Excess, Slow Moving and Obsolete Inventory

Managing Retail Inventory and Maximizing Return on Inventory Investment in Small Business (submitted 2009-07-10)  by Ted Hurlbut

“Our inventory is our most important asset.” Inventory may be the largest asset on your balance sheet, which makes it very important, but it’s not the most important asset. Your most important asset is the customer relationships which enable you to turn that inventory into cash, day after day, day in and day out. Inventory is one of those things where more is not necessarily better. When it comes to inventory, “more” generally leads directly to “too much”, which is usually the first step on the road to trouble. Ask yourself this; “If I could figure out a way to do the same sales volume with less inventory, would I?” You bet. Inventory is, in fact, an unfortunate necessity of doing business for a retailer, wholesaler or distributor.

So if inventory is an asset which may not always be an asset, how do you determine what is what? There are two key inventory productivity metrics which are widely known, but not always fully utilized. The first is inventory turnover. Ask somebody how many times their company turns its inventory and they’ll probably know the number right off the top of their head. What they may not be able to tell you as quickly, however, is how that turnover compares to other companies in their industry. Or, how many times they turn the inventory of their key categories or key items. Or, quite revealingly, how many times they turn the inventory of those items which makes up the last 20% of their sales (the 80/20 rule, but turned upside down, into the 20/80 rule).

The second key metric is gross margin return on investment, or GMROI. GMROI merely factors gross margin percentages into inventory turnover data to generate a financial measure of inventory productivity, the return on inventory investment. Which takes us directly back to the question we asked above, slightly re-stated; if you could generate the same gross profit dollars with fewer dollars invested in inventory, would you?

“I can sell it if we have it in stock.” I like to call this the Field of Dreams argument; if we stock it they will come. This is actually the inverse of “We can’t sell it if we don’t have it.” This is, of course, easy for a salesman to say because he doesn’t have to own the inventory personally, his company does, and if for some reason he can’t sell it, he’s not on the hook, the company is. But underlying these statements is an important truth about marketing: inventory doesn’t generate sales, marketing does. Granted, building a reputation for having an item in stock when the customer wants it is not an unimportant marketing message, but it is clearly secondary to communicating to customers the features, benefits and value of an item. That’s what truly builds customer demand. If you aggressively market it, if you aggressively sell it, they will come.

In fact, the marketing consideration that goes into the decision whether or not to stock an item is directly related to the customer’s expectations. If the item is a tube of toothpaste, or a pair of running shoes, or the latest compact disc, the customer clearly expects it to be in stock, and if it’s not, the sale won’t be made. On the other hand, if the item is a leather sofa, or a refrigerator, or custom draperies, the customer would rarely expect to be able to take the item with them.

Depending on the use and the value of the item, as well as whether the item requires professional installation, the customer’s expectations regarding delivery could range from several days to several weeks. Do you need to stock those items at the point of sale? Do the lead times within the supply chain allow for the stocking location to be centralized, back in the supply chain? Why own it at the point of sale if you do not have to?

By the same token, why own more of it than is needed to cover sales (plus an appropriate level of safety stock) until the next vendor shipment. While there are a number of formulas that will generate the appropriate replenishment parameters for any given item, the logic is pretty straight forward; every purchase for stock must be made with the informed expectation that you will be able to sell it within a reasonable period of time.

If an item is purchased from a vendor who maintains minimum purchase quantities, renegotiate those quantities or find another vendor. And if those quantities are being purchased to nail down specific purchase or freight discounts, run the numbers. You’ll quickly realize that in almost every case the discounts that are leading you to purchase more than you need at any given time are very quickly offset by the carrying costs associated with the excess inventory.

“Our customer says that if we stock it for them they will buy it from us.” Really? Do you have a signed purchase order from the customer? No? Not surprising. These types of opportunities should be viewed by understanding that the “if” part of the bargain is the driver, not the “then” part. It’s easy to get hooked in to a large, regularly recurring sale. It’s like finding cash on the sidewalk. Or is it?

In fact, the key to understanding and evaluating these deals is the requirement to maintain inventories for the customer. The customer is very astutely managing the inventory they need to support their business back up the supply chain, and with it the risks and expenses associated with carrying that inventory. They want to be able to count on you having what they need, when they need it. How much additional inventory will you need to stock? What is the incremental carrying cost of that additional inventory? What happens if the customer suddenly decides to switch items? Factor those costs in. How profitable does the business look now?

