The GroFin Guide for entrepreneurs: How to optimise inventory levels

‘Inventory is a necessary evil.’

Any business owner, particularly from the stock intensive manufacturing, wholesale or retail space, would likely agree with that statement.

Having too much inventory exposes your business to the risk of potential write-offs of unsold and obsolete stock, as well as to the pitfalls of committing money to slow-moving inventory when the same could be required soon for more immediate expenses – such as rent, labour costs or utility charges. On the other hand, having too little inventory could cause your business to lose out on a large order because you have insufficient stock on hand and there are delays in receiving much needed materials for the production process or re-sale, or pile-on expenses of ordering small volumes of inventory at higher rates because bulk purchases ran out mid-month.

At the outset, it is important to reiterate that inventory/stock purchases are part of the cash cycle or “operating cycle” of any business. First, the company makes payments to suppliers and then receives the stock (supplier days or payable days). Next, the stock is processed –depending on whether it is finished/ready to sell stock or raw materials that will be part of the production cycle – so the processing time should also be factored into the operating cycle. Finally, a critical component of the operating cycle of a business are the sales terms, whether on cash or credit terms. Hence the nature of the inventory, order amount, payment terms, time of receiving the stock, and processing time should be evaluated against sales and collection of monies from customers (receivable days) so that you can accurately assess your operating cycle and your business does not face cash shortages.

With its thoughtfully designed and well-structured suite of business support services, GroFin helps its clients add value to their business in the critical area of inventory management. Based on our wealth of experience in helping entrepreneurs manage their business without getting swamped with excess inventory, or facing a stock-out situation, here are eight ways in which you can optimise your inventory levels:

Categorise inventory

Before you take a decision on inventory, you must first break it down into levels such as safety, replenishment, and excess or obsolete. Every business needs a minimum level of safety stock to ensure that it can meet an average threshold of customer orders even if there is a manufacturing breakdown or bottleneck, or there are delays in distribution or delivery of fresh inventory. Next comes the replenishment level (“reorder point”), which refers to the inventory threshold at which an order must be placed, taking into account the average delivery time from your supplier. A trigger for replenishment orders is when you hit your reorder point which is essentially a sum of safety stock and demand to be met during the waiting time when you are expecting inventory from your suppliers. Finally, the last level, excess or obsolete stock, is an unwanted category but an unavoidable assessment if you wish to declare sales on outdated stock, clear storage space for new inventory, and keep accounts updated with write-offs on obsolete inventory.

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Prioritise inventory items

Manage by exception and focus on items that have frequent demand and high turnover. As a rule of thumb, it is estimated by inventory management experts that 15-20% of your items will generate as much as 75-80% of demand. Give more time, effort and frequency to forecasting, reviewing and reordering the A category items in your inventory composition. The second category should consist of “B” items that comprise a third of your inventory but generate only 10% of your sales. These items do not need as much attention as “A” category, so the frequency for reviewing “B” items would be necessarily less than that for “A” items. Finally, we come to the least important category of “C” items that account for as much as half the items stocked but generate as little as 10% of your sales. This category can be reviewed at a lower frequency compared to “B” items, considering that it has the lowest per unit contribution to turnover compared to the large base of inventory that it comprises.

Look at inventory in the broadest sense

Keep in mind that inventory consists not only of finished goods sitting in your warehouses, but also raw materials, work in progress, spare parts, stationery, and goods at your retail outlets. In fact, these items are likely to constitute as much as half of your inventory, and are as critical to keep track of as your finished goods. To decide how much stock to maintain for each component, ask yourself some basic questions: Are you in a position to accurately assess demand? Is the price of the item steady or volatile? Do you get discounts for bulk purchases? How efficient and reliable are your current sources of supply? Are there alternative suppliers in the market, in case your main supplier falls short or is unable to meet your demand in time?

Choose optimum inventory management techniques

Your business can follow either of two primary inventory management techniques – Just in Case (JIC) or Just in Time (JIT).

JIT is a modern technique companies employ to increase efficiency, decrease waste and reduce inventory holding costs by receiving goods only as they are needed in the production process. Made famous by Japanese automotive major Toyota, JIT works best for companies that have repetitive manufacturing functions and where producers are able to accurately forecast demand. If your business deals in high variety, perishable, fashionable, and high obsolescence products, JIT could save it from both high holding costs as well as write-offs. Efficient inventory management with accurate reorder points is crucial for firms that use a JIT approach, since supplies arrive just as they are needed for use in production or for re-sale. When using JIT, companies maintain little or no safety stock, and purchase materials & products in small quantities whenever they need them.

