Inventory Under Control?

Slow Moving & Obsolete Inventory – Excess Inventory Liquidation

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How tight inventory controls helps maintain cash flow.

A company’s warehouse of inventory gives banks many clues about the operation’s efficiency, cash flow and overall financial health. If inventory controls are not in place, accessing credit lines and funds to obtain additional inventory may not be possible in today’s banking environment.

“There is a significant cost to handling inventory, warehousing it and not moving it quickly enough,” says Louise Kirk, CPA, a director in the assurance services department at SS&G Financial Services, Inc. “With banks tightening up, there are less funds available. Companies need to control inventory levels and stock the right inventory.”

Smart Business spoke with Kirk about ways to develop effective inventory management controls.

What signs indicate that a company’s inventory is excessive and could harm financial performance?

Companies can compare certain key performance indicators to similar businesses in their industry, looking at measurements such as inventory turns, return on investment and gross profit margin. Excessive inventory may come to light when the company begins feeling financial ‘pains’ associated with too much of the wrong items or not turning inventory quickly enough. Cash flow might be tight, accounts payable may be excessive or aging beyond what is desirable. When assessing inventory flow and warehouse stock, the executive team should ask: How much inventory do we really need based on lead time to meet customer needs? Depending on the nature of the business, a company may be assembling products start to finish, producing a particular component or acting as a distributor. Regardless, when products are not moving efficiently, companies will struggle with cash flow, therefore limiting their ability to grow and prosper.

How does a company get back on track?

Careful planning, discipline and training are necessary so everyone involved, from purchasing to production and distribution, understands what steps are necessary to be competitive in today’s economy. One consideration is implementing a lean manufacturing approach, which will focus on improving the flow of the production process and elimination of waste. This process will establish effective controls and procedures that will require the buy-in of all departments and individuals and improve the company’s bottom line. The purchasing department should establish a replenishment schedule for each inventory item, which will provide efficiencies in the flow of inventory and reduce overall costs. Establish measurable goals and objectives, such as inventory turns and return on investment, for purchasing and sales personnel. Motivate these individuals to reach their goals by tying performance to compensation. Implementing these types of systems is a top-down process, which requires management’s commitment to putting a process in place and training every employee to follow the system. It is important to make everyone accountable.

What can a company do to ensure the processes are being followed?

Establish an inventory locator system along with a cycle inventory system that will improve efficiencies and identify discrepancies on a regular basis. Document all procedures and routinely test that they are being followed. Be sure effective security systems, both within and outside the facility, are in place to protect the company against theft. It is useful to identify and implement an inventory management software system that will enable management to capture crucial information and evaluate key performance indicators to assist in projecting customer needs. Providing tools, processes and procedures will assist in identifying and carrying items that will reap higher profit margins and improve cash flow.

What can a company do in the meantime with slow-moving or obsolete inventory?

Implement a system to identify and eliminate slow-moving or obsolete inventory that is consuming valuable warehouse space along with capital. There is value in slow-moving and obsolete inventory items, but if these items pile up and sit over a period of time, they become worthless. Inventory that isn’t turning or is no longer relevant to a company’s process can sometimes be returned to vendors. Offer special reduced pricing to help turn the inventory quickly. Give sales-people incentives to concentrate their efforts on moving that inventory. Determine if there is a market via the Internet or scrap. Or, donate the items to charity and realize tax advantages (though first discuss this with your tax adviser).

Why will banks scrutinize a company’s inventory management before granting loans?

Banks want proof that the money they lend a company for inventory investments will provide a good return. If inventory is sitting, it is not paying off debt. A bank will review inventory turns and ask questions about excessive inventory, slow-moving items, aged accounts payables and how all this affects cash flow. (If the company were moving and selling inventory, it would have cash to buy more rather than approach the bank.) A company will impress a bank if it has a well-planned inventory system in place.

LOUISE KIRK, CPA, is a director in the assurance services department at SS&G Financial Services, Inc. (www.SSandG.com). Reach her at (800) 869-1835 or LKirk@SSandG.com.

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