“We’ve built up a lot of dead inventory, but we’re not going to just give it away.” “We may have had it for several years”, (with no activity but the accumulating layers of dust), “but we paid $10.00 dollars a piece for it when we bought it” (three years ago), “and it’s still in very saleable. There’s no reason to let it go for less than a 20% margin. Besides, somebody might come in and need it tomorrow.”

Where to start with thinking like this?

First, the $10.00 spent three years ago is sunk and not relevant to any analysis today. The value of the inventory today is related to what potential customers might be willing to pay for it, which bears no relationship to what it originally cost. In fact, if you were to continue to try to market it at a price that would recover the costs associated with it, you would need to include in the cost basis the carrying costs that have been incurred since it was purchased, typically around 25% annually of the average inventory value. If these carrying costs were fully accrued, the cost value of our $10.00 item after three years would be $19.53. It would have to be sold at $24.41 to yield the desired 20% margin (compared to a selling price of 12.50 with a $10.00 cost base).

This is clearly absurd. Almost all inventory depreciates in value over time, anywhere from 20% to 50% a year. We understand this inherently; if a potential customer felt the inventory was fairly valued and desirable at a price of $12.50, they would have bought it long ago. The fact that it has still not sold clearly establishes that the market does not value at $12.50! There’ve already been plenty of tomorrows for customers to have bought it!

This may seem long-winded, but you can’t put too fine a point on it. Dead inventory is a problem for most every retailer, wholesaler and distributor at one time or another. It happens. When it does the key to maximizing your recovery is to act quickly, be clear headed and sober in your assessment of what it will take to liquidate the inventory, and take your medicine. Just the opportunity cost alone associated with management’s attention being diverted from constructive activities, like growing the business, argues persuasively that dead inventory cannot be allowed to build up until it’s like a lead weight the company is dragging around. I’ll say it again; take your medicine, learn from it, and move on. Don’t worry about what you once paid for it, or how much you’re carrying it on your books for. It’s not relevant.

Conclusion Don’t fall in love with your inventory. It’s not likely to love you back. It’s amazing how the investment in inventory can take on an emotional, almost passionate quality. But, if you think about it, it is understandable. For many owners and executives, especially those with an entrepreneurial investment in the business, their inventory is made up of products which represent a life’s passion.

For those of us whose focus is on managing retail inventory and maximizing the return on inventory investment, however, inventory is a dispassionate means to an end. We look at inventory, and we see a surrogate for cash. It’s either going to be sold and converted to cash, or it’s sitting there tying up cash, costing us more cash each and every additional day it’s not sold. Our challenge as inventory managers is to help retailers, wholesalers and distributors recognize and adopt sound inventory management practices, in order to maximize their return on inventory investment, without sacrificing the passion that is the lifeblood of any growing business.

 

About the Author

Ted Hurlbut is the Principal of Hurlbut & Associates, a retail consulting and business advisory firm based in Foxboro, Massachusetts. He is focused on helping his clients increase sales, margins, profitability, and cash flow, and is particularly attuned to the challenges facing smaller, independent, entrepreneurial retailers. You can learn more about Ted, and Hurlbut & Associates, at http://www.hurlbutassociates.com.

 

In the today’s highly competitive market, how we handle and manage our assets directly impacts our ability to compete and hopefully win with our customers.  With inventory comprising our largest asset base, we need to maintain a higher level of focus on managing it in every location.  Too often we hear distributors talk about the lack of focus their warehouse (vault) personnel place on properly managing and handling the inventory.  While many vault personnel have a great deal of pride in their work and work space, many do not go through their daily activities with the same sense of pride.  They see your inventory assets in the vault as just a bunch of stuff that creates hassle after hassle.

 

Everyone in the organization has some impact on the successful use of this asset.  Don’t kid yourself, when we say everyone, we mean everyone.  All the way from the person handling the incoming phone calls to the pickers, packers and shippers.  We all know that sales personnel have a large impact on our return on the inventory asset investment.  It seems like sales dominates many of the conversations with regards to inventory because they are the ones screaming about it most often.  But how about the inside sales people, the counter sales people, the accounts receivable people, the purchasing people and the vault personnel?  What they do has a huge impact on the effectiveness of the inventory asset.  But often they all fall into the mode of seeing all that cash invested as just stuff.