On the other hand, the traditional, JIC technique requires that companies keep large quantities of inventory on hand and incur associated inventory costs, to minimise the probability that a product will run out of stock and cause it to lose out on sales opportunities. For example, a hospital which needs life-saving drugs on hand at all times to meet emergency situations cannot afford to follow a JIT system as it must keep a sensible safety stock margin. Accordingly, for such businesses, the reorder point will be triggered with sufficient lead time to receive fresh supplies, as well as enough buffer in the form of safety stock to meet any unforeseen requirements, just in case. Also, a new business that is just making its first few customers might want to follow the JIC technique to begin with, as there would be difficulty in accurately assessing demand given lack of business history, as well as higher potential risk of losing a customer for good if stocks are not available immediately to meet demand.

Use software/spreadsheets to order and track inventory

When it comes to ordering inventory and tracking its movement in the business, it may save costs in the long run to purchase an inventory management software. Increasingly, businesses are using inventory management databases or inventory management software to decide when and what order sizes need to be placed. Many businesses also develop tracking systems over spreadsheets or software to control inventory and ensure that the purchase manager is aware of inventory movements through the business. A regular exercise/ or stock audit can be performed to compare “on the ground stock” with that recorded on the software/system. If differences arise, it allows you to dig deeper and address the underlying causes of such discrepancies – which could range from intentional factors such as theft or negligence, to inadvertent factors such as inaccuracy or waste.

Use consistent item descriptions

Whether you automate inventory management, or do it manually, the basics of any good inventory management system stay the same – location names must be well-organised and easy to explain, and location labels must be easy to recognise and unambiguous. Item descriptions used must be unique and can be reinforced with reference numbers to ensure that these items are tracked correctly. Finally, units of measurement, whether defined in terms of weight (such as kilograms or pounds) or batches (such as bags or crates), or individual items (such as pieces or units), must be consistent to facilitate placing of orders and tracking of inventory through the business. Your business may be small today and tagging items by label, description, and number may seem like too much effort to invest for a few inventory items, but once it grows big, it will be that much tougher to monitor inventory, unless such simple but essential details are fleshed out from the start.

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Prepare policies & operating procedures and train people on their use

Ultimately, it is the people who use the inventory system that are the most critical determinant of its success. Ensure that your staff knows what to do with deliveries received; stock held for immediate sale, kept for future use, maintained as safety buffer and needed in production; what to do in case of emergency; who will be in charge and what will be the protocol followed, among others. In case orders must be placed urgently, your staff should also know the concerned people who can undertake such transactions. Having policies in place that are easy to understand and simple to implement will ensure that training staff on inventory does not take time, and once trained, they are easily able to order and track inventory in line with provided guidelines. Staff must also be briefed on protocol for inventory movement in and out of warehouses such as receipt voucher, disbursement slips as well as approvals/signing by authorised employees, among others.

Make inventory a joint responsibility

Whether it is about inventory policies, or about inventory ordering, avoid making inventory the responsibility of only one key person in your business. For starters, do not show haste to pinpoint the production or sourcing manager as the sole person accountable for all inventory related decisions. Instead, sit down with him first to formulate clear policies around critical factors such as the depth and range of goods offered by your business, and the optimal manufacturing or distribution pattern for such products. Similarly, do not place responsibility for ordering inventory only on the shoulders of the production or sourcing manager, but also involve the sales and marketing manager to more accurately forecast the expected sales of the items, and work backwards to ordering inventory. A marketing campaign might cause the sourcing manager to run short on his purchase orders when it is launched and shoots up sales in what could normally be an off-peak period for your business.

When it comes to inventory, GroFin can provide your business with the stock financing solution you are looking for. Take the case of Dar es Salaam-based Ogopa Trading, where Ewald Chuwa wanted to grow his stock levels to cater to rising demand in his retail and wholesale business of clothing and accessories.

“I was faced with the challenge of acquiring the necessary working capital to increase stock and grow my business capacity to the level I wanted,” says Ewald.

GroFin’s business support enabled him to increase the stock variety and improve his offering to customers. Further, GroFin facilitated computer-based inventory management and, based on the team’s recommendation, a storekeeper/accounting clerk has been employed to ensure smooth running of the business.

Being a small enterprise we needed someone who could not only finance us, but a partner who could assist in structuring our operations. GroFin’s advice was priceless. We have seen the benefits in sales, turnover and business growth,” concludes Ewald.

Throughout our relationship with you, from the pre-finance stage to the post-finance stage, GroFin will provide your business with appropriate business support designed to meet its growth needs. To date, over 8,000 entrepreneurs have benefited from our business support expertise. You could be one of them! Apply today and get the GroFin advantage on your side.

This post was originally published on 26.11.15 on LinkedIn Pulse by Nishika Bajaj.