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Inventory Rationalization

Inventory Rationalization by Integral2u

While striving for optimal inventory is always the overarching goal, the actual ability to determine that optimal value can be a tricky affair. We can have target or set our own goal however it’s important that inventory aligns itself with the vision and direction of the company while meshing with its counterparts in finance and marketing to achieve the desired outcomes.

It could be the overall guidance is we want a leaner business, so we need to reduce our assets or stock in this case. The quick assumption is then we need to focus more on high volume goods which typically produce less margin%. Great for inventory, high volume products are easier to project sales for and order accordingly. But is it the correct assumption? Well more than likely not. You are very liable to have the scenario where there is a desired margin, what business doesn’t want a great rate of return for its investors? So now were heading toward dangerous territory. Without support from marketing to help grow sales or further improve the value in higher margin lines we are risking insufficient stock which will ultimately cost the business in terms of perception and loss of sales and can be further exasperated by supply shortages or increase in demands.

So, how to juggle all of it to fit in? Generally, set KPI’s(Key Performance Indicators) are a good start; though they can be targeted and made constant they are not adaptive or organic like a real business.

Let’s start with Stock Turn, Stock turn is a simple enough metric and slight variation can be more appealing depending one's mindset. Personally, I like to keep it simple 

the bigger the number the worse you’re doing. As a rule, our target has always been 2, meaning we turn over our stock value every 2 months. The other way of looking is Turnover which is the aforementioned just flipped upside down

and if your more finance minded the variation of

Additional Notes

Stock Turn is defined in its simplest form defined as However, it may be calculated in various ways such as  or it may be expressed as an average over a period of time which is essentially the same the same as the original except added more data and produced a slightly different result. And for the purpose of this document, we are not interested in calculating what it is we are calculating what it would be given targets. Inventory Value $3,550,000 $3,500,000 $3,560,000 COGS $1,613,636 $1,521,739 $1,695,238 Method 1 2.10     Method 2 2.08     Method 3 2.19     Generally, this is a KPI which is utilized quickly determine if you’re on track or veering of course. The metric should be set as a result of factors considered. How much safety do you wish to allow? Are you including sales (COGS) not traveling though inventory? And you would want that value to be based on present information not averaged out a period as the result would not be reflective of the current situation.

The later dilutes the usability or clarity of the figure but has true merit. Steeping back from an inventory mindset for a second, you’ll realize that here is in fact the tie in we are looking for. Given Revenue is a product of cost and margin, if we have a fixed Inventory Value Target and Stock Turn target, we are limiting potential for Revenue and Margin where we could in fact derive one or the other based off either and Margin% and Revenue. We can in fact look at it from all possible angles and say if you want this Margin% and that Revenue then you need this Inventory value, or any four targets given three known values.

Why this is Important

This is important because we don’t just sell 1 product. If we did great problem solved, we know exactly what margin we will get how much of it we sell and how much we need.

We don’t; however, we need to deal with ranges of products with varying turnover, revenue and margins aspects. And we need to accommodate hygiene, what customers expect to see visually, what they expect us to hold. And we also need to accommodate the directions of our leaders. Do we want to maintain a strong presence in power tools? Do we want to increase our landscaping performance and portfolio?

These are all things to carefully consider when planning. Revenue plays a massive role in business, and we know Revenue is comprised of Cost and Margin, we also know Cost is a component of Inventory Value and the Margin is obviously based on the Mix of product and sale of those products but that is defined and driven by us and our goals so just like the formula Inventory Value must be there under Revenue supporting it or propping it up.

The rules rewritten

There are various was to determine how much stock you should hold but not in terms of dollars and desires so I thought I would start from scratch and determine which factors I want to consider and how they all relate to each other, so this is what I arrived at.

The four equations below provide a means of calculating any one of each providing the other three.

Additional Note

To keep the equations limited in terms COGS is not shown however the expression. This is left out as during planning your targets, Revenue and Margin would be the focus. COGS are a result of that and or an actual known quantity during operations.

Examples

Total Revenue $2,215,000 and Margin% of 20.5% and a Stock turn of 2 would result in a desired Inventory Value of

Assuming there is a budget for Inventory $2,400,000 and desired Revenue $1,850,000 and Margin of 20.5%what then becomes Stock Turn

A target of 1.63 could be risky in and you may have already pegged that a fixed dollar value has the immediate effect of stifling growth along with other potential negative effects discussed in the opening notes.

Practical application

So now we know the formula’s we need to be able to apply this to our business. From there we can set or apply our turnover target and calculate day’s stock based of that.

Additional Notes (Reference)

Inventory days and Stock Turn or Turnover essentially have the same meaning.

We will at some stage need to intervene and consider our needs. Such as how much risk we should or shouldn’t be taking on, considering product mix, high margin low turnover or high turnover low margin while bearing in mind the lower the turnover figure the higher the risks, Range and availability and all the other factors no simple math can understand.

First let’s start with a baseline.

We need our Value our Revenue and Margin the actual Stock turn can be calculated.

We will simplify the Margin from % to $ because it’s more practical as we have a total target value, this will show us how to spread or apply that over groups.

Next, we need to add guides, this will allow us to tweak values. So, consider what we want to achieve we are possibly going to need to work within three targets Revenue, Margin which will remain and Stock Turn which we desire to improve. So given the relationships shown above under “The rules rewritten” we know our guide value for Inventory Value with be a result of those targets and we will plug this in first.

This is the formula we will put in the guide value total.

And our guide values over the groups will be.

We now have baseline guides; you can see our end value is the same and two things become quite apparent immediately. On the Face of it we are overstocked in Category B and understocked in Category D. We probably are over stocked in Category B but we don’t need more Category D and we can adjust this but what you’re seeing is the relation of stock turnover and profitability. So, let’s put in Stock Turn for actual and the guide. The total for the guide will be the actual because remember this is a target we are wanting to set.

Because Category B has lower Margin and generate less, they shouldn’t be afforded the same stock levels of say Category D with a higher Margin and generating us more. This is where we would need to step in because we know we need the visibility to keep up sales of the item above it, Accessories. And we can with Category D order more frequently, so we don’t need to stock more. It would be better to order less more frequently of Category B; say we sell the last one order another to replace it but in this case, there is reason for the high value. However, the Stock Turn Target makes sense to be utilized for setting the minimum and maximum vales for items in that group. Before that though, we need to put in our new Stock Turn target 1.6 or 48.67 days.

Now we have our Stock Turn targets we can tweak the values. Our end result should remain the same and we may want to keep in mind anything we move up in value way may not wish to use for setting minimum and maximum levels as it is not actually required it is simply what we have chosen to hold based on factors we have considered. The Stock turn is recalculated using the result of positive or negative adjustments to our guide values.

These function and or similar can be found one of our API's visit integral2u.com for or RapidAPI.com more.