaller suppliers – thus providing a win-win situation for all concerned.  Alternatively, these deals can be structured independently for either the large corporations or the smaller suppliers.  In either case, the cost and benefits would depend on each individual case.  However, it will prove a definite win for all concerned.

3PL would pay suppliers (finished goods supplied): In this case, if a supplier gets paid by the buyer in 60 days as per the commercial terms negotiated, 3PL can step in and pay the supplier in7 days’ time (imaginary).  The supplier gets the money fast and hence would offer a cash discount to 3PL.  On the 60th day, the buyer would pay 3PL the full value of the invoice, as they do currently.  In this scenario, this is transparent to all in the process. The supplier gets paid faster and therefore can afford to give a cash discount from 1 to 3%.  This enables the buyers to use their credit limits to handle their core requirements.  The discount rate would be less than the supplier’s cost of capital as 3PL would most probably be charging an interest rate that applies to buyer’s credit rating.  The savings for the buyer; would be that they can minimize their back office activities such as account payable to some extent.  They can afford to do this as the rates and quantities are already checked and vouched for by 3PL.

Finished Goods Inventory Financing: In another instance where 3PL may buy the finished goods inventory from their clients.  The clients would then be able to recognize revenues immediately and also get these assets off their balance sheet.  At the same time, their customers would be able to buy these products and thus put them on their balance sheet only when they absolutely have to do.  This would help clients in a “Vendor Managed Hub” situation and clients who need to get sales revenue recognized at the end of a quarter to meet their financial goals.  The risk of obsolescence would be borne by the client (would be treated as sales returns) and any shrinkage or losses would be borne by 3PL and/or client.  The benefits for the clients are phenomenal as can be imagined.  As part of this package, 3PL would also be willing to purchase up all the inventories of a client and “park” these assets on their balance sheet.  The immediate impact on cash flow and lines of credit for a client is immense.

Raw Materials Purchase: 3PL would also, as part of these activities, help finance the raw materials or finished goods (trading) for a client directly from the suppliers.  In this instance, 3PL would pay cash for the raw materials and put these assets on 3PL balance sheet.  The advantage for the client would be that the client can negotiate a bulk/cash rate from their suppliers and take advantage of the lower cost.  The client will then pay 3PL for the materials as and when they draw from this inventory.  Here again, the cash flow is a significant impact for the client as well as opening up the lines of credit for other core activities.  It is needless to add that the obsolescence is borne by the client and warehousing charges for holding the inventory will be paid by the client.

Best of the breed:  In this model they use a financial institution and 3PL act as a custodian of the inventory.  The material purchased by the 3PL client will be paid by the financial institution as per agreed commercial terms.  This helps the suppliers to get their payments quickly and is willing to offer cash discounts to the buyer (in this case 3PLs client).  3PL will release inventory to their client based on the amount of payments cleared and on the instructions of the financier.  However, the buyer (3PL client) will own the inventory and be accountable for the obsolescence.  This will help the buyer to have additional line of credit on top of working capital already borrowed based inventory held by them.

The main objective of inventory financing is to reduce burden on supplier and at the same time differ the inventory ownership for the buyer.  In the process, buyer end with low finance costs and 3PL add value to the business by owning inventory.  The author worked with major corporates who hates to own inventory at any part of the business process.

Cross-Docking

Four major functions of warehousing include, receiving, storage, pick-n-pack, and shipping, it is estimated that 70% of warehouse costs are incurred for the storage and pick-n-pack activity, storage because of inventory holding costs, and order picking because it is labour intensive.

Cross-docking is a logistics technique that eliminates the storage and order picking functions of a warehouse while still allowing it to serve its receiving and shipping functions. The idea is to transfer shipments directly from incoming to outgoing trailers without storage in between. Shipments typically spend less than 24 hours in a cross-dock, sometimes less than an hour.

