Importance Of Inventory Level Optimization to Enhance Business Performance

Prepared by Kaveen Gayathma

Inventories are actually money converted to the

form of physical goods, stored in a warehouse,

waiting to be converted back to money. Tying up

money in this form is inevitable in order to conduct

businesses in competitive and profitable manner.

But it is not logical to build up inventories without a

real demand driven reason to do so.

Amount of Inventory at SKU Level?

Why Inventory Optimization is Crucial?

“Inventory management is a vital part of any

modern organization, especially if it is associated

with a physical product. Suboptimal inventory

management directly impacts company value

through working-capital pressure and unrealized

revenue as well as through budgeting, planning,

and risk management issues.”

The three primary inventory issues impacting working capital

•How many inventory Dollars are on hand?

•How long do inventory Dollars sit on the

books?

•Why?

“CFOs can readily answer the first two questions. However,

only answers to the third question — why? — can enable

them to determine if inventory is an asset or a liability”

Better Managed Inventory…

Inventory costs represent a sizeable component out of

total logistics costs. Up to about one third of working

capital costs are also arising from inventories.

Inventory optimization has the potential to increase

profitability through multiple cost reductions tangled

with inventory such as holding costs, handling costs,

back order costs…

Increase Profitability

Inventory Rationalization is one of the most effective

ways to release up substantial amounts of cash for the

business enhancing liquidity position.

Inventory optimization paves a direct path to improve

ROCE, Asset Utilization.

Meaningful improvements in Current Ratio.

Significant and immediate improvements attainable on

Working Capital through multiple fronts.

Better Managed Inventory…

Financial Deliverables

It is often noticed that bottom 20% of the SKUs

are usually a significant drain on profitability as

they cannibalize demand and storage space from

higher volume products and are costly to

purchase, distribute and slow moving

“Companies often fail to recover a share

of money they tied up as “push

inventories!”

Reasons to Manage Inventory Better…

Inventory Hide Problems!

Providing a better service to customers is one of the

main reasons to carry stocks. But for this purpose or for

any other, maintaining irrationalized and excessive

inventory levels could hide not only supply chain

related, but also operations as well as finance related

weak links and problems in a business.

e.g. High level of finished goods buffer could divert the necessary attention from

recurrent production breakdowns or lower production efficiencies.

Inventory Rationalization is the sensible way forward…

Inventory Increase Risks!

Reasons to Manage Inventory Better…

Inventories could reduce risks such as stock outs. But on

the other hand damages, pilferages, expiries and

obsoleting of inventory which will ultimately cause

costly write-offs will introduce additional risk elements

to a business. Proactive and reactive measure such as

insurance that are essential to encounter such risks will

carve into ever thinning profit margins.

Steps Towards Better Managed Inventory…

Traditionally, many organizations have allowed

the managers in each business unit, factory, or

distribution center to set their own inventory

levels with little coordination. Eliminating the lack

of overall ownership of the inventory levels which

leads towards sub-optimization should be the

initial step towards rationalizing inventory.

Accurate and rational planning and forecasting could

effectively reduce complications which occur with

irrational inventories such as stock out situations and

maintaining unnecessary inventory levels.

A forecasting model which could relate to real customer

demand signals while incorporating other demand

affecting factors such as promotions and competitor's

actions could lay the foundation for appropriate

rationalization of inventory.

Steps Towards Better Managed Inventory…

Forecasting and Demand Planning

Time series models, What-if analysis tools and Sales

decomposition analyses customized to match unique

requirements of different business units will be used at

this level.

Steps Towards Better Managed Inventory…

Forecasting and Demand Planning

Each SKU will have different characteristics to another.

Dynamic requirements of each SKU should be

considered to avoid irrational inventory related

practices.

SKU rationalization will help determine the preferable

optimum stock level under each SKU and pave the way

for prioritized inventory investments

Steps Towards Better Managed Inventory…

SKU Optimization

Requirements to carry inventory will vary with SBUs,

geographical locations, product and market behaviors at

regional level and requirements of regional

stakeholders.

Understanding the rational behind each SBU to carry

the level of inventory could pave way to optimize SBU

level inventory.

Steps Towards Better Managed Inventory…

SBU Optimization

Rationalizing SKU-level inventory across all SBUs and

all inventory holding locations throughout the supply

chain will enable optimal inventory performance while

mitigating inventory risks.

Steps Towards Better Managed Inventory…

SKU & SBU Optimization