A Question of Purchasing

Have our inventories, compared with sales volume, gotten out of line with those of others in our industry? Which of our products, in these terms, are showing the best and worst records, and why?
Traditionally, management has been advised that “20 percent of your products probably account for 80 percent of your inventory,” so look to make the biggest cuts where most of the inventory occurs. In many cases, this approach can accomplish more harm than good and can hinder sales and deliveries of products that are among the most profitable. At the same time, it may overlook other situations that collectively account for much of the excess inventory.

Example: A manufacturer of a line of packaged housewares saw inventory values on suc-cessive reports climbing, and suspected they had gone too high. A check of inventory turnover ratios in its industry confirmed this suspicion. It began an investigation to discover why finished products were piling up, and how to correct the situation. The task was assigned to the sales man¬ager because he was responsible for projecting sales and requisitioning output from production. His first step was to have the available sales and inventory data organized on a detailed product basis so that he could calculate product-by-product inventory turnover ratios. It then became apparent that the suspected finished product inventories accounted for only a minor fraction of the rising inventory values reported on the balance sheet.

Furthermore, because of differences in production cycles, some products generated much heavier in-process inventories than others. Another less-expected finding was that purchased-materials stocks for certain products were a big part of the total inventory problem. Some specialized materials were in generous supply, although the products they were intended for were no longer sales leaders or were actually being phased out of the line. The inventory problem, in other words, was not only a product-by-product problem, but one that needed tackling on a stage-by-stage basis.

The sales manager’s report showed inventories of the appropriate materials for each product, work-in-process and finished items at the close of all of the past four quarters. He related each of these to product sales for each quarter, to produce inventory turnover ratios in each calendar quarter. Based on his specific recommendations, the company took several actions:
● For certain products, it sharply reduced heavy and aging materials stocks. Excess items were designated for possible use in other products, as substitutes for specified materials. Those not absorbed in this way were sold off, sometimes at a gain. It also made adjustments in seasonal ordering and other purchasing practices to minimize future buildups.
● Where in-process inventories were high, the company reviewed production scheduling. Some practices that it had once adopted for convenience, and to avoid more careful scheduling, were found to be causing a significant tie-up of expensive inventories—partly finished items were being temporarily shunted aside. The sales/in-process stock ratios were used to zero in on these. Then changes were made to schedules, size of production runs and other practices that were adding to the inventory load.
● Finally, in a relatively few cases, stocks of products awaiting shipment were, indeed, found to be excessive. Better coordination of short-run sales projections with production orders reduced some of these. Where there were pile-ups in anticipation of seasonal needs, special preseason offers to dealers not only trimmed stocks but often resulted in a net increase in annual sales.

A Question of Stability
How well could your company withstand adversity—a sudden drop in prices or sales, or an increase in costs?
One yardstick used to answer this question is the company’s break-even point. Expressed in sales volume, this is the point where income from sales covers total costs, both fixed and variable. Another factor that most managers watch for continuously, once the basic breakdown has been prepared, is any sign that fixed costs are rising.