Controllers: Do you have the know the exact value of the inventory you are carrying?
Do you know how your company is allocating purchasing inventory across the different locations?
If you answered No to any of the above questions, you are not alone.
It is obvious that companies have a good handle on the resale inventory.
Most of the small business accounting software like QuickBooks handles that very well.
However, they don’t have a good handle on inventory they are purchasing to manage their business.
For example, if you are a services company (let’s say HVAC) then you need to have parts etc. to support the operations pf the company.
To control cost, you land up purchasing less inventory or not having any inventory at all.
Or you have different systems for purchasing the inventory and issuing the purchase orders to the vendors.
That leads to inaccurate inventory counts, stocks out, or excess inventory.
If you carry additional inventory, it is not only additional capital invested but you also have an additional expense of inventory carrying cost.
So by carrying less inventory you could save capital and expenses but that might be at the expense of revenue.
There is a better way of managing inventory by having an integrated purchase order and inventory process.
That is what we are addressing in this article.
We will cover
- How to use an integrated purchase order and inventory process to get better inventory visibility.
- Setting up an inventory ordering process so that end-users know exactly what is available in inventory.
- How to use cross-location visibility to increase inventory turnovers.
Let’s get started
Typical challenges with Inventory management
Why managing inventory is such a challenge for many companies?
The first common challenge for managing inventory is companies have siloed systems. That could be because of a lack of automation or how the business has evolved over time.
Taking the example of an HVAC company, let’s see how siloed systems cause an issue for many companies.
Please note that this is generally an issue if you are carrying any inventory.
If you order on-demand to fulfill service orders then of course you don’t have inventory issues, but you are probably leaving money on the table because you are unable to service clients on time.
Work order management
You probably have a work order management system that you use to allocate work to your workforce.
That system house the data for all the customer jobs, what materials are being used to the service order, and so on.
Technicians are probably ordering parts as needed or calling someone at the warehouse to pick up the parts they need to service customers.
If they are picking more parts so that they can reduce trips to the warehouse, then you want to know how much inventory is in technicians’ trucks at any point in time.
But since the systems are not integrated, that data is being manually keyed in or not synced at all.
The other challenge is that if the purchasing system is not tied to your inventory system then you have to manually update the inventory usage information in the inventory system.
It generally leads to the following issues
- The ordering system doesn’t have the latest on hand inventory information
- That leads to users ending up purchasing more inventory even when you have on-hand inventory.
- If the order can’t be delivered on time, that leads to more stockouts.
So to take the HVAC company example, you are unable to service customers on time because your technicians don’t have real-time visibility into the available inventory.
Too much or too less inventory
When you have limited visibility into inventory due to a siloed system, your inventory is not optimized.
With the limited information, you land up in one of the following buckets
Too much inventory
If you are currently managing limited inventory and you have stock out scenarios or unable to fulfill customer orders, the natural tendency would be to carry more inventory.
Who wants to leave money on the table because you didn’t have the right parts to service the customer.
Let’s continue with our HVAC company example. In our experience, the following are likely to happen
- Your technicians start carrying more stock in their trucks becuase they want to avoid stockouts.
- You build a monthly consumption model based on how much stock is issued to technicians.
- You start seeing fewer stock-outs and everyone is happy.
- One day you wake up to a large number of inventory sitting on the books.
Since everyone is carrying a buffer to avoid stockouts, you land with more inventory then you actually need.
Too less inventory
The other scenario is the opposite of what we described above.
This generally happens when you have no inventory management program or you have just implemented a Just in Time (JIT) inventory model.
The problem you are carrying less inventory is for the following reasons
- Your purchasing system is not linked to the Inventory system, so you have a lag in the information being updated back to the inventory system.
- By the time you update the inventory models, the consumption has changed again.
- If the lead times are not accurately added in the purchasing system, then could lead to delays.
Is QuickBooks good for inventory management?
One of the common questions we get asked if QuickBooks is a good system for inventory management.
