During a staff meeting with a client recently, I made the statement that contrary to most peoples' thinking, "inventory is a liability, not an asset".

 

This raised the eyebrows of most of the participants and in particular the VP of Manufacturing, who responded with "inventory is a valuable asset to the company because it is needed to produce products that are sold to customers".

 

Why this difference of opinion?

 

The VP is somewhat correct, in that inventory is needed to produce products that are then sold, but he did not consider the inherent risks with carrying inventory.

 

These risks include the following: 

• Inventory is purchased in many cases long before it is needed or used and while it sits in a warehouse the cost of carrying that inventory reduces the profit of the company.
• While it is sitting in the warehouse it is prone to loosing value due to obsolescence, damage, and product changes.
• Carrying inventory has the additional cost of managing it, due to additional staffing and facility requirements.
• The larger the inventory, the less cash and borrowing is available for growing the business by developing new products and marketing.
• Unless the inventory is reviewed on a regular basis, it is a good place for costs such as scrap, rework, slow moving parts, and obsolescence to reside. 
• Consider the cost involved in taking a physical inventory, and include not only the people cost but also the cost of essentially stopping production activities during that period.

The underlying thought is to maximize cash and minimize risk, and while inventory is a part of most of our everyday lives, how do we manage it?

 

I recommend that the first step is to calculate how often your inventory turns. Many of you will be surprised by the result. A recent study I read stated that Dell Computers has an inventory turn of 43 in 2011, which is down from 107 in 2004 during a better economy.

 

Once you know what your turns are, you can look at ways to increase them. Some suggestions for you to consider are:  

• Look into ways to reduce lead time with suppliers and work with them towards a Just In Time system.
• Question minimum order quantities and quantity price breaks.
• Set up a supplier managed inventory program.
• Improve supplier quality and delivery.
• Reduce production lot sizes by implementing a program of set up time reduction.
• Review inventory to determine obsolete parts and then scrap them to reduce handling costs.
• Set up a supplier managed inventory program.
• Get everyone involved. Form a team to focus on reducing inventory.
• Establish a procedure to identify slow moving inventory and then make a disposition.

With today's stringent lending practices, it has never been more important to conserve cash and develop ways to improve cash flow. Inventory reduction or elimination is one way to improve your cash balance and available credit line.