Your business is doing well and your hard work is finally paying off with your sales steadily increasing every month. Until one month your sales drop because you ran out of stocked items several days in a row. This trend continues until you are back to square one – couple sales a week and a possibility of shutting down the business.
What can you do to prevent this? One of the answers is implementing quality inventory management processes. Restocking you inventory when you see empty shelves, and placing inventory items in the first empty spot you find is definitely not it! So what does it mean to have a good inventory management plan in place?
First, make sure to make sure you are keeping track of inventory balances and historical usage in an inventory management software or, MS Excel, at a minimum. For most small business, MS Excel is the perfect (and affordable) option. Here is an example of a simple inventory tracking spreadsheet.
For businesses that may need something more sophisticated than MS Excel, but cannot afford a system like SAP, there are other options. For example, QuickBooks is used by many small businesses for payroll, accounting and tax preparation. QuickBooks Advanced Inventory solution would be an affordable feature to add to your current plan.
Setting and reviewing Reorder Point is the second step. Having too much inventory is not good for your business since it means that you have less cash to spend on operations. Stock outs are even worse – this is where you end up losing customers. The best way to prevent or reduce the impact of stock outs is by setting a reorder point, sometimes also called minimum stocking level, to every inventoried item. Most inventory software systems have the functionality to calculate the reorder point and trigger stock replenishment order when the quantity in stock reaches it.
For small businesses that use MS Excel for data entry, the formula is:
Reorder Point = Average Daily Quantity Sold * Average Delivery Lead Time
+ Safety Stock Quantity
To calculate Average Daily Quantity Sold, take the total number of units sold during a certain period of time and divide it by the total number of days. For example, if you sold a total of 500 hats between January and April, you would divide 500 by 122 days to come up with the Average Daily Quantity Sold of 4.
Average Delivery Lead Time is calculated by the total number of lead time days for a certain period of time divided by the total number of orders (not quantities!). Lead time is the number of days between order placement and material arrival. For example, the 500 hats you sold between January and April were purchased into your inventory on 50 separate sales orders. The lead time ranged between 5 and 7 days with the total number of days for the 50 sales adding up to 305 days. 305 divided by 50 is about 6 days on average.
Safety Stock Quantity is not needed to be maintained by every business, but it can help you avoid stock outs caused by unexpected delays. The easiest way to calculate Safety Stock Quantity is to first decide how many extra days of stock you would like to have in case of unexpected shipment delays. Multiply the number of days by the Average Daily Quantity Sold. The Safety Stock Quantity for our hat example for the company that wants to have about two weeks of extra stock on hand is 56 (4 times 14 days).
The math can get complicated – the spreadsheet attached to this blog includes the formulas to calculate Reorder Point in MS Excel if this is the inventory tracking method you choose.
Let’s move on to FIFO – First In, First Out. How many times have you bought an item at a grocery store that you already had in the pantry or in the fridge? When you got home and figured it out, did you place the newer item behind the one you already had, and make sure you used the older item first? I do this with batteries at home when either my husband or I accidently purchase batteries, especially AA’s, when we already have some at the house. I store the batteries by their expiration date, newest in the back, and add a note to the box to remind us to use oldest batteries first.
FIFO approach method is commonly used by businesses that use perishable inventory or items that need to be periodically inspected to ensure that they are still functional. It may seem like common sense, but go ahead and check your pantry or your garage – is your personal ‘inventory’ organized by the expiration or purchase date? FIFO method is an effective way for business to avoid spoilage costs. Or, for non-perishable inventory, make sure older items are sold first before they become damaged or unsellable due to the trend or label changes.
The last step is to organize your storage room and have a cycle count program in place to ensure inventory accuracy. Easy access to inventory that you know for sure is physically there could be one of the most important factors for inventory management for business of any size. By organized and easily accessible inventory I mean:
· Items have assigned spots with labels – this is extremely useful for businesses that have multiple employees accessing storage room. It is also useful for situations when front side of the package does not list all of the important information.
· Heavy and oversized items are stored on the floor or bottom shelf for easy access, especially if they require a forklift.
· Frequently purchased items are stored in the location closest to the entrance to save pick up/delivery time and are easy to reach – i.e. at eye level, if possible.
Once your storage room is organized, make sure to set up a cycle count program to periodically audit the quantity and inspect the condition of the inventory items. ABC Analysis the one of the frequently used programs to prioritize which items you review most often. Chartered Global Management Accountant (CGMA) website has a pretty good explanation for ABC analysis. In summary, ‘A’ items have the highest consumption value and should be closely watched to reduce potential losses due to inventory write offs. ‘B’ and ‘C’ items may have higher usage frequency, but the overall consumption value is so much smaller, that the business can afford losses due to stock outs or inaccuracies.
There are so many more ways to ensure that your inventory management practices are helping you to keep up with customer demand and to eventually lead to increased sales. And each step or method I described above deserves its own blog. I hope that the spreadsheet attached to this blog is useful, in case you are not ready to invest into a software or would like to use it to organize your garage or your pantry. Also, feel free to reach out to us with any questions by sending an email to firstname.lastname@example.org.
ABOUT THE AUTHOR
Rosita Johnson is ASCI's Business Development Manager. Rosita has been with the company for over 20 years in different areas of supply chain management: procurement, contracting, inventory management, and ERP system implementation. Contact her at email@example.com to set up a free consultation appointment or to share any ideas or experience that could help other businesses.