If you are looking to just stock items for re-sale, then it makes sense to keep using QuickBooks.
However, if you are looking to purchase items for consumption, for example, supplies then QuickBooks might not be the best option for the following reasons
- The inventory and purchasing system still remains different. Most of the companies don’t land up using QB for creating a purchase order. That is primarily to do with the control issue rather than the capability of the system.
- Since the purchasing and inventory are not in sync in realtime, it leads to the same issues of data mismatch as we discussed in the above sections.
You can still maintain inventory in QuickBooks if we have another system updating the inventory information in realtime so that you know the inventory value as well as the on-hand quantity at any time.
Implementing an integrated inventory and purchasing process
So far we covered issues companies are facing when it comes to inventory management. In this section, we will talk about an approach to resolve those issues.
Specifically, we will cover how an integrated purchase order and inventory management system helps you get a better handle on the inventory, reduce stockouts, increase revenue while maintaining an optimum level of inventory.
What is the best way to track inventory?
So let’s first define how an optimum approach for inventory tracking should work for your organization.
In an ideal scenario
1. You should have the inventory management process integrated with demand planning.
For example, what are our demand patterns?
Notice, we didn’t say consumption patterns. If you are just tracking what is being consumed, you might be missing the need that is driving that consumption.
To continue with the HVAC example, let’s say technicians use a widget for servicing HVAC equipment for the customers.
If you look at the service requests from your customers for the last 12 months, you should be able to easily identify the demand requirements along with the seasonality of the demand.
For example, the demand should be higher in the summer months as compared with winter months.
With this approach, you would know the exact demand requirements vs. consumption.
That data should also give you an idea about the demand patters. For example, you can calculate the average number of widgets per customer request.
2. Automation to drive real-time data synchronization
Once you have your demand patterns established, that should help to define the optimum on-hand quantity.
Once you have established inventory levels, do the following
a) Work with your vendors to establish lead times.
It is key that the vendors have established reliable lead times so that you know when you need to re-order the products to keep inventory at a healthy level.
With the lead times established, you should update lead times in your purchasing system so that purchase orders reflect correct lead times.
b) Automate systems for better visibility
The next step is to automate wherever possible so that the data is updated as items are ordered or consumed.
- Update Inventory records when a widget is released for consumption.
- Increase the on-hand quantity when the item is received.
- Having visibility into on-hand orders.
Integrated purchase order and Inventory experience
We will use ProcureDesk as an example to walk you through how an integrated purchasing and inventory process that can help you track and maintain optimum inventory levels.
You could achieve this using any integrated purchasing and inventory management system.
Catalogs for accurate data
Catalogs help you reduce the data entry for repetitive orders. For example, if you are purchasing the same widget from the same supplier again and again, just put that in a catalog.
Catalogs are important for the following reasons
- It provides accurate information on what is being purchased, and at what price point. This avoids any delayed shipments because of missing information. For example, the wrong part number, etc.
You can add additional data to make purchasing accurate, for example, pictures of the parts being purchased.
- You can keep track of accurate lead times so that you know when the part would be delivered.
For example, it doesn’t help anyone if you ask for next day shipment on an order when the vendor lead time is 2 weeks.
You can keep track of min and max levels on a catalog, so that way you know when an item needs to be ordered.
- An item can be tagged to an inventory location so that you know inventory by location.
Following is an example of a kind of information you can maintain in a catalog
Central visibility into Inventory
By central visibility into inventory, we mean knowing how much inventory you have at any given time.
Some things to consider while understanding current inventory levels
- Do you know the total inventory value? Yes, it is more for finance but this number will help you understand the capital invested in inventory.
You can compare this number with your peers and assess if you are carrying less inventory or more inventory.
- You should know how much inventory exists at different locations so that in case of stock-outs you could potentially use inventory from other locations.
- It is important to understand the inventory on hand but also what is already on order. To avoid excessive inventory, carefully review what is being requested, what is on hand, and what is being shipped or already on its way.
A central inventory dashboard should look like this.
