Why inventory planning is crucial and the tools available to tackle this task
We all know the old saying that a person’s two happiest days are the day he buys his inventory and the day she sells it, or maybe it’s his boat. Anyway, I’ll go with the inventory version and use a company, rather than an individual in this story, noting there is some similarity between these two scenarios.
Companies that buy and sell inventory, either because they are retailers or wholesalers, or manufacturers that buy raw materials and parts and convert them into sellable goods all encounter this basic dilemma: How much inventory should they have on hand and when to bring in additional inventory and at what quantities.
Have you experienced having too much of a certain item with little demand from sales orders or work orders while scrambling to uncover parts that customers all of a sudden have placed orders for? To make things worse, these are often the parts with the longest lead times. How are you supposed to know how much material to keep on hand and when to place orders for parts, while maintaining acceptable customer service levels but without tying up too much cash in inventory that may become obsolete?
A lot of these decisions are based on sales forecasts, budgets and planning. Other factors are supplier lead times, workforce planning, employees’ availability and training, requirement of safety stock levels, volume cost incentives and other factors.
In manufacturing it is common to use MRP (Material Requirement Planning) which is usually a component within the ERP (Enterprise Resource Planning) software. MRP looks at many factors and then recommends purchasing of certain parts and raw material, as well as manufacturing parts designated as made-in parts.
MRP uses assumptions and user preferences, entered in the settings section of the software. It also produces purchase orders for all required material and can be run at varying intervals, with daily being the most common.
My observation with early MRP systems was that upon introduction and setup, many manufacturers experienced an increase in their inventory valuation, mostly in raw material and parts but also in some of the WIP inventory attributed to MRP driven made-in parts.
Some of that phenomenon was due to incorrect assumptions and settings in the MRP software, but a large factor was due to recommended purchases with due dates prior to the date these parts were needed for various production activities per the work orders’ routing sequences.
I remember that after spending considerable time trying to figure out what really caused this, we discovered that some of the logic built into the MRP software assumed the material was needed for Operation 1 (this was largely depended on how the part BOM was structured) on the work order and not according to the actual sequence of operations. For example, an expensive engine and transmission were received and were immediately available to use when the work order was released to production, and not when really needed, weeks or months later.
This, of course, resulted in an unnecessary increase in inventory and a serious decrease in cash flow. Manufactures’ borrowing needs suddenly increased, supplier payments were delayed, and balance sheets started to deteriorate. To alleviate some of these problems many expensive parts had their MRP attribute changed to Non-MRP which required manual PO management. As expected, this caused sporadic purchasing errors, like forgetting to purchase that engine and transmission needed in the final assembly sequence only to delay production for an additional 8-12 weeks.
That has largely changed in modern day MRP software, but inventory planning remains as valid as ever. This means that when preparing your plan and budget you must pay close attention to planning your inventory needs which requires a super conscious effort in forecasting sales and combining that with the existing backlog. To do that you need a modern-day planning, budgeting and analysis software solution that is specifically designed for these tasks.
This means that traditional spreadsheet models and even certain first and second-generation FP&A (Finance, Planning and Analytics) software solutions may no longer be a viable option because they lack the built-in business logic, accounting rules and planning intelligence present in some of the modern solutions.
Unlike modern-day FP&A solutions, these older applications are hard to implement because they require extensive programming and setup work, and in the case of spreadsheets are nearly impossible to scale and manage.
Today, even smaller manufacturers (or any kind of business) can benefit from implementing a sophisticated FP&A software solution, one with built-in planning intelligence, at a modest cost, with little or no IT involvement and be operational within days or weeks as compared to months or years not too long ago.
Plan your inventory correctly and every day of buying and selling inventory will be a happy day.
Alan Hart, MBA, is Principal Consultant at Pacific Shine Group in Portland, Oregon, with responsibility for client business development and hands-on client project implementations. Prior to starting Pacific Shine Group, he worked in various executive accounting and finance positions with technology and growth companies. Notable is his 18 years in the hi-tech manufacturing industry where he served as Controller, Vice President of Finance and CFO of several privately as well as publicly held companies in the Hi-Tech industry, such as Hybrid Arts, Inc., Hamilton Bay Associates and Syncronys Software. In his role in management consulting, Alan has worked in diverse industries and with a variety of clients, including fortune 1000 companies such as Boeing, Delta Airlines, Intel, Wyndham Worldwide and others, as well as many mid-market organizations such as Guitar Center, Ducommun AeroStructures, Cypress Semiconductor, TriQuint Semiconductor and others.
Combining his skills and experience in engineering with deep understanding of technical accounting, he is able to assist small and medium-size manufacturing companies establish GAAP compliant accounting and reporting systems.