Why is inventory accuracy important? From an accounting perspective, the answer is simple. Organizations must know what inventory is on hand to understand their financial position. But from a supply management perspective, the day-to-day operations are extremely complex if inventory counts are unclear or if the inventory management is unreliable.
Effective production scheduling is impossible without accurate inventories because companies will always have too much or too little inventory on hand, and the cases in which the inventory is just right can be attributed to pure luck. Inventory inaccuracy makes for bad forecasting, effectively rendering the organization blind to production requirements in the future – a challenging place to be in this fast-paced manufacturing economy.
Consequently, ensuring inventory accuracy should be a key initiative for every company. After all, how can you know how much to build without knowing what you already have? How can your suppliers know how much to build for you? This uncertainty leads to the bullwhip effect, where suppliers carry excess safety stock throughout the supply chain in order to account for inventory and demand uncertainty. Avoiding this problem is difficult, but we recommend using a few low-cost methods to help steer your organization back on the road to accurate inventories.
3 Methods for Improving Inventory Management
1. Classify the Inventory
Not all inventory is the same. Certain SKUs cost more than others. Knowing the characteristics for each SKU goes a long way towards controlling inventories in an organization.
A traditional method used is the ABC classification, which groups SKUs by the total dollar value purchased annually; the thought being the high-dollar SKUs will account for a small portion of the total number of SKUs. “A” SKUs usually account for 80% of an organization’s purchases, “B” SKUs account for the next 10%, and “C” the lower 10% of purchases. Classifying inventory in this way enables managers to focus their inventory control efforts on a subset of the inventory where it’ll have the greatest impact on operations and profitability.
2. Implement a Cycle Count Program
Cycle counting goes hand-in-hand with inventory classification. Cycle counting is the act of dividing inventory into defined groups and then physically counting it at a specified frequency. SKUs with an “A” classification are counted more frequently than those with a “B” classification, and so on. Cycle counting allows an organization to maintain inventory accuracy without engaging in frequent, costly, wall-to-wall manual inventory counts.
To set up your cycle counting program, first classify the inventory. Then, select a team of counters to execute the inventory check. Counting shouldn’t be this person’s primary job function. Cycle counting is an organizational commitment and shared responsibility for ensuring accurate inventory. Appoint a team lead to distribute count sheets to trustworthy associates to execute the counts in the required intervals. Once inventory is classified and teams are selected, the only thing left to do is count and adjust the inventory to your needs.
Every business is different, so count frequencies can vary, but a good rule of thumb is to count “A” SKUs monthly, “B” SKUs quarterly, and “C” SKUs every six months. It’s important to ensure that time is spent according to the impact the inventory has on the business. Counts should be submitted to whichever team member supervises your inventory management, then inventories should be adjusted in the ERP system to make sure the entire organization is aware of the current levels.
3. Set Economic Order Quantities for Each SKU
Price breaks are great, aren’t they? Who doesn’t like to buy in bulk to “save” a few dollars here and there? While reductions in direct material purchases are the quickest way to affect the bottom line, it’s crucial to be aware of the hidden costs of inventory that could drag down profitability.
If your company is committed to only getting the best price per unit no matter what, this leads to larger order quantities and, of course, larger inventories. In the short run, it’s not very impactful, but in the long run as inventories climb higher and higher, the need for warehouse space becomes a costly one for the organization. Setting an Economic Order Quantity (EOQ) for each SKU is the solution to this problem.
The EOQ is a way to set the fixed order quantity for a SKU. It is a quantity determined by considering the cost to order the units as well as the cost to hold them. Here’s the basic EOQ formula: √[(2D*K)/h]
Where “D” is the annual usage, “K” is the cost per order, and “h” is the carrying cost of the inventory. Using this equation can give supply management professionals a good starting point on how much to order for each unit, preventing the allure of price breaks from driving up inventory counts and costs.
Rising inventories can be a major disadvantage for operations and profitability, and inaccurate inventories cause endless challenges for production schedulers while creating opportunities for waste to pile up. An organization-wide commitment to inventory accuracy, implementing cycle count programs, and instituting documented inventory practices will help prevent this waste from becoming routine.