Many businesses need to have some inventory available. But having too much inventory is expensive, not just to purchase but also to store, safeguard and insure. So, keeping your inventory as lean as possible is critical.
Here are some ways to trim the fat from your inventory without compromising revenue and customer service.
Where to Begin
Effective inventory management starts with an accurate physical inventory count. This allows you to determine your true cost of goods sold and identify and remedy discrepancies between your physical count and perpetual inventory records.
Next, compare your inventory costs to those of other companies in your industry. Trade associations often publish benchmarks for:
- Gross margin ([revenue — cost of sales] / revenue),
- Net profit margin (net income / revenue), and
- Days in inventory (annual revenue / average inventory × 365 days).
Try to meet or beat industry standards. For a retailer or wholesaler, inventory is simply purchased from the manufacturer. But for manufacturers and construction firms, the inventory account is more complicated. It’s a function of raw materials, labor and overhead costs.
The composition of your company’s cost of goods will guide you on where to cut. In a tight labor market, it’s hard to reduce labor costs. But it may be possible to renegotiate prices with suppliers.
Don’t forget the carrying costs of inventory, such as storage, insurance, obsolescence and pilferage. You can also improve margins by negotiating a net lease for your warehouse, installing antitheft devices and opting for less expensive insurance coverage.
More Steps to Take
Cut your days-in-inventory ratio based on individual product margins. The goal is to stock more products with high margins and high demand, and less of everything else. If possible, return excessive supplies of slow-moving materials or products to your suppliers.
Keep product mix sufficiently broad but still in tune with the needs of your customers. Before cutting back on inventory, try to negotiate speedier delivery from suppliers or give suppliers access to your perpetual inventory system. These precautionary measures can help prevent lost sales due to lean inventory.
Take Inventory of Inventory
It’s easy for inventory to get lost in the shuffle when you and your leadership team may be focused on big-picture strategic planning to grow the business. But if you don’t put some time into ensuring effective inventory management, your business likely won’t be able to achieve its strategic goals.