 

Getting and keeping everyone’s attention on managing, turning, handling and re-investing in your largest asset is a challenge.  You have to work on establishing both short term and long term focus and goals.  The length of the goal and corresponding rewards should have both short and long term options depending on the group of personnel you are addressing.  If everyone in the organization stays focused on your inventory and manages it with a greater degree of caution you win big in both the short and long term.  Isn’t that the goal anyway? 

 

Let’s take a look at a couple of groups who might benefit from some simple changes in their motivation, rewards and performance levels.  Purchasing personnel clearly spend more money in the organization than any other group.  People think that sales personnel are big cash spenders, and to some degree they are.  However, on a recurring basis, the purchasing personnel write thousands of purchase orders a year totaling hundreds of thousands of dollars.  Keeping them on task sure seems like a good idea.  When they make a mistake on the purchase or buy side the impact on your potential return on investment is substantially reduced.  When they are looking at their respective product lines to purchase, you want their motivation to be maximization of net profit.  Purchasing is often considered a fairly mundane job.  There is a myriad of data that needs to be reviewed and analyzed before making the next purchase. The operational software you use hopefully will provide a historical view of the ins and outs of every product by day, week, month, quarter and year.  This is critical information for purchasing.  What has happened with each and every product within defined time periods is a guide for predicting future usage.  Not using this data correctly can cause mistakes in future buying.  Purchasing personnel therefore need to have the ability to earn a little more money or be rewarded or recognized for maximizing the dollars invested on both a short term and long term basis. 

 

If purchasing personnel are compensated via a salary plus a potential profit sharing bonus at year end, their focus on making good buys in mid-July is not as sharp as it is at year end.  They also know that in addition to the weekly or bi-monthly paycheck they are getting, the bonus is coming soon (or at least they hope it is). Their attention has changed from just doing their job, to doing their job with the potential bonus in the offing.  How about looking at this group and seeing if we can create numerous rewards for performance throughout the year?  How about giving them an annual purchasing budget that is broken down to quarters and months?  How about looking at the effectiveness of their in-season versus out of season inventory levels for seasonal products?  How about looking at their ability to negotiate dating, terms, returns and discounts?  How about getting their input on why the inventory levels and purchasing dollars spent vary from the established budget?  How about looking at their effectiveness at reducing the number and level of C and D items you have in stock? How about looking at your dead stock and measuring how purchasing is either adding to or reducing the level every month?  In essence, we need to give them plenty of opportunities to help us maximize our return on the dollars they are investing.  We might think that they do this all the time just because it is part of their job.  I would like to think that is the case as well, but in reality I don’t think it is.  We have such a broad breathe of products and product lines they need to review, the ability to do all the other things above often just won’t get done.

 

Part of the challenge we have in maintaining focus for the purchasing personnel is that we have grown our product offerings exponentially but have not grown our purchasing department in a corresponding manner.  We seem to be asking them to review more and more products and lines in the same time frame they did when we carried fewer products.  Their ability and time to do the needed analysis just doesn’t exist.  However, the tasks they are forgoing are very important.  We even assume they are still doing all the analysis even though we have heaped a bunch more products on top of them to review.  Step back at take a look at how we can re-adjust their daily, weekly and monthly tasks. Look at what we can implement in their daily, weekly and monthly buying cycles and tasks that we can measure and thus recognize and reward.  Can we find a way to recognize their additional maximization of our gross margin?  If you do this, it will help them to maintain the focus on cash spent, cash invested and return on investment.  After all, this is what we need this group to do more than anyone.  We need them to focus on cash, not just stuff.