Different types of Cross – Docking:

  1. Manufacturing cross-docking – the main function of this activity is to receiving and consolidating inbound supplies to support Just-In-Time manufacturing.
  2. Distributor cross-docking – consolidating inbound products from different vendors into a multi-SKU pallet, which is delivered as soon as the last product is received
  3. Transportation cross-docking – consolidating shipments from different shippers in the LTL and small package industries to gain economies of scale
  4. Retail cross-docking – receiving product from multiple vendors and sorting onto outbound trucks for different stores

 Success Story:

“The “warehouse concept” made famous by Costco is all about reducing logistics costs, and cross-docking is at the centre of the strategy. Because the outlet (itself a warehouse) displays pallet quantities, cross-docks in the Costco system receive and ship pallet quantities. At one distribution centre in California, 85% of all pallets move across the dock in tact; the remaining pallets are broken down and sorted by case in a lay down area. By not breaking most pallets at the distribution centre, Costco saves labour costs that other retailers have to pay for order picking, packing, and shipping.

Costco currently uses a post-distribution system, meaning that they attach labels to pallets after receiving them. In the future, they hope to have their vendors attaching those labels for them, so they can avoid all touch labour in the warehouse.”

The urge to produce and sell goods at a very competitive price is on top of the agenda for the organizations due to global competition, dynamic market conditions, product proliferation and scrambled merchandizing.  There is no end to this drive.  Someone in some corner of the world is always exploring the ways and means of bringing down the cost of the product by implementing supply chain improvements to meet the customers’ expectations.  Some ideas take a shape and get experimented and implemented and some go into cold storage.  However, the quest for innovation never ends and thus makes Supply Chain Management a challenging and intelligent task. I strongly believe that all supply chain professionals are part of that elite group of individuals who strive every day to produce that magic called innovation to bring down the cost of the goods and the cycle time to deliver.

 

 

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We all wonder from time to time about some intriguing words used in Inventory/Materials Management function.  I picked-up some unique, some common, some uncommon words from the glossary published by The Institute of Logistics and Transport, UK and furnished the same hereunder.

