Inventory — is it an asset or a liability with a host of hidden problems? True, it is an asset shown on the balance sheet, but what is inside that number? And, more important, how can an owner or CEO stay informed as to how that line item affects the company’s bottom line results?
A company’s owners and key management personnel often spend their time working on sales, product development and operating the day-to-day business. Most do not have an operations or production background so they rely on others to manage inventory and the production process. Even though inventory and cost of goods sold represent significant numbers on their balance sheets and income statements, operations managers typically have little oversight from owners and CEO’s in this area. How can owners know when there is a problem or even more important, what information do they need in order to identify an issue early before it becomes a major issue affecting customers and the bottom line of the company?
Key Metrics to Measure
The good news is that owners and key management personnel do not need to spend hours on the factory floor each day or sign up for multiple production process seminars to be able to identify problems and direct company efforts to fix issues and improve efficiencies. Best practices in this area can help provide owners with key metrics and information via dashboards or other timely reports to monitor activities and oversee company personnel in charge of the inventory and production processes.
These metrics can be broken down into three different categories: Valuation of inventory, quality of inventory and production process assessment. Each of these categories has specific measurements that can be easily produced and shared not only with management, but also with warehouse employees and other key personnel. These measurements will help identify areas where problems may arise and areas where improvements can be made, as well as the status of ongoing improvement projects. Often, these metrics will tie into Lean efforts to enhance the efficiencies of warehouse operations.
Valuation of Inventory
Valuation of inventory metrics use readily available information. Typically, the numbers will need to be organized in a more structured and comparative method to make them useful. End of the year inventory values compared over several years show trends that may be consistent or inconsistent with what is happening with the business. The same applies to inventory reserve balances. These simplistic schedules can provide a high-level look at inventory and the underlying processes so that an owner can ask basic questions that may lead to more in-depth analysis. Showing the levels of inventory on a monthly basis by component, raw material, work in process and finished goods is another good metric to help identify potential issues. This is especially true if a business is seasonal (do the inventory levels follow that seasonality? If not, why not?).
Quality of Inventory
Quality of inventory metrics take a little more work to generate, but allows an owner to get a better view into how well operations is managing the inventory throughout the year. How many months inventory is kept in the warehouse, how often is the inventory turned each year, how does that compare to the best of the best in the industry? Is there obsolete inventory in the warehouse? Almost always, the answer is yes. How is this being managed, and what effect is this having on the operations of the business and the bottom line?
Production Process Assessment
Production process assessment metrics start tying together production processes and their effect on customer satisfaction. Efficiency in the production process and the information flow starting from order entry to shipping the product can be monitored by these statistics to answer the questions:
- What is the size of a company’s backlog?
- How often do customers’ orders get shipped on time to meet their demands? and
- How many reject pieces are generated and why is that occurring?
Scrap and returned defective goods not only create a cost to the company, but also can have a very strong negative impact on a company’s marketplace reputation.
With a little effort, all companies can set up dashboards or timely reports that provide key information management can use to drive improvement in each of the three categories mentioned above. Entrepreneurs can make informed decisions to fix issues and spend company resources on areas to improve them once they know the problems and understand how they can be rectified. Another benefit of these metrics is that management can now set up the proper financial incentives to drive operational manager’s behavior and reward them for achievements. Inventory does not need to be just a number on the balance sheet, it can be a well-managed asset that enhances a company’s profits.
If you have questions or concerns about your company’s inventory, please contact Mark Thomson or your ORBA advisor at 312.670.7444.