 

In addition to purchasing, the vault personnel are very intimate with your stuff.  They take it from the receiving dock to the shelf, pick it pack and ship it.  They touch it more than anyone.  Getting them to focus on the fact that damaging, losing or mishandling this stuff is the same thing as tearing up hundreds of dollar bills.  If you went back and physically stood in front of these people and tore up hundreds of dollar bills, they would look at you like your were crazy.  After a few hundred, they would accost you and force you to stop.  They would make statements about your sanity.  But the point you are making is that if they mishandle the product once it arrives, it is no different than if they were tearing up hundreds of dollar bills.  Distribution is tough enough already, the last thing we need is our own people damaging our precious asset.  So we should attempt to keep them focused on managing our assets on a daily basis.  Maybe adding in some simple focus points and corresponding incentives would help everyone to handle this asset more effectively. Do you think there are a couple focus points and possible additional incentives you can provide for the vault personnel?

 

Working in the vault can be the most challenging of all the jobs in distribution.  The number of items they receive, track with a high degree of accuracy and handle with caution is often unbearable.  Then there is the task of managing all the locations and corresponding labels.  In receiving, you have the added pressure of getting right the first time, or else you will generate 10 additional errors in the organization.  So what can we do with this group to make sure they handle your stuff better?

 

Consider the personnel we are talking about here.  Many of them are hourly employees with relatively short timeframes of focus.  They look at the future as the work week they are in.  They see Monday as a new starting point and Friday as an ending point.  Often their enthusiasm changes by day, often getting higher as the end of the week approaches.  But between Monday morning and Friday afternoon, are there tasks we need them to consistently perform?  Well we would like them to keep the place neat and clean.  We would like them to receive and put away items with 100% accuracy.  We would like them to pick orders with the same degree of accuracy.  We would like them to pack the orders such that products are not damaged in shipping.  We would like them to cycle count to improve our inventory accuracy.  We would like them to process a large number of orders in a condensed period of time.  We would like them to take great pride in dealing with our stuff (cash).  So in addition to a paycheck, we should consider a series of additional rewards and recognitions.  Remember, if they are more successful in managing your inventory, you win big.  Maybe you come up with some cash and non-cash rewards programs that are possible to achieve every week.  Maybe you look at cycle counting accuracy goals for the day, week or month and recognize their achievements when they hit our goals.  Maybe we look at the number of returns due to broken or damaged goods.  Maybe we look at the number of orders processed over and above the norm.  Maybe we look at the receiving accuracy for the week. 

 

All personnel in management struggle with cash flow, asset management, cost management and inventory.  In today’s world, we need everyone to help us achieve these goals.  We need them to maintain a consistent focus on the end result, which is an increase in net profit.  We need them to treat our stuff just like it was hard cold cash.  Above all, create multiple and frequent re-focus points for all your people to keep their attention on return on investment.  Giving some additional rewards and recognition will help all your personnel treating your stuff more life it was their stuff.  And in the end, it all becomes good stuff!

 

 

One of the most common struggles all distributors face is managing their dead and obsolete inventory.  It is one of those back burner items that no one wants to bring up for fear that they will be appointed to deal with the task.  Most people like to employ the ostrich approach to dead stock – just stick our head in the sand and hope it goes away. 

 

One of the more novel approaches I have ever heard of took a little help from Mother Nature.  This clever individual had a facility right next to a river that flooded seasonally.  He had built this large deck overlooking the river in order to entertain customers and employees during the summer months.  On a particularly wet year, they received word that the river was going to flood much higher than usual.  When life gives you lemons, make lemonade.  The distributor hauled all the dead inventory out to the deck.  He sandbagged the walls of the facility, in order to protect his turn and earn inventory, and let the rising river manage his dead stock for him.  Something tells me that Allstate would take issue with this approach.

 

The power report I will be discussing this month deals with a more proactive approach to managing dead inventory.  As in previous articles, I believe that the key to getting a return on your software investment is to learn how to extract and manipulate data.  We all paid a significant sum for our software, yet we typically use only a fraction of the capability.  Mastering the report generating function will substantially increase your overall system utilization and give you the tools necessary to make significant improvements to your bottom line. 

 

A number of years ago, my business partner Scott Stratman wrote an article where he stated, “Wouldn’t it be great if dead stock would just stink?”  As inventory managers, we have a very difficult time identifying the moment in time when a product ceases to be part of our turn and earn inventory.  Our lives would be infinitely easier if we would enter the warehouse on the first day of the month and a pungent odor, something akin to dead fish, would tickle our nostrils.  We would be forced to hunt down the offending item and eliminate it from the premises.  Unfortunately, most of our products do not emit an odor when they parish.  Our challenge is to use our software to make them stink.