ABC Classification The classification of inventory, after ABC analysis, into three basic groups for the purpose of stock control and planning. Although further divisions may be established, the 3 basic categories are designated A, B and C as follows:
A Items – An item that, according to an ABC classification, belongs to a small group of products that represents around 75-80% of the annual demand, usage or production volume, in monetary terms, but only some 15-20% of the inventory items. For the purpose of stock control and planning, the greatest attention is paid to this category of A-products. A items may also be of strategic importance to the business concerned.
B Items – An intermediate group, representing around 5-10% of the annual demand, usage or production value but some 20-25% of the total that is paid less management attention.
C Items – A product which according to an ABC classification belongs to the 60-65% of inventory that represents only around 10-15% the annual demand, usage or production value. Least attention is paid to this category for the purpose of stock control and planning and procurement decisions for such items may be automated.
Bill of Material A listing of components, parts, and other items needed to manufacture a product, showing the quantity of each required to produce each end item. A bill of material is similar to a parts list except that it usually shows how the product is fabricated and assembled. Also called a product structure record, formula, recipe, or ingredients list.
“Control Group” Cycle Counting The repeated physical inventory taking of a small “control group” of parts, in the same locations, within a very short time frame to verify the design of a new inventory process. It is the only form of cycle counting not truly used to measure inventory record accuracy.
De-Coupling Stock Inventory accumulated between dependent activities in the goods flow to reduce the need for completely synchronised operations
Economic Order Interval (EOI) In fixed order interval systems, the interval between orders that will minimise the total inventory cost, under a given set of circumstances, obtained by trade off analysis between the cost of placing an order and the cost of holding stock
First-in, First-out (FIFO) 1. Stock Valuation – The method of valuing stocks which assumes that the oldest stock is consumed first and thus issues are valued at the oldest price.
2. Stock Rotation – The method whereby the goods which have been longest in stock are delivered (sold) and/or consumed first.
GUS Classification A classification of products into three categories for the benefit of goods flow control and stock control, based on a products area of application within a product division.
G = General products that may be required in several main article groups or operations centres and are administered centrally in the division
U = Unique products that are used uniquely in one main article group or operations centre but in several of its products, and administered locally in the division
S = Specific products that are used exclusively in one higher level product, and whose procurement is effected per individual order
Holding Cost The cost associated with holding one unit of an item in stock for one period of time incorporating elements to cover: Capital costs for stock; Taxes; Insurance; Storage; Handling; Administration; Shrinkage; Obsolescence; Deterioration.
Independent Demand A classification used in inventory control systems where the demand for any one item has no relationship with the demand for any other item and variations in demand occur because of random influences from the market place
Just-in-Time JIT A dependent demand inventory control philosophy which views production as a system in which all operations, including the delivery of materials needed for production, occur just at the time they are needed. Thus, stocks of material are virtually eliminated.
Kanban A simple control system for coordinating the movement of material to feed the production line. The method uses standard containers or lot sizes with a single card attached to each. It is a pull system in which work centres signal with a card that they wish to withdraw parts from feeding operations or vendors. Loosely translated from Japanese, the word “Kanban’ means literally means “billboard’ or “sign”. The term is often used synonymously for the specific scheduling system developed and used by Toyota Corporation in Japan.
Last-in, First Out (LIFO) 1. Stock Valuation. The method of valuing stocks which assumes that all issues or sales are charged at the most current cost but stocks are valued at the oldest cost available. 2. Stock Rotation. The method whereby the goods which the newest goods in stock are delivered (sold) and/or consumed first.
Materials Management The planning, organisation and control of all aspects of inventory embracing procurement, warehousing, work-in-progress, shipping, and distribution of finished goods.
NDC National Distribution Centre. Centralized distribution warehouse depot serving the whole country
Obsolescent Stock Parts which have been replaced by an alternative but which may still be used until stock is exhausted.
Perpetual Inventory System An inventory control system where a running record is kept of the amount of stock held for each item. Whenever an issue is made, the withdrawal is logged and the result compared with the re-order point for any necessary re-order action.
Quarantine Stock On-hand stock which has been segregated and is not available to meet customer requirements.
Rotable An repairable inventory item that can be repeatedly restored to a fully serviceable condition and re-used over the normal life cycle of the parent equipment to which it is related. Such items have a repair lead time as well as a procurement lead time and normally have a serial number that is retained throughout the rotable life regardless of the extent of replacement of its component parts.
Service Level The desired probability that a demand can be met from stock (for an individual item, group of items or a system) which can be expressed in a number of ways:
Percentage of orders completely satisfied from stock.
Percentage of units demanded which are met from stock.
Percentage of units demanded which are delivered on time.
Percentage of time there is stock available.
Percentage of stock cycles without shortages.
Percentage of item-months there is stock available.
Total Acquisition Cost (TAQ) The sum of all the costs to an organisation of carrying an item in stock including reorder, carrying and shortage costs.
Unit Cost The cost to an organisation of acquiring one unit, including any freight costs, if obtained from an external source or the total unit production cost, including direct labour, direct material and factory overheads, if manufactured in-house.
Vendor Hub Third party operation of a warehouse, funded by suppliers, containing Vendor-Owned stock for delivery to a customer.
Working Stock The stock of materials, components and sub-assemblies (excluding safety stock) held in advance of demand so that ordering can done on a lot size rather than on an as needed basis. In other words, the normal stocks formed by products arriving in large regular orders to meet smaller, more frequent customer demand. Also known as cycle stock or lot size stock.
X ???????????
York antwerp Rules A set of rules in marine insurance relating to the adjust of general average
Zero Inventories Part of the principles of just-in-time which relates the elimination of waste by having only required materials when needed.

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Weight in gym room

Do you know that carrying excess Inventory costs financially?  Well, you may not see the cost of carrying inventory in your Profit and Loss statement, but trust me it hurts you big time financially.  According to one survey conducted by IMR in conjunction with Harding & Associates indicate that almost 45% of the respondents have no inkling of what is Inventory carrying cost and how it is calculated.  Joseph Mazel of IOMA believes that, “The higher the number used to calculate carrying costs, the more potent it is in reducing inventory.”

But what is Inventory Carrying Cost (ICC)?

“Inventory carrying cost (ICC) is the cost of holding one unit of an item in stock for one period of time” – Waters, D.

Inventory is a tangible asset that is intended for sale. For most retailers, wholesalers and distributors, inventory is the largest single asset on their balance sheet. We do come across business leaders who are comfortable in carrying buffer inventory by sacrificing a portion of their profit margin in the form of inventory carrying cost.  Some believe that carrying buffer inventory is a kind insurance to ensure better service levels.  In my opinion carrying right inventory may improve the service levels.  But the trick lies in determining the right inventory.  There is a cost associated with carrying excess inventory and that cost is known as Inventory Carrying Cost.

