Update on Inventory Issues
Originally published: 1/1/10 by Ruth King
Reminders on inventory management.
There have been a lot of questions about inventory lately so I thought that I would answer them here. First, remember that inventory is a bet. You are betting that you can sell the parts or equipment that you are purchasing with your hard earned dollars. Some of you make great bets and closely manage the amount of inventory that comes in and goes out of your shop. Others of you have inventory sitting on the shelf that was bought last year or earlier. Each year more comes in without enough going out. Try to become the owner who manages your inventory bets well.
If you order for a job, then your probability is close to 100 percent that you will be using your hard earned money wisely. Why not 100 percent? Because there are a few times where your customers will go bankrupt without paying for the parts or equipment.
If you have a floor plan, your probability is also close to 100 percent that you will be using your hard earned money wisely. Why not 100 percent in this case? I've seen contractors have to pay restocking charges or for the equipment when they don't watch
Pre-season orders can cause inventory headaches.What looks like a great deal (i.e. low price) might actually be extremely expensive. Let's say you have the opportunity to purchase 10 fan motors at a great price. If you have never used 10 fan motors in a season before, it is unlikely that you will use 10 fan motors this season. Don't buy them. If you buy 10 and use only 2, then the other motors are infinitely expensive... they are sitting on your shelf and you've paid for them without selling them!
On the other hand, if you've used 12 fan motors in the past season and the supplier is offering 10 at a great price... try to get 12 at that great price. You'll increase your margins assuming you don't change your pricing to reflect your lower cost. And, you won't have any stuck on a shelf that you have to pay for without selling them!
The best way to gauge whether you have too much inventory is with your inventory days calculation. (Annualized inventory divided by cost of goods sold = inventory turns. 365 divided by inventory turns = inventory days). For you bank purists, this is not the "textbook" definition of inventory days. I use "cost of goods sold" rather than the textbook "material expenses" because in our industry it is very rare that you sell a part or install a piece of equipment without accompanying labor. The number of days that I consider acceptable is based on this "cost of goods sold" usage rather than "material expense" usage in the calculation.
If you are residentially based, your inventory days should be less than 30 days. If you are commercial and cannot charge for stored materials on jobs, you inventory days will be somewhat higher. If inventory days is going up each month, you are buying without selling the materials and equipment you have on hand. This is a warning sign!
The solution? Stop buying! I know that this is difficult. Try it for a week. Most wholesalers hate me when I say this. However, I think that they would rather have you pay your bills because you collected the revenues rather than out of your own pocket...or not pay your bills at all because you don't have the revenue to pay them.
The biggest culprits are usually the technicians. I've seen too many trucks with too many parts on it. The parts get damaged, lost, hidden under junk, and have a tendency to disappear. The best thing you can do is to create a standard inventory on the trucks for the different types of work you do. For example, you might have different inventory for a technician who performs mainly residential service, different inventory for a technician who performs mainly maintenance, or who performs commercial service.
Technicians hate this in the beginning. They come up with all sorts of creative reasons why this won't work. You have to be strong and make sure that they know you mean business. Also, it helps when you let them have input into the parts they would like to have on their trucks.
One of the most creative things I've seen with respect to inventory is to have an "on call box" which gets put on the truck of the on-call technician. This box contains the "unusual part" that the tech might need on a weekend when the parts stores are closed. It isn't used enough for all of the techs to have on their trucks all the time. However, it is valuable enough so that one is needed for the on-call parts box.
From an accounting perspective, your accountant calls and says that you owe thousands on taxes...and you don't have the cash to pay the taxes.You might wonder where all of your cash went. Many times it is just looking at your warehouse and in your trucks.
Inventory is not an expense. You can't decrease profits by the cost of inventory until you actually use the part or piece of equipment on a customer's job. So, those parts sitting on shelves and on trucks are costing you money...money that you need to pay your taxes. Inventory needs to be treated just like cash. When you monitor what comes in and goes out every week, you'll find that you buy less and use more of what you bought.
Articles by Ruth King
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For a realistic goal, include owners’ compensation in the net profit equation.
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Enact a profit sharing program, rather than a bonus entitlement.
Prevent Employee Embezzlement, Part 4
Most contractors don’t think about how much time is stolen by employees doing personal activities on company time.
Prevent Employee Embezzlement, Part 3
If you ignore locking your warehouse and limiting access to it, don’t use material sheets and don’t make your technicians responsible for the inventory on their trucks, you’re inviting theft.
Keep Your Money Safe
Keeping your hard earned money safe is your responsibility. Put the procedures in place to keep the honest people honest and protect yourself from employee embezzlement.