 

When I speak to distributor groups, I usually pose the question, “If I wanted to find the dead stock in your building, I would ask for one piece of equipment.  What would it be?”  Several folks mention the white glove and a dust mask.  Perhaps, but I have a feeling that a majority of our live products would not stand up to white glove scrutiny.  I would ask for a ladder or forklift.  I’m not sure where we picked this up, but we tend to move all the dead stock a little closer to heaven.  It could just be the old out of site, out of mind.  In many facilities, there is no discernable separation between the dead and the living.  Both occupy the same shelf space.

 

In order to help us identify our dead inventory, we must define the moment of death.  We have seen some unusual methods for defining the point in which an item is classified as dead.  The rainbow method comes to mind.  During an annual physical inventory, many distributors use colored dots to mark the items that have been counted.  When a product displays stickers from all colors of the rainbow, it is most certainly dead.  I would not suggest that this is the most effective definition.  In our practice, we suggest that distributors choose a moment in time.  When was the product last sold?  The most common definition for dead stock is:  zero sales in the past 12 months.  There are several distributors out there who need a much shorter window.  The paper goods industry uses a much shorter 3 month window.  For most hard goods distributors, 12 months is a good place to start.  Over time, a distributor can begin to decrease the months.  I generally suggest that companies exercise caution when going below 9 months due to seasonality issues.  Once a definition has been created, everyone in the company must know it.  This is not a time to be secretive.  When I work with a private company, it is a big red flag when I get several different answers as to the time of death. 

 

Once we have defined the time of product death, we need to let our software make it stand out.  As I mentioned before, most dead items do not appear or smell any different than our living products.  Enter the Inventory Obituary.  Some folks who use the no sales in 12 months definition refer to this as the “13^th month, first day report”.  Not nearly as colorful, but not all of us are motivated by style points.  The report can be formatted in a simple spreadsheet using these columns:

 

1.      Item Code

2.      Description 1:  This will help us pull the item out of the live inventory.

3.      Quantity On Hand

4.      Unit Cost

5.      Total Investment:  This is the motivational column.

6.      Date of Last Sale:  Exclude anything sold within the last 12 months.

 

Run the report and this will become your inventory obituary.  In order to really turn up the stink factor, calculate the sum of column 5.  Don’t be shocked if you have a significant amount of money accumulated.  Let’s just call it job security for some lucky individual to be named later.  I will touch on the role of the mortician a little later.

 

Identifying dead products is not an annual event.  I recently ran into a software package that recommended running their dead stock report on an annual basis.  This is not a good suggestion.  We need to be far more proactive than this.  If we employed this method, we could tack on an additional 11 months of inventory carrying cost to any items that died in February.  I need to know what died every month.  Make this report a part of your first day of the month routine. 

 

Once you have run your obituary and identified the dead items, we need to perform some tasks to help prevent further bleeding.  As I mentioned above, we have been losing money on these products in the form of carrying costs.  Carrying costs accumulate at an average of 25% annually.  For example, an item that originally cost us $1.00 will actually end up costing us $1.25 by the time we hold it in our inventory for an entire 12 months. 

 

The first task is to shut off the faucet.  Turn off the automatic replenishment controls for all the items on the list.  We do not want to buy more.  Incidentally, the worst thing that can happen on day 1 of the 13^th month is that someone will buy a dead item.  All of a sudden, we think there is new life in the product.  Out come the shock paddles and we are ready to give mouth to mouth to a stiff.  Dead is dead.  Let the item rest in peace.  Change the controls in your system to identify the item as non-stock. 

 

The next step is to remove the living from the dead.  It is one thing to make an item stink on paper; it is entirely more effective to make it stink visually.  Create a dead stock graveyard.  Move all the dead items to your newly created cemetery.  Don’t hide the cemetery in the back of the warehouse.  We want it visible.  We really want the owner to be able to see all the old money accumulated in one place.  It tends to give additional motivation when we see a visual representation of the total problem.  Some distributors have added their creative side to the project.  A few well placed tombstones would not be out of order.  Who says you can’t have fun in the warehouse?

