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Problem: Inventory is out of control.
Diagnosis: You can set up a financial reporting system that track five different inventory relationships. Together, they will function as an early-warning system against possible inventory problems.
Prescription: Implement the following systems and follow them carefully to safeguard against future inventory problems.
1. Gross margin return on investment
Subtract the cost of your product's raw materials, direct labor, and factory overhead, including your warehousing costs, from your selling price. Then divide that by the selling price. Administrative costs should be left out.
A manufacturer should be able to demonstrate a 15 percent to 25 percent return on each product line. A distributor, who has no production expenses, simply subtracts the cost of goods bought from goods sold and divides that by his selling price. Distributor's goal should be a 25 percent rate of return.
Improve your profit picture by eliminating any lines, including best-selling ones, that are not profitable and look for ways to reduce costs in all lines. Example: Instead of offering your customers packages in a dozen shades of red, all of which will have to be stocked in inventory, reduce their choices to two.
2. Inventory turnover.
To determine the rate of turnover by product, divide the total number of units sold during the year by the average number of units on hand during the year. As a rule, a manufacturer's inventory should turn over six to eight times a year to minimize the amount of cash you have tied up in the warehouse. If it only turns over three times a year, you have tied up twice as much cash in warehousing as necessary. If you can find a particularly good deal on raw materials and stock, make sure your cost savings outweighs the additional expense of supporting a slow inventory turnover.
Track finished and on-line goods weekly; raw materials, monthly.
3. Percentage of orders shipped on time.
If the inventory turns over too quickly, lean companies may not be able to fill their orders as promptly as they should.
Try to fill orders according to the delivery terms you have set up with your customers 98 percent of the time. If the percentage of on-time shipments drops below the mid-90s, pump up your inventory levels. Monitor this once or twice a month.
4. Time it takes to fill back-orders.
Weekly, watch to see how long it takes to fill back-orders. If you know you're going to sell 50 items a week and you know that it takes two weeks to make those 50 items, then keep at least 100 of them in stock. If you see your orders increase, react immediately by increasing your production.
5. Percentage of customer complaints to shipped orders.
Divide the number of customer complaints by the number of orders shipped. If it exceeds 2 percent, you could be facing real problems.
Analyze each complaint to see if you can determine the problem. Example: Incorrectly shipped items might indicate mislabeled storage bins or badly-trained warehouse personnel.