United Kingdom
Inventory reduction: how to free up cash to survive and fund restructuring - Stephen Cooney
A kitchen cupboard is a good analogy for what can happen in any stock holding business. Without focus, the goods value represents six months of meals but includes 10 jars of jam and obscure items like fig vinegar which will never get used again.
Managing stock in retail and manufacturing is complex and inventory levels are driven by numerous factors including:
- supplier minimum order quantities and delivery lead times
- how demand for the product being sold varies and ability to forecast this
- customer penalties for being “out of stock” driving the level of safety stock
It is difficult for some medium to small sized businesses to manage stock as their IT systems and internal processes controlling stock are often inadequate or misused which often leads to higher than necessary levels of stock.
For manufacturing businesses, key performance indicators often focus on deliverables such as service levels, safety and efficiency. Increasing stock levels is an easy solution to many of these issues but inadvertently promotes excess inventory and ties up capital.
In retail and wholesale businesses, which demand forecasting, product replenishment and managing obsolescence is often weak. Excess stock often leads to higher costs through excessive warehouse usage and inefficient retrieval and merchandising processes.
The onset of the tough economic conditions in which we find ourselves now, marked by the reduction in credit availability since 2007, ongoing uncertainty over future demand and wildly fluctuating raw material prices has dramatically altered companies stock profiles. Lower inventory levels are more common as sales decline, risking stock outs, customer penalties and further loss of sales. Subsequent trading losses consume cash, reducing the available funds to re-stock or purchase raw materials. As sales decline, pinpointing exactly what stock to buy and having effective supply chain processes is critical to preserving cash. Navigating an upturn is also challenging for these businesses as they often have a lack of funds to invest in the working capital required to drive sales.
In growing businesses, inventory management issues are often ignored. Where working capital is available to fund additional stock to service new orders, stock turn improvements often occur due to more frequent deliveries, masking excessive stock build.
Setting optimal stock holding for companies with stable demand is relatively straightforward. Companies whose offer relies on choice and availability of thousands of products often have low demand predictability. These businesses seek to provide a desirable offer without crippling levels of current and obsolete stock.
In theory it is easy to set target inventory levels and adjust the supply chain to get new materials delivered just in time. Implementing this in practise is much harder: companies need to assess theoretical inventory requirements and then determine how order, sales and manufacturing processes can be tuned to get actual inventory to this level.
The Operational Advisory Services team at BDO employs a defined process to reduce inventory levels. This approach can be adopted to assess the level of opportunity, or risk, on a due diligence or independent business review assignment or as a standalone performance improvement project.
Reducing inventory levels and freeing up cash can allow investment in restocking of fast selling items or funding of a restructuring programme to drive down costs and improve profitability.
If you would like to find out more about how BDO can help with any working capital or operational support, please email me at stephen.cooney@bdo.co.uk
11 January 2012
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