 

If you are anything like me, this next suggestion will resonate.  I hate to lose money.  When we are selling a stinky dead item, our first inclination is to give a discount so that it will disappear.  Remember, we have already accumulated an additional 25% in carrying cost.  I’m no math major, but if we bring the sell price down and our costs have gone up, this ain’t good.  Perhaps we need to give ourselves a fighting chance at some cash.  My suggestion is that you jack up the price on any dead item by 300%.  Since we are going to give someone a discount anyway, why not start from the highest point?  When someone calls, do you really think that we are the first person they have tried?  We have it, the previous 5 distributors didn’t.  Gotta love supply and demand. 

 

The final step is to turn the list over to the mortician.  Hire a dead stock manager to liquidate your dead inventory.  Wait a minute, doesn’t this sound like throwing good money after bad?  If you structure the position right, it will be a positive contributor to your bottom line.  Look for a part-time employee for this position.  I happen to like retirees for this job.  Pay the person a commission on the dollars recovered – not on gross profit dollars.  We are probably going to be selling things below what we paid for them.  I have seen commission ranges from 25-50%.  Do what works for you.  The sole mission of this individual is to make our inventory obituary disappear in 30 days because something new will die every month.

 

A consistent running of the inventory obituary will yield tremendous bottom line results.  At the beginning, the list will seem like an insurmountable task.  Over time, and the efforts of a diligent dead stock manager, the list will reduce to an acceptable level.  If you need some suggestions on methods of dead stock disposal, please feel free to contact me or look for articles on our website.  Purchasing your distribution software was a significant investment.  The return on that investment is up to you.  Good luck.   

Slow Moving & Obsolete Inventory – Excess Inventory Liquidation

Deadstock Network

 

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.

 

As we roll through the back half of the year, many manufacturers are gearing up for their Fall product launches.  Programs are being created and promotional literature is going to press.  Prepare yourself for the latest improvement to your favorite products.  Since football season is around the corner, get ready for the “Touchdown to Savings” sheet.  It seems like this one never gets old.  The manufacturer’s reps are gearing up for a full scale assault on your purchasing folks.  Take the time now to prepare them to ask the right questions so you can avoid problems in the future.

 

Buyer beware.  The leading cause of dead stock is bright, shiny new items.  This is the new improved model of the new improved model that you still have on the shelf from last Spring.  This is worse than your run of the mill dead stock.  This stuff was dead on arrival.  We seem to have forgotten that only a few short months ago, during the annual physical inventory, our warehouse was filled with the unsold carcasses of last season’s sales darlings.  Dead inventory kills your profitability in two ways.  Not only does it tie up capital; but it actually costs you money in handling.  I think that we all agree, dead inventory should be avoided at all costs.  Since we know that new items cause dead stock, we should use caution and scrutiny when adding new items to our inventory.

 

Manufacturer sales reps are trained professionals.  They are masters at telling you how great your life would be if you sold their product.  More often, they appeal to the emotional side of the buyer.  An old friend of my father’s once told me, “It’s easy to sell to a salesman.  Just get his head to start nodding…”  So given this bit of gray haired wisdom, who do you think these reps target in your company?  The Sales Manager!  Salespeople love to have new things to sell.  I should also note that the owner of the company, usually with the heart of a salesman, is also easily excited about new items.  More DOA(Dead On Arrival) stock can be attributed to owners than anyone else in the company.  Here is a quick tip:  Don’t let the owner of the company wander through a trade show alone.  There are tons or bright shiny new things at trade shows.

 

As I said earlier, we must make it difficult to bring new items into the company.  Instead of letting just one person make the buying decision, consider forming a committee of three.  The three committee members should be the Sales Manager, the Purchasing Manager and the Controller.  The Sales Manager is there to determine the market for the product.  Who are the potential customers?  Does it replace a current item?  The Purchasing Manager is there to determine how to buy the product.  Sometimes buying a lesser quantity as a test is a more prudent alternative.  You may pay a premium; but you won’t be stuck with a mountain of inventory if it fails.  Finally, the Controller is there to determine how to finance the purchase.  By utilizing the committee, you will reduce the chance for an emotional buy. 

 

In my former company, we called this group a “Line Buying Committee”.  The group met on a monthly basis to review new product offerings.  During the review process, some very important things need to be accomplished.  Marketing plans need to be established.  I’ve been around this industry long enough to know that paperwork is akin to swallowing cod liver oil.  Keep the plans simple, leave the powerpoint slides to someone else.  A simple one page plan will suffice. 

