Inventory management and forecasting is integral to providing superior customer service while maintaining optimum working capital and cash flow.
What it is: A company may need to have an inventory of raw materials, work in process, finished goods and terminalized storage. Inventory decisions can impact how much working capital the company must finance, the efficiency of the manufacturing process, the square footage of warehouse/storage needed, and the timely delivery of goods to customers. Inventory levels must be determined based on historical information, forecasts of future trends & needs, and prioritization of operational and financial options.
What does it do: Too little inventory can cause the manufacturing to shut down (causing underutilization of labor and fixed costs) and customer orders to be missed (lowering customer satisfaction and revenues). Too much inventory can harm cash flow, carry excess working capital, and increase the opportunity for spoilage or obsolescence of inventory.
Uses:
How is it used: Inventory management is used to determine optimum inventory levels, order frequency, and order sizes to balance company priorities.
Where: Inventory management can be managed for a number of situations such as:
Raw Material Inventory: In a manufacturing setting it is necessary to have raw materials available for the production of finished goods. Having too much inventory can harm cash flow, carry excess working capital, and increase the opportunity for spoilage or obsolescence of inventory. Coordination between marketing, manufacturing, and suppliers is necessary to forecast the need and timing for raw materials as well as order frequency and quantity.
Work-In-Process: Many manufacturing processes have multiple steps and so there is a number of materials that are in process. They are no longer raw materials because they have been partially processed, but they are not finished goods, because they have more processing required. The amount of work in progress can become very large and impact cash flow and working capital levels. Minimizing work in progress without harming manufacturing efficiency or customer supply timing is critical to company profitability.
Finished goods inventory: Carrying too little inventory to meet customer demand can reduce customer satisfaction and can cause the loss of customers, leading to reduced revenues. Carrying too much inventory can require excess warehouse space, increased working capital, and reduced cash flow.
Terminalization inventory: Many companies will create intermediate storage facilities (Terminals) away from the manufacturing site and closer to the customer's locations. This allows larger quantities to be shipped at a lower cost to a location. Then customers can order smaller quantities and receive them quickly from local terminals at a reduced shipping cost. But the company has to manage this inventory as having inventory spread across the country can cause outages in one location while there is excess inventory in another location.
Why: Inventory Management and forecasting can have a significant impact on revenues, costs, capital, financing, and many sources of inefficiencies.
Limitations:
Where it shouldn't be used: You can hire a third party logistics manager and contract manufacturing who will manage all of your logistics needs. In this case, you may have little or no inventory management issues to consider. This can be a very cost-effective option for a smaller business that does not want to set up all of the resources necessary to manufacture and manage their own logistics.
Any restrictions: None
Warnings: Carrying a safety stock that is seldom if ever used is potentially beneficial if the cost of inventory shortages is significant. On the other hand, carrying large safety stocks, when there is little or no penalty for late delivery to customers, is wasting money and capital.
The step by step process for inventory management can vary significantly based on the needs and priorities of the company. The steps below are very generic, but I suggest you review further ideas in the titles under Additional Resources.
Develop a list of priorities associated with your inventory management philosophy
How important is it to you that you never miss an order?
How important is it that you maximize inventory turns and minimize working capital?
How available is warehouse space and how will it be managed?
How consistent are your order patterns and ability to forecast sales?
How do your manufacturing processes impact the need for inventory management? If your process can only make a product once every 6 weeks, how will your inventory need to adjust?
Complete analysis of what your products are and what your customer needs are:
What products do you make or buy and how are they managed?
Who are your customers and what are their buying patterns. How important is it to your customers that you deliver on-demand?
Where are your customers and how long does it take to ship to them?
Segment your customers to determine how you will manage your inventory for each customer group
Determine which products require specialized inventory methods to meet particular market needs.
Can you use third party manufacturing and or third party logistics to reduce your involvement in logistics planning?
Develop inventory levels and reorder quantities and frequency
Safety stock can be estimated by analyzing the historical fluctuation in sales activity and considering the impact on customers if delivery is delayed. The greater the impact on the customer, the greater the percentage of the potential fluctuations your safety stock will need to cover, and therefore the size of the safety stock required.
Consider the potential for delays in production that could impact the ability to deliver products
Consider the potential for logistical disruptions that could extend the delivery of raw materials to you or finished goods to your customer.
At a minimum, the safety stock could be the same as the reorder point (average of sales per day times the days from order to delivery from your supplier).
Identify the inventory needed to meet sales (sales quantity X days between expected order dates).
Determine the reorder point (average of sales per day times the days from order to delivery from your supplier).
Where necessary utilize regression analysis and other forecast tools to understand average historical performance and the expected forecast if trends remain unchanged. Determine the level of fluctuations in sales and the standard deviation levels to cover sales variability.
Never assume that trends will remain unchanged, so forecast what changes are occurring in the market and estimate the impact they will have on historical trends and regression lines.
Identify safety stock to meet the needs of customers when sales fluctuate and sales exceed standard inventory stock levels
Consider fluctuations in your own production that could impact your ability to supply in a consistent manner
Determine if you can save more money through larger orders of products, or by ordering more frequently with smaller order quantities.
Consider other factors that could impact inventory levels
Utilize Inventory management software (like an ERP system) or management sheets to keep track of what you are doing and how well your inventory system is meeting your needs.
You can display the data in the excel formats, but a summary of your inventory management system and priorities are normally shown in a PowerPoint format.
Examples:
An example of excellent inventory management is the Dell computer company. They maximize the impact of working capital by leveraging their sales model. Dell accepts orders on-line and indicates that they will supply the computer in 1 to 2 weeks. They require payment at the time of order, but they do not order the parts until the product has been purchased. They then order the raw materials to construct the product. Because they do not order the parts in advance, they have no inventory to carry and not obsolete inventory to write off. They do not pay their vendors for 30 to 60 days, but they get paid immediately, so they carry about $2 Billion of negative working capital. So instead of needing to finance $2 Billion dollars of working capital, they have $2 Billion to run their business or invest. This is an amazing model that serves them well. They do not need to forecast inventory, carry safety stocks, or any other problems with inventory forecasting or management.
