Inventory Health Self-Assessment

12 questions for evaluating how well your business manages inventory.

Are you carrying “healthy” inventory?

Chief Financial Officers (CFOs) and other senior executives tend to be hyper sensitive to the influence inventory has on the businesses bottom line. It’s not a mystery that identifying the right inventory levels is vital to their organization since it not only controls costs, but also serves as a key indicator of their company's overall health. Nevertheless, even the most attentive managers often find it difficult to truly maximize inventory return on investment.

At EazyStock, we work with CFOs and other senior executives that typically rely on external benchmarks that seldom deliver expected insights. Data is often inaccurate, which results in inventory management objectives missing their intended targets.

In our work with clients, we come across many misconceptions. The two most common are:

1.  Improving the accuracy of sales forecasts is the best way to reduce inventory.

2.  Improving customer service requires keeping more inventory on hand.

The fact is, both assumptions can lead to excess inventory or shortages which can be costly to the business.

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Inventory  Health  Self-­‐Assessment  

Take the pulse of your inventory health

Take a moment to read, review and answer the questions outlined in this assessment. These questions are designed to assess the effectiveness of your inventory management processes.

The questions are intended to reveal the sophistication and extent of your company’s inventory reduction and service level improvement efforts. The answers or lack of answers could be a major eye-opener. Let’s get started!

Are you able to break down your operating inventory into the three major categories when reporting levels— cycle, excess and obsolete stock?

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By understanding the current status of your inventory on hand you can start assessing the root cause of why excess stock, also known as “over stock”, has built up in your warehouses. This analysis will help you take steps towards dealing with obsolete stock levels, as well. Ideally, your business is only carrying cycle stock or “healthy” inventory items to meet customer demand.

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Let’s begin with clarifying the difference between service level and fill rate. Service level is the probability of not having stock outs and fill rate is the fraction of order fulfilled. Both of these KPIs can be calculated in many different ways.

It is important to have company-wide agreement when it comes to balancing target service levels compared to inflating carrying costs. To avoid making decisions within departmental silos, executives with insights to the whole supply chain need to have a major say in the fundamental issues that impact inventory management.

Do you have the RIGHT persons and system support to make these decisions?

Who decides key inventory-related policies such as determining the right balance between customer service and cost-effective product inventory levels?

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Make sure you understand what it is you are measuring.

First, make sure you understand exactly what it is you are measuring. Once you know that, you are in a better position to set your goal.

Remember that your overall company goals should be considered when setting your Supply Chain targets. You want to make sure that your Supply Chain goals do not conflict with your company objective or that department goals are misaligned.

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What is the current service level or fill rate achieved by each warehouse? Do you know how that KPI is calculated? 2

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Demand forecasting should work as an active part of your ERP system in order to forecast purchase and stock requirements to predict customer buying habits. Most ERP’s are good at placing Min/Max order quantities but items being reordered are seldom optimized to keep costs contained. Demand forecasts need to be fine tuned to ensure inventory levels are optimized while meeting customer demands and keeping costs under control.

If demand forecasts are calculated manually, planners need to ensure that it’s done on a regular basis for each Stock Keeping Unit (SKU) and that the ERP system is kept up to date for the replenishment calculations. This can be a very labor intensive job without automation.

How often do you update your demand forecast in your Enterprise Resource Planning (ERP) system? 4

Your systems should have advanced demand forecasting functionality to keep items optimized.  

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•  Are you able to follow demand trends or the product lifecycle’s of items?•  Are there seasonal factors you need to consider and how is that managed?•  Do you apply the best possible forecast technique for different demand patterns or do

you use simple moving average as a forecasting tool?•  Do you calculate your forecast accuracy?

How accurate are your demand forecasts? 5

To determine the most suitable forecasting technique the demand patterns needs to be identified first. Different forecasting techniques should be applied at different phases of the product life-cycle to best exploit the available historical data and degree of market knowledge. Demand types will vary as a product moves from new entry to fast mover to declining or end of life stages. Forecast error is an important factor that affects the overall performance of your business. Calculating your forecast accuracy at the SKU level will help planners to continue enhancing forecasting process and accuracy.