Why Companies hold Inventory?

The main objective of holding inventory is to maximise the customer satisfaction by avoiding loss of sales due to lack of inventory.  However, there are six basic reasons why companies hold inventory and they are:

  • Globalization;
  • It enables the firm to achieve economies of scale.
  • It balances supply and demand.
  • It enables specialisation in manufacturing.
  • It provides protection from uncertainties in demand and order cycle.
  • It acts as a buffer between critical interfaces within the supply chain.

All the above reasons are compelling business reasons to support the top line revenue growth, to maximise customer satisfaction and at the same time to improve the gross margins.  Inventory holding helps organisations to achieve first two objectives.  In order to achieve the third objective, Inventory carrying should be optimised.  Excess inventory carrying means an additional cost of carrying which shrinks gross margins and cash flows.  It’s the emphasis to improve the bottom line performance and enhance the organisation’s cash flow position.

There are six different types of Inventory we carry.  They are:

  • Cycle Inventory – Average amount of inventory used to satisfy demand between shipments.
  • Safety inventory – Inventory held in case demand exceeds expectations.
  • Seasonal inventory – Inventory built up to counter predictable variability in demand.
  • In-transit Inventory – Inventory in transit between origin and destination.
  • Speculative Inventory – Inventory held for the reasons of speculation.
  • Dead Inventory – Non-moving inventory.


When we see the value of inventory in the balance sheet as an asset it could include all above different types of inventory.

Components of ICC:

Inventory carrying costs influences many decisions in Strategic, Analytic and Operation levels.

Strategic Decisions: Profit Margins, ROI, Make or Buy, Global or local sourcing etc.

Analytical Decisions: Total Cost of Acquisition; BTO (pull) or BTS (push); Where and what amount to store, Annual Operational Budgets etc.

Operational Decision: Lot Size; Price Break even analysis, EOQ, Evaluating promotional deals and lifetime buys etc.

As inventory carrying costs encompasses several critical decisions, it is necessary to determine what cost should be included in inventory carrying costs. Generally,  ICC is reflected in a percentage of the value of an item.  It contains several components.  The ratio of such components may vary depending on the organisation,  product involved and location.  The components of ICC would typically include the following:

The general thumb rules used for Inventory Carrying cost would be 25% per annum.  However, one has to customise the formula based on various factors.  The dominating factor of Inventory carrying cost is the cost of money, followed by local taxes, Warehouse costs, Obsolescence, and Pilferage etc.  Supply Chain Manager all over the world is concerned about carrying additional inventory. Inventory carrying is directly linked to gross profit of an organisation and profits would go up when inventory carrying is reduced and the profits diminish when inventory carrying goes up.

As mentioned in one of my articles, it is very easy to convert cash into Inventory.  However, it is very challenging to convert Inventory into Cash even though it is considered as a tangible asset.  There are several ways one can optimise inventory levels. I have already written an article on Managing Inventory, hence I am not going to spend time on how to optimise inventory.

Industry wise Inventory Carrying pattern:

Inventory carrying varies industry to industry. I was involved in a research supervision while I was teaching, based on the data collected by a student, I would like to compare the inventory carrying trends of Retail, IT/High Tech, and Automotive industries.  All of them are considered as growing industries.  The average data pertains to year 2000 to 2005.  By analysing the gross profits and inventory turns, the numbers reveal great opportunity for improving inventory carrying in Automotive, IT/High Tech and Retail.  The data pertains to the global players and they have the clout to dictate terms to their suppliers and manage better inventory turns.  The below-given data may be used for reference purposes only.

TO: Turnover; GP: Gross Profit.

Optimising the supply chain and inventory management delivers the benefit of freeing up working capital that could be used for business expansion activities.  When we reduce inventory, we are not only freeing up invested capital but also creating opportunities to reduce expenses and improve profitability and maximise cash flows.  We announce productivity numbers, we announce sales achievements, we announce profit margins periodically and we seldom come across Inventory Performance announcements.

Inventory needs our attention! Inventory reduction improves profit margins, maximises cash flows and reduces operations cost.  Let us just do it!

Cartoon Source: ReadyToManage

finance-non-financial-managers-cartoon

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