The Secret to Successful Inventory Management

Sometimes, concepts of Business Acumen can seem really straightforward, and other times they can seem very complex. Inventory management is one of those concepts that seems fairly easy to grasp but in practicality, it is a complex and critical science that can make or break a business.

I’ve been facilitating an awesome high-potential leader program for a client who manufactures large and expensive B2B equipment. They design and sell superior, high-quality products to their customers and one of the issues that has bubbled up for some great learning is inventory management. Part of the learning journey involves a customized business simulation and they have learned a lot about operations including inventory management.

Some of the key learnings have centered around:

• How much inventory should we have?
• How do we optimize our supply chain?
• What do our customers care about?
• Are there benchmarks for our industry?

All of these are very important questions and there are some foundational answers.

Common Benchmarks

There are several very good methods of calculating the appropriate level of inventory. What we have discovered is the methodologies for having enough inventory can vary significantly depending on the industry, the type of products being sold, seasonal fluctuations, and various other factors. However, an excellent common benchmark used by many organizations for solid inventory management is the concept of days sales of inventory (DSI).

DSI is calculated by dividing the average inventory by the cost of goods sold (COGS) per day

The calculation represents the number of days it would take for a company to sell its current inventory at its current rate of sales. A lower DSI indicates faster inventory turnover, which is generally desirable because it means that products are not sitting in storage for long periods.

Another benchmark is having 2 months of inventory. It’s a common metric, especially for larger, bigger ticket items that are hard to produce.

To calculate, take the total number of units sold last year, divide it by 12, and multiply by 2.

A third benchmark is looking at inventory as a percentage of assets. A common metric is to target about 10%-20% of your asset base to be inventory.

To calculate, take your total assets on the balance sheet and multiply it by .20, and that will give you a reasonable target.

Some Key Learnings

In general, having enough inventory means maintaining a balance between having sufficient products to meet customer demand and avoiding excess inventory that ties up capital and increases storage costs.

Other factors to consider when determining if you have enough inventory include:

• Finances and Key Metrics - Balancing the cost of carrying inventory with the cost of stockouts and lost sales is crucial.
• Warehouse Costs and Space – You must ensure that you have enough physical space to store your inventory efficiently. This costs time and money.
• Seasonality: If your business is seasonal, you will need to adjust your inventory levels accordingly to address fluctuations and meet increased demand during peak seasons.
• Demand Fluctuations - If demand for your products is highly variable, you may need to carry more safety stock to prevent stockouts during peak periods.
• Production / Manufacturing Lead Time: Some products may take a long time (months/years) to manufacture and produce. You need to ensure that you have enough inventory to cover lead times without running out.

In summary, the appropriate benchmark for enough inventory depends on the specific circumstances and goals of the business. Regularly monitoring key inventory metrics and adjusting inventory levels accordingly can help ensure that you have enough inventory to support your operations effectively.