 

While marketing a new product is exciting, creating the exit strategy is the key to inventory success.  The most important task of the committee is to develop three different exit strategies for the product in the event that it is not the greatest thing since sliced bread.  Each of these exit strategies needs to have a time line.  For example, if we do not sell our projected quantity within the pre-determined time frame, what is the cost of returning it to the vendor?  Again, don’t make these plans too complicated.  You can sell it off at a discount, return it to the manufacturer, or you can throw it in the dumpster.  One of the more creative solutions might be to give it to the salesperson that had to have it, in the form of Christmas bonus.  You must not allow this new item to become buried on your shelves and contribute to your dead inventory. 

 

The least painful way to dispose of a failed product addition is to simply return it to the vendor.  Have you ever noticed how some manufacturers reps seem to become less available when you are trying to return something?  Sure, they were in your office on a daily basis prior to the sale.  In addition, many reps will give you a verbal return policy, “Sure, if it doesn’t work out for you, we’ll just take it back.”  Verbal agreements just don’t cut it today.  Get the return policy in writing with timeframe and costs clearly defined.  Be wary of those individuals who won’t sign a simple agreement.  Remember, we are trying to make it hard to create dead inventory in our companies. 

 

In order to help weed out the less than reputable companies, I developed a little checklist for every new line presented to the company.  This will assist the committee in making a good decision on the line. 

 

Manufacturer Name

 

• Make sure that the full name and address of the company, including the parent company, is written down.

 

Representative Name

 

 

Shipping Location

 

 

Freight Policy

 

 

Terms

 

 

Volume Rebates

 

 

Co-Op Advertising Funds

 

 

Pricing Available on Disk

 

 

Training Support

 

 

Engineering Support

 

 

Local Distribution

 

 

Average Gross Profit Margin

 

 

Market Potential in Dollars

 

 

Guaranteed Sell Through

 

 

Certificate of Liability

 

 

This checklist is just a guide.  If you would like a copy of the checklist, please email me and I will send you a simple checklist to help you prevent a build up of DOA inventory.  You need to modify it to meet your specific needs.  Most reps will not be able to fill out all the questions on the spot.  Let them bring it back for a follow up call.  The pace at which they return the information can give you some insight on how hard this rep is willing to work on your behalf.

Amerisource Industrial Supply can help you reduce your MRO inventory.

  

Over the past 20 some years of working with distributors, one thing I have found in common with every single one is the existence of dead stock.  It is nothing to brag about, but there are some distributors who work with more dead stock than live inventory.  There are some who think it is dead and forget about it.  Then there are those who like to keep their dead stock around for years on end, almost to the point that it becomes part of the family.

 

I tell distributors all the time that there are not stages of deadness.  In other words, inventory does not go through stages like dying, dead, really dead and then stinky dead!  If it is dead then it is dead.  Make something happen.  Many distributors believe in the stages of deadness.  They think it might be dead with a heartbeat so maybe we can revive it.  We often believe that if we hit our dead stock with some electronic charge (like a sales promotion), it will pop up off the table and start living again.  This is not true.

 

One of the major reasons so many distributors have larger quantities of dead stock than they would like is because they do not have a rule of dead stock.  I challenge all distributors to establish a company dead stock rule or definition.  When I ask distributors their definition of when something becomes dead, I hear no sales in ninety days, no sales in six months and no sales in twelve months as common answers.  Those actually sound wonderful if you ask me.  But then let’s add a dose of realism to those answers.  In other words, what is really happening in their operations?  What I find as the truer definitions are something like no sales in twelve months, no sales in twenty four months, no sales in five years.  I even hear that some distributors use the rainbow method of identifying dead stock.  This is not a commonly known method, but too often it is applied.  The rainbow method is used by distributors who do annual physical inventories and put colored inventory stickers on the product once it is counted.  Each year they use a different colored sticker. When all the colors of the rainbow have been applied to a product, they deem it dead.  Hey at least it is a visual method of knowing what is dead.

