Inventory Management: a Direct Link to Profitibility

By James Blake, David Rim and Noreen Taylor

Inventory management is a critical function affecting a firm’s profitability. Cycle counting can increase inventory accuracy by 95% according to a review by the University of Arkansas.

The advent of Internet and online sales has changed consumer behavior and increased expectations. The Internet has created many new outlets for sales, however, it has also increased competition amongst retailers. For mixed retailers i.e. retailers operating through brick and mortar and online stores, having sufficient inventory, balancing it across channels, constantly updating and replenishing it is very challenging. Online mediums are utilized to not only check assortment and availability, they may translate into purchases or subsequent store visits. Retailers constantly tend to juggle between opposing requirements of stock-out and excess stock. Along with the contradictory situation with inventories, companies also face hidden costs like labor, transportation, storage rent and risks of products expiring/ diminishing in quality over time.

As most business activities revolve around inventory, it is imperative to have an effective inventory management system. A good program should form a process chain between customers, sales, production and suppliers. Poor inventory management could lead to increased storage costs, stock-outs, loss of consumer confidence and enterprise image.

Causes of inventory mismanagement
• Faulty inventory planning,
• Improper accounting for purchases and sales,
• Inadequate tracking for losses like theft, spoilage etc.

Periodic count v/s. full year count
No disruption in business

In a periodic count cycle i.e. year-end count, the business operations of a company are required to be shut down till the process of counting is over. This results in a loss in sales for those days. In a cycle counting, the counting process is continuous and therefore does not disrupt the business hours of a company. The company does not require hiring extra help for stock counting at the year-end which further saves overhead costs.

Reduction of theft and increase in accuracy
In a year end count, losses due to theft, breakings, spoiling of goods etc. are detected toward the end of the year, making it too late to take corrective actions. This can be avoided in a cycle count as inventory is counted regularly, thus any discrepancy is timely detected. Consequently, it helps increase the accuracy of accounting and reduces over stocking/under stocking.

Efficient inventory management
Cycle counting enables managers to understand exactly how much inventory is left and the amount that is required to be replenished. It also helps to understand the pace of the movement of goods, which enables better inventory planning. This reduces the number of cancelled orders/lost businesses due to product unavailability as well as the need for over-stocking and storage expenses.

Improved process efficiency
In a cycle counting process, workers examine inventory or a regular basis. This helps them keep track while reducing unnecessary time consumed to search for items.
Accurate costing and reporting
Accurate reporting enables companies to precisely report inventory. This in turn helps companies to make strategic decisions to minimize waste and under/overstocking, thus saving cost.

Indicators of a successful cycle counting program Goals to be achieved
Most businesses aim to optimize business processes and improve overall customer experience. However, the plan should aim for finer points like anticipation of demand, improving stock levels, reduction of losses due to theft/ spoilage, proper/sufficient insurance etc. The objective needs to be properly defined and quantified for effective implementation of a cycle counting program.

What is to be counted?
Items to be counted will depend on company’s objectives to be achieved. Determining what is to be counted e.g. physical inventory (retailers/ wholesalers), raw materials and finished goods (manufacturing units), vehicles, items in different geographical locations with third parties, loaned items etc. should be decided beforehand as the process will depend on the items to be counted.

Many companies use the ABC classification for the purpose of deciding what inventory should be counted. In this practice, the products are classified into three categories.

• Category A – Contains the most expensive and biggest selling items in the company’s repertoire. These items for a typical company constitute only 10% of the inventory.
• Category B – These are the next most important and costly items in a company. They constitute about 20% of total inventory
• Category C – These are the least expensive, most of the items, about 70%, fall into this category

While classifications like these help formulate an effective program, it is not a rigid rule and should be modified to suit a company’s needs and objectives. Determination of audience is also necessary, as accountants require stock keeping in value terms, it may benefit the business unit to assess in terms of volume. However, accuracy is most important.

Inventory record accuracy is a measure to determine the discrepancy or parity between official inventory records and the actual units in hand.

Time and count frequency
After determining the most important items for an organization, count frequency should be decided. Companies tend to count items in Category A more frequently than others as their monetary value is also highest. After frequency of counts, it is important to ascertain the right time for counting stock. For a retail store, counting should be done after store hours. For other types of organizations, counting should be done in the beginning or at the end of the shift/process as to avoid any variance in the number of units. All counting exercises should begin with closing out inventory transactions.

A cycle counting program should employ formal methodology. Employees should be made responsible and given full ownership of the program. They should be adequately trained. The counts made should be documented in standardized formats, which can then be used to analyze further and make decisions.

Many companies use automation as an effective tool for inventory management. Barcoding has been used by many large organizations in the past, however smaller ones still lack them. Software for inventory control systems which are a part of warehouse management systems can help an organization keep track of inventory more efficiently. These systems employ tools like mobile computers, barcode scanners etc. that identify various items and enable operators to enter data via keypads. This data is then transmitted to systems that generate reports.

Inventory is a firm’s asset, it is imperative to have good internal control practices to manage it. Preference for cycle counting is increasing. A survey performed by Brooks and Wilson, indicated that 50% of companies use both periodic and cycle counting, whereas 36% use only cycle counting. While improved inventory was reported by all of them, a whopping 60% of companies reached inventory accuracies of 90-97%. Inventory management is the most important part of the business, leading to better customer service, cost savings and greater profitability

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