Publication Detail
The Crucial Nature of Inventory Balance

Tenaka Budiman, Executive Board of ALI and Supply Cain Director

At the end of every calendar year, most companies take stock every single month or more based on the need of the individual company. If the problem of no stock often happen to a company, then more stock-taking is necessary.

As an analogy, if we go to the mall, security may check the car to make sure it contains nothing dangerous. But if the mall starts finding bombs in cars, the inspection naturally become more intensive. However, if conditions are secure for a long time, car inspection may become less intense. In regards to stick taking, for many companies this pattern may be happening mostly undetected.

Besides taking stock at the end of year, most companies also try to maintain just enough stock the reach their sales targets for the Christmas and end of year season without being left with too much extra stock which must be warehoused at high cost. In theory, there should be not surplus and no deficit stock because if there is a surplus of stock which is not salable by the beginning of the next year, it may create cash flow problems for the company. Careful attention should be paid to sales histories and new items which may be launched as promotions at the end of the year.

On the other hand, if there is a deficit of stock, loss of sales opportunities will occur. So how should a company achieve the right balance of stock? The fact is that most companies will increase their salable stock, which is defined as stock which is fast moving, ready for sale and provides increased cash flow. The exact speed and ability of fulfillment form suppliers and lead times for deliveries should be monitored closely. Based on those aspects, among others, we can determine how much safety stock will be needed to obtain the sales target. It is also necessary to adjust the calculation of safety stock by considering factors like lead time variability and demand variability. The kind of forecasting is needed to determine the exact purchase order which will be sent the suppliers. As for the products themselves, the appropriate brands, types, models and prices must be well considered before the order is made.

Having strong synergy between the divisions of marketing, sales, supply and demand, logistics and finance is important because together they must operate as an internal cross functioning team to determine what kinds and in what volumes stock is needed. Retail stores with product assortments made ups of the thousands of stock keeping units (SKU) require stock taking precision based on factors like product availability and sales opportunities. Retail store managers should also consider creating a flexible action plan focused on minimizing unsold stock managers should also consider creating a flexible action plan focused on minimizing unsold stock so that it will not pile up in the beginning of the following year and disrupt cash flow. Such an action plan must considered factors such as promotions, B2B, sales to institutions and the effectiveness of clearance sales which may or may or reduce profit margins. To hold a successful clearance sale, it must be centralized in one area and not spread across multiple stores or warehouses with the aim of allowing every consumer to see the largest variety of goods possible.

Appropriate steps should be taken to avoid taking stock at the same time as when new stock is being received as this can potentially raise discrepancies resulting in inaccuracies. However, this can be minimized if the arrangement of the products in the stock-take are arranged neatly following the 5S's principle (Seri, Seiton, Seiso, Seikutse, Shitsuke) otherwise known as 5S (Short, Straighten, Shine, Standardize, Sustain). Either way, it will be more difficult for those who will do the stock taking if new stock is present.

Management may often find itself in a difficult situation. Here is an example of the company selling retail consumer goods and the problems it might face:

1.    For example, this company's sales target for November and Desember is about @ Rp. 175 million/month.

2.    The approximate sales from January to October was about Rp. 120 million.

3.    The company's stock target with DOI (days of inventory/inventory days of supply) is 30 days at Rp. 120 million. The calculation of DOI is stock divided by the approximate amount of sales per day in one month of sales.

4.    Let's say the condition of stock by mid-November was Rp. 170 million, with the status of products ordered at Rp. 150 million and products received until mid-November reaching Rp. 85 million with completed sales at Rp. 90 million.

5.    It is expected the stocks in both November and December will remain within DOI.

6.    Operating expenses per month run about Rp. 20 million.

Now, let's question the above situation:

1.    How much DOI was there in mid-November with stock of Rp. 170 million?

2.    How much DOI was there at the end of November when sales reached Rp. 150 million and final stock reached Rp. 220 million?

3.    What amount of cash flow was available in late November / early December? Is the answer satisfactory of problematic? If sales only reached Rp. 150 million, what amount of cash flow should be available if the sales target was reached?

4.    What should be done is mid-November if it is already evident that there would be a cash flow problem at the end of the month?

5.    How much purchasing should be made in order so that DOI can be maintained over 30 days? For example, if it is equivalent to Rp. 150 million, if the stock at the beginning of November is reached Rp. 200 million?

To answer the questions above, use the formula DOI = stock/approximate sales. Let us try to answer those questions above:

a.    DOI is mid November

Rp. 170 million/(Rp. 85 million/15 days) = 30 days

b.    If sales only reach Rp. 150 million, with the last stock reaching Rp. 220 million, DOI will be achieved in 44 days (Rp. 220 million/(Rp. 150 million/30 days).

c.    If sales achievement reaches only 86% (including Rp. 150 million from the target Rp. 175 million) and purchasing reaches Rp. 150 million with operating expenses of Rp. 20 million, it can be assumed that there will be a cash flow problem. If the sales target is Rp. 175 million with purchasing of Rp. 150 million, it means that there still is a deviation of about Rp. 25 million, which can be used to cover operating expenses of the Rp. 20 million.

d.    If DOI (assumed Rp. 150 million = 30 days of DOI) is likely to be reached at the end of month and the status when first stock was about Rp. 200 million with a sales target of Rp. 175 million, it means that last stock = Rp. 150 million (PO = first stock + sales target Rp. 175 million) the calculation to be : last stock = first stock + PO - sales target (150 = 200 + PO - 175) (PO to be Rp. 125 million. Therefore PO which should be released is about Rp. 125 million).

From the sample case above, the expectation of the last DOI should be calculated with the condition of cash flow and the level of optimism in achieving the sales target in mind. As explained above, the company does not want an excess of stock which can effect cash flow. In practice, it is not quite as easy as it sounds. It requires close collaboration between suplly chain management, the supply and demand planning divisions can function as a term and can work together to keep achieving sales targets, keep stocks valuable and maintain cash flow. Absolutely every department's management, in its capacity, should strive minimize inventory costs.

Meanwhile, in supply and demand planning keeping the inventory level stable at times may require buffer stock which potentially can effect lead times, lead time variability, approximate demand/approximate PO/supply, and PO/supply variability.

The Z value is constant based on the total expected service level, usually at 95%, so Z's value is about .65

•         Inventory management is about two things: not running out, and not having too much.

•         Inventory is a reserve system to prevent no stock situations

•         Don't hold onto too much inventory because of holding costs

•         So how do you balance the two and what is the right amount?

•         More importantly, when should you re-order in order to prevent a no stock situation?

Safety stock, of buffer stock, or desired buffer stock, should be utilizes at the reorder point. Reorder point = safety stock + the usage during lead times.

The measurements made by inventory management for this article included one common and one simple to be used to more easily explain how DOI (Days of Inventory = Inventory days of supply) fits in with the calculations.

Hopefully, every supply chain users will now realize that it is very important to closely control inventory as one of its core focuses. Also those who is working in supply chain management that supply chain is not only managing the flow of goods, and flow of information, but also flow of cash, and flow of product return. As every business is related to money and cash flow, this saying surely applies here:

"All mistakes in forecasting end up as an inventory problem."


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