Example Target Forecast Accuracies

Laggards    Accuracy  <65%

Followers  Accuracy  65%  -­‐  80%

Leaders  Accuracy  >80%

Performance •  Service level•  Stock Levels (in weeks)

92%7.4

94%5.6

95%4.1

Understanding and following the lifecycles of your products will help you to better forecast your demand, ensuring you don’t miss sales opportunities, as well as, you will have healthier stock levels over time and not end up with excess or obsolete stock in your warehouses.

Carefully review all products for seasonal activity. You do not want to lose sales due to shortages during the season or end up with expensive surpluses after the season ends.

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•  Are you using statistical formulas that incorporate forecast errors, uncertainties in lead times, and service level data for each SKU?

•  Or are you using a rule of thumb?

The ideal way to set your safety stock levels is to calculate them statistically based on what you have learned from previous forecasts. Inventory optimization software that manages the calculation for you is even better. Safety stock should be driven off of your forecast error, target service level and take supply variabilities into account.

If your business is using rule of thumb metrics for safety stock, you are likely carrying too much inventory and underperforming on your customer service targets.

How does your company calculate your safety stock levels? 6

In the ideal world, safety stock level calculations are made on a monthly basis for every SKU. If it is done manually in a spreadsheet a good target is to review and update your calculations every 3-6 months.

Typically, the more time between updates the more risk there is of your excess stock levels piling up.

Do you recalculate safety stock levels on a regular basis to ensure they are up to date? 7

How much to order can be based on two criteria: •  The ordered quantity can be a pre-determined Fixed Order Quantity (FOQ).•  Or a variable quantity, which supplements the inventory in each case up to a certain

order level.

How do you calculate order quantities? 8

If you reorder a product at the right time, you will protect customer service levels. The amount you order, however, will determine your company’s profitability over time.

Companies with efficient inventory management have processes and systems that continually or perpetually calculates the optimal order quantity based on sound mathematical models. The order quantity for each SKU is automatically updated and tracked in the ERP system for ongoing optimization.

Companies with efficient inventory management processes calculate their optimal order quantities based on sound mathematical models.  

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An order is made either if inventory has fallen below a defined level (reorder point system) or if a predetermined period, Fixed Order Cycle (FOC) system, has expired.

How do you determine the optimal frequency for ordering inventory? 9

Once you have reached your target service level or fill rate you will have to put new processes in place to continuously reduce your inventory levels while while still maintaining your service level goals.

It is much less expensive to calculate the correct reorder quantity on the front end than to try and purge overstock later in the process.

Is your optimal reorder frequency and order quantities reviewed and recalculated on a regular basis as part of a continuous improvement process?

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Do you have the systems in place that provide useful data?

When it comes to procurement practices, companies should consider calculations that minimize the overall cost such as inventory and changeover costs.

Do you have the systems in place that provide useful data or calculate the reordering points? ”

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Typically, excess and obsolete stock stems from ineffective demand forecasting, rule of thumb methods for deciding safety stock levels and out dated replenishment parameters in the company’s ERP system. Inventory planners and managers should establish processes to determine why excesses are being created and then develop a plan of action to sell it off.

Do you have regular visibility into excess and obsolete stock, and is it linked to targeted action plans to sell off or reduce this inventory?

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The most common mistake made by businesses today is that they only are looking at a small fraction of all inventory being carried. Specifically, multi-echelon supply chains that have large warehouse networks. As a result, they miss potential savings across the entire supply chain, that build up over time.

Do you apply the above practices to all parts of your inventory management, including finished goods, raw material, works in process and spare parts?

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In some instances, the fear of the write-off has led to a large buildup over time of obsolete inventory.

Senior executives and CFOs need to be actively involved in this planning process to ensure this type of situation is avoided.

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Don’t just manage inventory, optimize it. It’s important to realize when your organization is in need of an inventory optimization solution. Make no mistake about it, sophisticated inventory management isn’t an option anymore; it’s a necessity. If you are not able to serve your customers effectively your organization will not be able to stay competitive or keep up with growing demand.

This eBook is an exercise in how to recognize and identify gaps in your inventory management processes. After answering all 12 questions, right or wrong, the diagnosis of your inventory health sets your company up for significant opportunities to improve expense and asset effectiveness.

If you struggle with any of the assessment questions listed in this eBook, you are likely in need of inventory optimization software to support your current inventory management processes and ERP system. EazyStock can help.

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Are your inventory management processes in a good shape?

Learn how your organization can improve inventory health and

become more profitable.

Sign up for a free inventory health check up

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