 

I admit, the rainbow method is a terrible approach for anyone, but it is still being used today.  Now let’s look at some more practical ways to handle the dead stock you have in your inventory.  Let’s step back and look at a company definition that you can really live with and implement.  I would contest that no sales in six months is a great strategy but too hard for many to implement.  Find a definition and rule that most of your inventory can live with and most your people can execute.  Let’s use the no sales in twelve months as a realistic rule. 

 

Using this approach, you can easily run a report at the beginning of every month and look at those items with no sales in the previous twelve months.  I call it the “13^th month first day report”, or “your inventory obituary”.  In other words, using this approach allows you to easily identify which products died last night (the last day of the previous month).  In an article we published years ago, I thought it would be a great idea if all your dead stock would start stinking as soon as it died.  Then you could just walk in the vault the first of the month and smell your way to the dead stock.  For some distributors, the first day of each month might be pretty stinky.  But since most of the hard goods we deal with do not stink all by themselves, we need a report to help make them smell up the place.  The “13^th month first day report” is just that.  It will quickly list out all items that have had no sales in the past twelve months.  This list needs immediate attention.  If we do nothing, another thirty days will pass and more dead stock will pile up.  Having said that, what do you think is the worst thing that can happen on the first day of the thirteenth month?  Yep you guessed it, we sell one! I say that is the worst because you know you will have someone come up and tell you something like “See I told you if we kept this stuff long enough someone would buy some!”  It can only get worse when we think that it is now alive, and we go buy more of it.  I hate to be the bearer of bad news.  If it is dead, according to our definition, then it is dead forever.  Now take action.

 

Similar to when a human dies, the mortician works on us immediately because we start to decay and smell bad.  Your dead inventory will only cause infection to your good inventory if you do not act immediately.  Once identified as dead, you should make the appropriate adjustments to your accounting system.  You should also adjust all ordering controls in your software such that no one can buy anymore of it.  You might want to consider moving it out of the good inventory because if you don’t, you might know it died on paper, but you may not be able to find it in your vault.

 

I see a number of distributors who actually have created an inventory graveyard for their dead stock.  They identified it as being dead, moved it out of the living inventory and set it in a predetermined location.  Some have even decorated the graveyard with dark colors and the grim reaper standing guard.  Why would they do something like this you might ask?  Well, many distributors will take the dead stock and move it higher up on the shelves, maybe to the top shelf to get it out of the way.  You just compounded the problem.  You not only have dead stock, but you just implored the age old rule of “out of sight out of mind”.  Putting it out of the way, and out of sight, only makes your dead stock “deader”.  Ok, maybe it becomes more dead, but in any event, you will not keep it in focus if it is out of view.  Remember there are not stages of deadness!

 

Once identified as dead, and moved out from the good and living inventory, you can work on it more actively.  You see it all the time and your daily efforts will be more focused on moving it out.  By the way, don’t kid yourself, once inventory has died there is only one action item left – move it!  The goal is to make it go away or disappear from your inventory.  There are plenty of ways o make that happen and we will talk about those in our next article.  However, at this point some distributors have plenty to do after reading this.  Let me outline the steps you need to take when your inventory had died to eliminate any confusion:

 

1)  Establish a company wide dead stock rule – and follow it.

2)  Print out your inventory obituary on the first of every month

3)  Make the appropriate cost adjustments or write downs in your accounting system

4)  Pull it out of your good and living inventory

5)  Adjust your purchasing controls such that no one can buy more of something that has    

     already died once.

6)  Establish a dead stock area or cemetery in your vault so everyone can see what died.

7)  Do not push it up to the top shelves and use the “out of sight out of mind” strategy.

8)  Appoint someone to start dealing with it on the 1^st of the month – a dead stock manager.

9)  Don’t ignore it, because in another 30 days something else might be dead, and you do not want to use the “rainbow method” of inventory management. 

10)  Do whatever it takes to make this stuff disappear!

 

Remember, there are not stages of deadness when it comes to inventory.  When something is dead, take action before it starts to stink.  It is when you do nothing, or you become too emotional about disposing it, that you end up spending many more hard earned dollars.  If you take the easy way out when it comes to dead stock, you will soon need a full time dead stock manager just to deal with the mess you created.  So if you don’t have a rule of dead stock today, establish one soon, because the 1^st of the next month is just around the corner.