First Thoughts
  By Dan Gilmore - Editor-in-Chief  
  July 30, 2009  
  Readers Respond: Measuring Inventory Performance  

Again this year I am biking across the state of Ohio, and am using that opportunity to let SCDigest readers carry the burden for this week’s column.


A number of weeks ago, I did a column on “Measuring Inventory Performance.”


It was really just meant to be a preliminary column to a subsequent one that would outline my thoughts in more detail. Nevertheless, we received a significant amount of reader feedback; we’ve had columns in the past that generated more, but I don’t think ever of this total quality. This week, I am sharing some of the highlights – am quite confident you will enjoy them.


David Gustin of Global Business Intelligence said that “This is a very complex journey you have embarked on Dan.” Why? In part because “CFOs and Treasurers of corporations are increasingly becoming responsible for “Supply Chain Finance” solutions, yet there is a general confusion as to how SCF works and the role of different players.”

Joseph Barnes Says:

Inventory is like any other “asset” which has to generate a return. I like to look at inventory as a portfolio of assets, each generating a return to shareholders.

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He also observes that “functional conflicts exist within companies due to different success factors for Procurement (obtain best price), Finance & Credit (increase DPO, reduce DSO, focus on buyer risk and maintain liquidity), and Sales (sell more and extend terms if need be). These are not easily resolved.” I guess we could say Sales, Inventory and Operations Planning (SIOP) is a tool to manage these trade-offs, but most are still very early in that venture.


Fred Schafer of Trane opined that “the best measure for inventory management/planning is Days Forward Inventory (DFW), or inventory/(forward sales forecast/days in forward forecast period). The forward forecast period may be set to reflect what is most meaningful for the respective business/need."


Why a forward forecast as the denominator? Because, Schafer said, “inventory is in place to satisfy forward demand.”


He adds “Another set metric is the “quality” of inventory. This is more about the make up of the inventory and readiness to serve.  There are three: (1  available to commit inventory;  (2) categories of inventory [which he explains as basically a categorization of inventory by status]; and (3) SKU level/ mix performance [how close SKU inventory levels are to targets].”


Joseph Barnes of Orco Construction Supply says that “Inventory is like any other “asset” which has to generate a return. I like to look at inventory as a portfolio of assets, each generating a return to shareholders. That return is based on a number of different factors, including how often it sells, the gross margin it returns, the cost for holding it, buying it and moving it along with some expectations on shelf-life. By looking at inventory this way, it basically equalizes across industries what the true value of inventory is for the investor."


David Armstrong of Inventory Curve agreed with my point that there are often definitional problems with how we calculate some inventory measures – even something as simple as “turns.”


“The complications mentioned in the article include calculation of average inventory along with use of cost of goods sold versus sales revenue to calculate turnover,” Armstrong says. “The reality is that there is not a single, defined standard method for either of these, so one must be careful in reviewing data to try to understand exactly what is being calculated and how.”


Daniel Araujo from Brazil’s DAC & C also notes some challenges in the area of measuring “turns.”


“I prefer to calculate either Turns or DIO (Days Inventory Outstanding) at an aggregate level using the value of inventories and the cost of goods to be sold. Using revenues (with profits and sales, administration, distribution and advertising expenses) distorts the performance of the inventories,” he wrote. He added that “At the item level, where good or bad management of inventories really needs to happen, units instead of $ is the most appropriate. If you calculate aggregate turns, including profits and expenses and item level turns in units, you will never be able to reconcile management policies and planners' actions.”


Bob Belshaw of GE Capital says getting to inventory measures that are most meaningful to CEO/CFOs is critical.


“The impact of decisions made around inventory policies, including strategies like JIT, VIM, timing of title change and the newly packaged financial products that target supply chain finance require significant thought and discussions,” he wrote. “I have come to believe the power of using the CFO metrics is that the organization begins to find a language to communicate in that is understood in the C-levels and on Wall Street,” adding that often, in his view, the impact of inventory on key corporate financial metrics “has gotten to senior leaders in our supply chain and procurement organizations.”


I also really like what Dwayne Wildhagen of Springs Window Fashions had to say about looking at inventory and demand.


I believe the best measure of inventory performance is to compare average inventory over a period of time (typically monthly) to the inventory consumption over the same period of time,” he wrote. “This is the only "true" measure in my mind because it removes all the other variables contained in COGS, so it is a true reflection of how well your inventory is "turning" or being managed.” Like Schafer, he prefers a more forward looking view, “because we are not bringing in inventory to support last month's sales, rather next month's sales.”


Jennifer Vaughn of private equity company American Capital says inventory management effectiveness is key to the success of the company’s they invest in and that the tool they prefer is the Inventory Quality Ratio (IQR). We’ll cover this in more detail in a future column, but, in summary, IQR looks at inventory levels versus targets for different SKU velocity categories (e.g., ABCD), and at levels of slow and obsolete inventories, all of which results in a “score,” with 100 being a perfect score.

“IQR is a better metric of inventory performance than either turns or DIO because it is based on future demand, provides a performance measure for each segment of the inventory, and shows you where you can actually take action to reduce excess inventories, free-up working capital, etc.,” Vaughn says. She adds, “It has opened our eyes to better ways of managing one of our largest balance sheet items – Inventory.”

Brian Coats of Carrier agrees. “Inventory metrics which fail to address the usability of on-hand inventory are insufficient in measuring the true value of what is in stock. Inventory Turns and DIO both are inadequate in that they do not take into account the usefulness of the inventory on hand,” he wrote. “With IQR, Carrier has been able to quickly monitor performance at individual factories and identify opportunities for improving Inventory Performance.”

I could add lots more, but am out of space. As always, I am simply impressed with the collective knowledge and wisdom of SCDigest readers. Thank you.

What is your reaction to the feedback from SCDigest readers on Measuring Inventory Performance? What would you like to add? Let us know your thoughts at the Feedback button below.

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