SM2.11 80/20 Inventory Management

If inventory is something you have to manage in your business, the The Amazing 80/20 Rule Tool can have a powerful impact on Profit and Cashflow.

This is a Yellow Belt article.

At several places in 12Faces we discuss the fact that inventory is not necessarily an asset to a company. Inappropriate inventory management can mean that inventory actually becomes a liability to a company aspiring to high performance.

It is very easy to see that the 20% of your best selling products are likely to be the first ones to run out of stock in your inventory for the very reason they are your fastest moving lines.  This can be very expensive.  The 80/20 theory says that you need to focus attention on making sure that you don’t run out of the 20% of your best selling lines so as to minimise the loss you make from stock outages.
See the article: Cost of Over and Under Stocking

On the other hand, it is also immediately obvious that any product that sells slowly is likely to mount up in your inventory.  This will be especially be true if your inventory system is not very well tuned to monitor the sales of your product and inventory is bought on automatic pilot rather than tracking the rate it is sold.

Look at your present inventory, there are several things that you can do to improve your inventory management.

Inventory Tracking Systems

First: 

Make sure that your inventory tracking systems are adequate to ensure that you don’t run short of your best selling lines.  By definition, any money lost here is comparatively easy money to make.

Also, the fact that they are best selling lines means that they are popular and if you don’t have them in stock when your customers need them, they may well go elsewhere to shop.  Having gone elsewhere to shop, they may stay at that other place and you lose them.  So your best selling lines are both critical for your immediate income and to maintain your best customers.

Second: 

Cut back on purchasing items that are very slow moving so that you have only sufficient in your system to meet immediate reasonable demands.

Third: 

You can attempt to reduce your cost of inventory by putting that cost somewhere else in the supply chain.

• Consider only buying comparatively small quantities from your suppliers as you need them.  You may find that you are making purchases more frequently but, providing the delivery costs are not extraordinarily high, you have placed the cost of inventory back in your suppliers’ accounts rather than on your accounts. 
• Alternatively, you can move stock to your own clients and stockpile it with them so that they draw on inventory as they need it and you replenish it as they draw down.
  • A good example here would be a client that is a supermarket and they have a large amount of product at any point in time stored on the supermarket shelves.

There is a negative to watch out for in this last example.  The term “channel stuffing” refers to pushing your product on downstream customers in volumes greater than their demand calls for and may not be a healthy practice.

Throughput Accounting points out the fact that you haven’t made any money on a sale until you have the cold hard cash in your hands. Even if the client has taken the product, it is still your inventory until they have paid for it. Pushing this excess inventory downstream without being paid and booking “sales” looks good on paper but will adversely impact on your cashflow. Many companies have collapsed because of cashflow problems from “channel stuffing” even though their sales looked good.
See the article: Change Your Accounting Mindset with Throughput Accounting