Inventory Optimization Creates Expanded Working Capital
Many businesses were caught off guard by the COVID-19 pandemic. Stay-at-home orders and mandatory business closures created significant operational challenges. Not only were many businesses forced to change their operating models (almost overnight), but so too were key vendors and partners, creating strains across the entire supply chain. The result was a sharp decline in new sales, difficulty obtaining materials and other inputs, and diminished ability to deliver products which led to issues with working capital. As many worked quickly to adjust to the new situation, it became obvious there was an immediate need to secure new sources of capital. To bridge the gap, some turned to exist financing relationships, created new banking relationships, or took advantage of federal loan programs. Now that attention has shifted from survival to recovery, businesses are looking at internal changes that can be made to free up capital. Key elements of the change process include optimization of several processes including inventory management. How inventory is managed, when it is ordered, and how quickly it is consumed has a meaningful impact on working capital. To help clients, prospects, and others, Clayton & McKervey has provided a summary of key details below.
Importance of Working Capital Management
Until the abrupt changes brought forth by the COVID-19 pandemic, many middle-market businesses did not experience working capital gaps. According to the Working Capital Management Report issued by the National Center for the Middle Market, 59% of participants do not at all experience issues with working capital and only 36% have issues more than twice per year. For those facing regular issues, the challenge is typically solved by tapping lines of credit or taking additional business loans. In the “new normal” businesses need to carefully review various practices, including inventory management, to determine where optimization can occur. Even relatively minor adjustments to inventory can result in significant payoffs.
Inventory Management Best Practices
There are several optimization steps that can be followed to improve inventory management. The best practices outlined below apply to businesses across multiple industries.
- Establish Inventory KPIs – These key performance indicators (KPIs) help a business measure performance towards inventory management goals. They are an especially useful tool for businesses seeking to improve in one, or more, areas. Common inventory KPIs include inventory carrying costs, inventory write-offs or write-downs, rate of inventory turnover, cycle time, and fill rate. By regularly evaluating processes in these areas, it becomes easy to identify trouble areas where changes are needed.
- Reduce Inventory – Most businesses have between 25%-30% of working capital tied up in inventory. For this reason, it is important to find the point where the lowest amount of inventory can be maintained without being understocked. Common inventory reduction methods include:
- Lowering Lead Times – This can be accomplished by tracking existing lead times, sharing sales data with suppliers, and reducing minimum order quantities.
- Liquidate Obsolete Inventory – This can be accomplished by offering customers discounts or positioning it as a tax write-off.
- Improve Inventory Forecasting – By implementing real-time tracking and reporting, integrated communication, and large volume inventory management tools, businesses can make more reliable forecasts.
- Optimize Inventory Turnover – Inventory turnover refers to the number of times inventory is sold or used in a given period. This will help management understand the market demand for products and the amount of old or obsolete inventory being carried. Common ways to increase inventory turnover include testing new pricing strategies, getting rid of old inventory, improving demand forecasting, and streamlining the supply chain to reduce delivery costs and in-transit times.
- Carry Safety Inventory – This is a small amount of select inventory designed to protect from sudden spikes in market demand and lead times. Without this reserve inventory, a business could be exposed to a loss of revenue, customers, and market share if unable to fulfill orders. When properly used, it manages against risks of unexpected demand and acts as a buffer for longer than expected lead times (more prominent during the pandemic).
A few small changes in inventory management can free up critical working capital to better position businesses for unexpected market conditions. As 2021 quickly approaches, businesses are looking for new ways to manage capital concerns due to the uncertainty created by COVID-19. If you have questions about the information outlined above or need assistance with inventory optimization, Clayton & McKervey can help. For additional information call us at 248.208.8660 or click here to contact us. We look forward to speaking with you soon.