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Reducing Inventory Turnover Improves Cash - Dec 14, 2009

Posted by: David Kirkup in Success Stories

A manufacturing client of mine faced 2009 with some major challenges. The company builds sophisticated “metal boxes” such as commercial HVAC and telecoms enclosures. This involves purchasing large quantities of metal sheets with volatile pricing, cutting and bending them, and then assembling and painting the final products. It involves managing a wide inventory of miscellaneous hardware items for further assembly.

Recessionary pressures were affecting sales as large customers put purchases on hold, or reduced demand temporarily – forcing the client to maintain sufficient inventory to meet upsurges.

Inventory consumes a lot of the resources of any company. Of course, most companies need a certain level of inventory in order to meet the demands of customers. In most cases, inventory is purchased and paid for long before it is sold to a customer.

For some period of time it sits in a warehouse, and the cost of carrying that inventory (i.e., interest expense) reduces the company's profits.
Moving the inventory always raises the possibility of damage, but some inventory will diminish in value just sitting there. The more inventory you have, the more will "disappear." That costs the company more money.
Maintaining large levels of inventory requires people to manage it, adding wages, benefits and other costs.

So a company must manage inventory very carefully. To do so, the company needs to understand what they have, and why they have it. The company must be sure it has the right information:

Routinely prepare and review detailed reports about the inventory. What kind of inventory is it (finished goods, raw materials, work-in-process, or other categories)? How much of each type?
How often does the inventory turnover? What are sales of the finished goods, and what level of sales are expected in the near future? Based on that forecast, is there too much inventory on hand?
Manage slow-moving or obsolete inventory and plan to minimize scrap or sell.

A key measure on inventory management is days turnover. This is an overall measure of the length of time it takes for incoming raw materials to be turned into finished goods and sold to customers. Along with measures of receivables and payables performance, the inventory turnover is a key factor in the cash cycle of a company. Starting 2009 with an inventory turnover of 68 days, we realized that lower sales would significantly impact cash flow, and that improved inventory management was a major source of cash. Our plan for better inventory management included improved reporting using a database to key in on slow moving, expensive and unusual items, with management dashboards to maintain focus. Better factory organization, frequent item counts, and better procedures for receiving inventory and allocation to jobs all helped. During the year we were able to reduce inventory by nearly 30%, and to reduce inventory days turnover to less than 40 days. This is a major success for the company, positioning for a profitable 2010 and saving significant cash that would have been used to purchase unneeded inventory.

Based on an article from B2B CFO Partner - Paul Shackford