I was walking through the warehouse area of a plant the other day and couldn’t help doing a quick analysis – it’s an occupational hazard; as a consultant and supply chain professional, it’s really in my DNA. Anyhow, I was trying to do a quick assessment of whether this company had the ‘right’ amount of inventory.
Many of the shelves were empty. This could be a good thing – lower inventory is always a goal for efficient operations and lowered costs. On the other hand, too little inventory can lead to customer service problems, late shipments, lost orders, plant disruptions, and all kinds of other undesirable effects. So, are the shelves half empty or half full? Or is the warehouse just a lot bigger than it needs to be?
Inventory is the most visible indicator of tight, efficient operations or operations out of control. Inventory can also indicate increasing or decreasing sales, good or bad forecasting, and a number of other measures of the health of the business. But you can’t know which just by looking at the shelves. Inventory level has to be put in context to have any real meaning.
Most companies watch inventory turns – simply the ration of the amount of inventory divided into annual cost-of-goods sold. For example, Cost of goods $12 million and inventory $3 million relates to 4 “turns”. Higher turns are always better, of course, and are considered a sure sign of improvement.
But the ‘turns’ number itself is only meaningful in context. Compare yours to the average in your industry, the best performance in your market, and/or your closest competitor. Also consider that too little inventory can lead to shortages and all the nastiness mentioned above and realize that turns can be too high to be healthy.
And also consider that there are different kinds of inventory – raw materials and components, work-in-process, finished goods, supplies –each serves a different purpose and each is managed differently.
Inventory level can be a useful indicator of performance and company health but only in context. You can tell only so much from a walk through the warehouse.