Requesting Inventory/ Inventory Orders
This is the most important piece of the integrated purchasing and inventory experience because this helps you to present the current inventory levels to the end-user.
When a user is entering an order, they should be able to see whether the item is in stock or not.
Additionally, if the item is in stockout, do you want a user to directly place the order with the vendor or just wait for the inventory to be replenished.
For example, if you have an inventory planner who is responsible for placing inventory orders then it is better if you don’t allow your end-users to place orders directly with the vendor.
So the system should be able to handle scenarios where the user can place the order even when the item is in stockout position.
An additional consideration is whether you need approval for inventory orders. This is important for two reasons.
- You can use the approval process to accurately allocate the cost of Inventory to the consuming department.
- If you suspect misuse or excessive use of the inventory for certain individuals, then a review process ensures a compliance check before the inventory being requested can be issued to the end-user.
Updating Inventory records
You need a mechanism for updating the inventory records as and when inventory is consumed or new inventory is being purchased.
The most important benefit of an integrated purchase order and inventory system is that you always have an accurate record of how much inventory you are carrying at any time.
Here are some touchpoints where the inventory record needs to be updated.
- When the inventory is requested by the user so that you know what is being requested. You can probably use a different classification for this, for example – reserved inventory.
- When the item is finally issued to the user, so in that case it moves from reserved to issued inventory, and the on-hand inventory quantity is adjusted accordingly.
- When the items are ordered, the status of items should move to on order and when the inventory items are received, the status should change to on-hand quantity.
Benefits of improved Inventory management
If you have an integrated purchasing and inventory tool then you should expect the following results
Improved productivity through less stock-outs
What is the cost of the stock-outs for you?
Is that lost revenue or is that delayed service for your customers.
Continuing with our HVAC company example – if technicians don’t have the right parts available at the time then that could lead to the following issues
Customer cancels the order
If the customer can’t wait for the product to be available then that is a revenue loss for the company. This is most likely the case with emergency services.
It takes a long time to serve the customer
If the customer decides to wait for the part, this might impact your SLA’s over a long time. Let’s assume your client is a corporation with a long term maintenance contract.
Most of the corporate agreements have service level agreements and if you miss the SLA’s you probably have to issue service credits for missing the SLA’s.
Not only it costs you money, but it also leads to lower customer satisfaction.
The technician waste times on finding the part from a local store
What is the cost per hour for your technician?
Let’s say the cost is $100/hour.
Now assume that the technician has to go to a local store to find the part to complete the job.
Let’s say the total time adds an hour to the job.
You not only lost $100 but think about the opportunity cost because you could have used the same time for another job.
Reduced inventory carrying cost
So with all the reasons we mentioned above, companies decide to maintain inventory.
Inventory is an investment and there is a cost for carrying the inventory on the books, So it is critical that your inventory levels are optimum.
The steps we have mentioned in this article should help you carry optimum inventory levels and that should reduce your inventory carrying cost.
How much is inventory carrying cost?
Industry estimates 20-25% as the inventory carrying cost.
So if you are carrying $100,000 of inventory on your books, then the cost for carrying the inventory could be anywhere between $20,000 to $25,000
How is inventory carrying cost calculated?
- It includes the cost of the capital required to purchase the inventory. For example, if your WAC is 10%, then that is the cost of carrying the inventory.
- Other costs like insurance, taxes.
- Warehouse cost or storage costs
- Cost of obsolescence or damage
You can calculate your inventory cost by asking your finance team for these metrics.
Reduced inventory usage through a multi-location warehouse
The biggest benefit of having better visibility in the inventory process is that you can increase the cross-utilization of the inventory across multiple locations.
Let’s say you need a part that is not available at your location but if you can easily check what other locations keep an inventory then that is very helpful.
For example – depending upon the lead times, sometimes it might be just easier and cheaper to have the product shipped from another location.
If the inventory system provides cross plant/location visibility then it is very easy to deal with these situations.
This increases inventory turnarounds and of course, you need to invest less in the inventory.