Why We Struggle with Inventory and Forecasts

Inventory Can Be Very Valuable

Inventory is a valuable tool to help any organization deal with three primary problems:

• The customer is unwilling to wait.
• The economics and physical constraints of production and distribution. This includes manufacturing batch requirements, price incentives, hedging, and preparing for seasonal demand.
• The uncertainty of customer demand and supply. 

These problems increase as supply chains produce more sophisticated and complex products, involve many supply partners, and stretch across continents. 

Its Cost Is High

Any use of inventory must be carefully considered or its value is quickly lost and can have detrimental affects on a company and its supply chain partners. There are three major areas of impact. 

The first is on working capital or the ability to use current assets to cover current liabilities. This is defined as:

Working Capital = Cash + Inventory + Receivables – Payables 

Increases in inventory lock up cash making less available to pay expenses. Lock up too much, and questions arise regarding solvency or the need to take on more debt. A decrease in inventory frees up cash, and it also speeds up the cash cycle or return on investment.

The second impact affects expenses. The two major spending sources are the order costs such as clerical, sourcing, transportation, expedites, and receiving; and holding costs such as storage, security, insurance, and obsolescence.

Lastly, inventory contains hidden costs that can mask a company’s inefficiencies and make it harder to respond to market changes and competition.

These last two, expenses and hidden costs, can represent a sizable impact to net profit. Hold more inventory than is needed and cost-of-goods sold and overhead expenses are increased.  Flexibility in the market place is lost. Hold the right amount of inventory and the cost-of-goods and overhead decrease. Net profit and flexibility change accordingly.