How Important Is Inventory?

By Paul Starkey
Published on: April 26, 2019

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Inventory in a business like yours should not be a big thing. In fact, some experts believe it should be nothing. To the point of saying: it’s a contractor business and materials should be expensed as bought and hence no inventory asset.

Others believe it’s a project business and inventory should be kept and relieved when delivered to the project.

Most contend it should be a just-in-time business but we rarely see that in practice. In fact, most CI companies have much more inventory than they should keep.

So, how important is inventory and how should we manage it?

Inventory is extremely important and to some degree it can be free. That is, from a cash standpoint. You say, how is that possible? Client deposits and vendor payment terms can finance correct inventory levels; using other people’s money!

One important distinction here: inventory is components goods – the boxes – if you will. Consumable materials, like bulk buy items, things you don’t know how much you may use in a job and truck items below a given small value – $100 for instance – all can be considered non-inventory. Together, they are typically less than 2 percent of Revenue. Inventory items can be 35 percent to 40 percent of Revenue.

So what’s the impact of too little inventory?

Yes, it interrupts the job and probably will cost you more labor. It also can have bad client satisfaction consequences (delays). A few (I mean few) expediting charges versus carrying $100K too much inventory or multiples of that at 6 percent to 8 percent return on money is a good trade off.

What’s the impact of too much inventory?

It’s a bad investment; don’t justify making profit on it. You make the same profit if you have fewer inventories and you get a higher return on your cash if you minimize it. Heavy inventory always results in losses (shrinkage, write-offs, discounting to close it out).

Your inventory is like perishable goods. Yes, like tomatoes or fruit, they will over time become useless and cost you money. Inventory older than 60 days has a high rate of obsolescence because your salespeople move on to other things and vendors change models quicker than we think.

So the best practices are clear:

  1. Keep only the inventory you need to serve projects. Be ultra-disciplined.

  2. Buy it at a discount, only if it is product under-contract. Resist stack ‘em high deals. Make your vendor a full partner.

  3. Order. Receive. Manage it like it is gold.

  4. Pay very close attention to inventory coming back to the shop (returns, unused parts, loaners, defects, etc.) Have a well-tuned process for getting these goods dispositioned. A RED table (scrap or vendor return) and Green table (restock) at the receiving door works well for this.

  5. Monthly, flag everything in inventory approaching 90 days and take action on it.

  6. Control your consumable parts; beware of usage rates by major SKUs; hold the team accountable.

  7. Pay your purchasing and warehouse people extra on lean inventory goals achievement.

  8. Okay, you want a critical metric for inventory: How much of your inventory is assigned (allocated) to specific jobs? Can you get to over 80 percent? Good just-in-time companies can do better.

In a well-run CI business inventory costs will be about 35 percent of revenue in a given year. You should be getting six turns if you are on top of it and managing it. So a good rule of thumb is: every $1M in Revenue should carry $60K in inventory or less.

Why is INVENTORY so important to your business model? Well, over 60 percent of your contribution margin should and will come from equipment and parts. Manage it well and your cash woes will be in the rear view mirror.

Keep it Vital.

Paul Starkey

Paul Starkey

Paul Starkey is a 23 year CI industry veteran who led control manufacturer ELAN from infancy to a 150 person company. He is a visionary, keen on innovation, pioneer of on-line training, and numerous product innovations. He is co-founder of Vital Management.

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