The fundamental principles of effective Inventory Management as they relate to the precast concrete industry.
By Terry Futrell
Terry Futtrell has more than 35 years of professional experience in the development, application and management of advanced technologies.
Is inventory a blessing or is it a curse? The answer is an unequivocal “Yes!” Sound confusing? Perhaps, but it’s no more confusing to many precast concrete manufacturers than the constant struggle to minimize investment in inventory while filling every customer order on time. This constant struggle represents a process called Inventory Management.
Whether you realize it or not and no matter what you call it, inventory management is an integral part of your business and has a significant impact on your profitability. You likely manage your inventory in one of two ways: as a formal process based on solid business data, or as an informal process based on feeling and intuition with little or no correlation to actual business data.
In the ideal situation, inventory is virtually nonexistent. Raw materials show up just in time for use in manufacturing, the duration of manufacturing operations is as short as physically possible, and the finished precast product is immediately delivered just in time to a customer. In other words, no raw materials sit in a warehouse awaiting manufacturing, and no finished goods are stored awaiting a future sale.
Unfortunately, reality prevails. The ideal is just a lofty goal, and every precaster must deal with inventory issues. Furthermore, precasters who primarily build to order have different inventory issues than those who sell mostly from stock on hand.
The precaster who builds to order must be concerned about the availability of raw materials in order to manufacture in time to meet a customer delivery date – and the lack of raw materials can be disastrous. Consequently, this same precaster may maintain larger quantities of raw materials in inventory, which must be managed effectively to assure that reorders take place when stock falls to a certain level. The precaster who sells from stock, on the other hand, will tend to have more flexibility in manufacturing and may not be as concerned about raw material inventory levels. In either case, because the cost of manufacturing labor has not yet been applied, the investment in raw materials is much smaller than for finished goods. As a result, supply chain management issues such as selecting suppliers, determining how to allocate orders among suppliers, and building trusting relationships with suppliers are primary challenges in assuring that raw materials are available when needed for manufacturing. (See “Precast Procurement,” MC, July/August 2006, for a more in-depth discussion of these issues.)
Due to the inherent nature of many precast operations, manufacturing duration is relatively short and may even be driven by the curing time of concrete. As a result, work in process is typically not a major issue from an inventory perspective.
Unless a customer is waiting to take immediate delivery of your precast products upon completion of manufacturing, as is the ideal case for the build-to-order precaster, finished goods inventory represents a major investment and must be managed effectively to minimize your costs. Finished goods inherently represent the value of raw materials, the value of labor applied during manufacturing, depreciation on your tooling and plant, and other overhead expenses. In addition, if you finance your production using a line of credit, you must also add the interest costs. Alternatively, if your cash flow is sufficient to cover production costs without borrowing, you must add the interest you could have made had you invested the funds. Either way, the cost of your finished goods inventory continues to escalate throughout storage, delivery, and your billing cycle up to the point that the customer’s payment is actually deposited in the bank. Accordingly, you should only maintain enough finished goods inventory to assure that you can responsively meet your customer’s needs – hence, the balancing act mentioned earlier.
Effective inventory management
As you begin to evaluate the effectiveness of your own inventory management approach, pay close attention to the two key enablers of effective finished goods inventory management. These are:
- Accurate counts of each product currently in inventory
- Knowledge of how many units are already committed to customer deliveries
How do you know what finished goods you have on hand? Do you track inventory quantities manually using summary sheets or perhaps index cards? If so, how often do you reconcile your numbers by taking a physical inventory? The methods you use for tracking inventory can severely limit your ability to effectively manage it. Some precasters are beginning to use automated systems and bar code technology to more accurately track inventory.
Equally important is knowing how much of your current finished goods inventory is already committed to customers. Feeling safe in the knowledge that you have 45 units of product XYZ on hand can lead to disaster if you don’t also know that 40 units are committed for delivery to a customer on Monday of next week. So it is vital that your finished goods inventory system also be linked to your order entry system. It is really the difference between quantity on hand and committed order quantity that is important in making decisions such as when and how many additional XYZ units to manufacture.
The difficulties of forecasting sales
As mentioned earlier, it is a struggle to minimize investment in inventory while filling every customer order on time. Perhaps the greatest contributor to this struggle is the difficulty of forecasting sales to help determine what new inventory to create. This problem is not unique to the precast industry but is a concern to every manufacturer. It is no wonder that a significant industry has grown out of providing inventory management consulting services to manufacturers, especially in the area of sales forecasting.
Numerous sales forecasting methods are available, and all are generally based on past sales volume. These range from simple methods based on average sales to complex mathematical formulas that take other business factors into account. One inventory management consultant offers a spreadsheet for sale that selects from 15 different formulas to forecast sales. Just as with a pair of shoes, one size does not fit all. No single forecasting method works for every industry, for every manufacturer within the same industry, or perhaps for every region of the country. Demand may be stagnant in one region while construction in another region is booming. Factors such as the nature of customer demand – is it cyclical, relatively constant or steadily growing (or declining) – are primary determinants of which forecasting method works best. Needless to say, the precaster must select the most appropriate sales forecasting method to achieve the greatest level of success in finished goods inventory management.
No matter which sales forecasting method is used, there are shortcomings that must be understood and compensated for. First, all sales forecasting methods tend to be biased by unusual orders and cannot differentiate between increased sales that result from special promotions, such as an inventory reduction sale, and those resulting from a real change in customer demand. Though some forecasting systems can detect unusual changes in past sales quantities, human intelligence is required to make a final determination of why such changes occurred and whether they should be considered in generating future forecasts.
Second, while sales forecasting methods may accurately predict future sales in a stable business environment, none can predict unforeseen changes in business climate. No “system” can foresee a major new construction project starting up in a few months. No “system” can know that your best customer will soon begin construction of a large development and will need more precast products than in the past.
While we talk about two approaches to inventory management – formal vs. feeling and intuition – the reality is that both elements are required. The best sales forecasting method can only serve your needs well when it is supplemented by your knowledge of your customers and their future needs. That kind of insight results from establishing trusted business relationships with your customers.
Effective use of key performance indicators
Achieving future improvements in your inventory management process requires that you regularly monitor the performance of that process. Fortunately, there are a number of standard performance indicators from which you may choose. One that is often used for industry comparison purposes and as an indicator of your competitiveness is Inventory Turns, which is simply the ratio of sales (in dollars) to the average value of your inventory (in dollars) over the same time period. Obviously, higher numbers are better and indicate that you have less cash tied up in inventory at any given point. One of the simplest performance indicators is the average time that each product you make remains in inventory before delivery to a customer. Shorter times mean your final product cost is less. Whichever performance indicators you choose to implement, they should be based on fact and supported by an accurate inventory tracking system.
So is your inventory a blessing or a curse? Hopefully you now have a basic understanding that will enable you to make that determination and a few ideas to guide your next steps toward improving management of your precast finished goods inventory. Taking those next steps is up to you. Can you really afford not to take them?