Posts tagged "inventory"


Champions know that success is inevitable; that there is no such thing as failure, only feedback. They know that the best way to forecast the future is to create it.Michael J. Gelb

Forecasting and inventory management are intricately related. Any mistakes made by forecasting incorrectly will impact directly on the level of inventory at the end of a financial period. It is therefore critical that management spend time and effort in forecasting market demand as accurately as possible to avoid difficult situations in the future. Forecasting is a very tricky exercise, especially for entrepreneurs who are introducing new products or services into the market. Many a time this uncertainty is used as an excuse to overlook market data. I have been guilty of doing this a couple of times, and if you are running a product based business, the consequences can be quite severe. Listed below are a couple of pointers to help with the revenue forecasting exercise.

1. Market Data: Identify your target segment and the budgets for the problem your business is planning to solve. How is your competition addressing the problem at hand currently? Is there a high switching cost in the industry? At what rate is the target industry growing? How have embedded competitors innovated to get ahead of the competition? Can you find your competitors revenue statistics? What are the industry operating margins?

2. Sales Channels: How will your product/service be marketed and sold to customers? How many sales representatives are going to be allocated? What are individual targets set for each representative? How will each representative be compensated? Do any of the available sales channels vary cyclically?

3. Pipeline Management: How are leads collected and passed to sales representatives? How many collection points does your business have? How many leads can be managed per representative in the pipeline? How long does it take to convert a prospect to a customer? What is the average value of a prospect in the pipeline?

4. Scenario Planning: When creating forecasts it is best to come up with multiple scenarios. This helps develop strategies to manage the best case situation, the expected situation, and the worst case situation. These scenarios take into account certain uncertainties and help devise strategies for measures to be taken half way through the year when things take an abrupt turn.

Collecting this data can be an extremely challenging task. Be careful of information sources used. Forecasts are only as good as the assumptions which they are based on at the end of the day. A tip I use personally is to start looking for very specific statistics before I dive into the research. Lets say I want to know what the total revenue for our target industry is in Asia Pacific during 2007. This helps me narrow my search queries and focuses my attention to relevant information sources. No matter how challenging this process may be, it is far better than making some fatal errors in the future.

Inventory Velocity

“Inventory velocity is one of a handful of key performance measures we watch very closely. It focuses us on working with our suppliers to keep reducing inventory and increasing speed.” Michael Dell

To understand the importance of inventory management with clarity, we have to understand a key metric, inventory velocity. Simply stated, inventory velocity is the speed at which a business can move it’s stock. The speed at which a business moves it’s inventory will impact substantially on its profitability and ROI. Whenever the subject of inventory velocity is brought up, the example of Dell is almost certain to arise. Dell revolutionized the personal computer industry with it’s direct sales model. Michael Dell understood that in an industry where margins are low, and inventory depreciates rapidly, the only way to be highly profitable is the ability to improve inventory cycles faster. His business model hence eradicated the need for holding inventory to the absolute minimum, resulting in Dell becoming an industry leader.

Inventory velocity can be calculated by simply dividing the cost of goods sold by the average inventory for the period. This is a benchmark all businesses should watch very closely. When your inventory velocity is low as compared to your peers, this is definitely a red flag which management should take very seriously. Having excess inventory left over, poses a major risk to any business. The inventory experiences depreciation, holding cost and reduction in the price of the product. In my experience getting rid of old inventory in the market place is a very challenging task. Therefore I recommend most businesses to have internal policies to deal with inventory which has not been moved a particular period of time say 12 months. These should either be disposed of or sold at whatever price the market will offer.

The concept of inventory velocity can also be applied in some cases to the services sector. For example, if you are running a consulting practice and bill your clients by the number of hours. The number of hours that are left outstanding at the end of a certain period of time, is your inventory. Inability to turn around your inventory quickly will result in massive cashflow gluts which can severly harm business operations. Lets say that one calculates on average the business settles outstanding balances in 90 days. What do you have to do to reduce the average to say 60 days? How will be the impact of the available cash flow? We have to think of ways to optimize our business operations continuously. As a younger company, this is always a challenge as larger companies take advantage of their clout. However keep track vigilantly of this key metric, and work on increasing it.

How full is your warehouse?

“Just-in-time inventory…improves cash flow while its partners bear the brunt of long payment cycles.” Andrew J Lauter

Inventory management is a matter which should be of concern to entrepreneurs. However the truth of the matter is much to the contrary. This is an area in which I have made some pretty major mistakes in the past and still do to a much smaller extent to date. So what do I mean by inventory management? It is basically how effectively an organization balances it’s stock demand and supply. When our warehouses are full or we have many unbilled invoices, cash flow is reduced drastically. This has major repercussions on our ability to manage day to day operations as well as grow the business.

Mismanagement of inventory is an area where many entrepreneurs make mistakes because of their inexperience in managing cash flows and liquidity. One of my initial entrepreneurial experiences was in my design firm, we had pre-ordered a lot of fancy paper to reduce production lead time and get deep discounts. It seemed like a good idea in principle. However, when deals in the pipeline kept getting delayed, and we lost a big account, we began to seriously feel the pain. We were fortunate to save the business because of a close friend who helped us bridge our cash flow gap. It was through this lesson that I began to learn how important it is to manage inventory intelligently and not make orders on a whim because of a “good deal”.

Over the next week I plan on demystifying this topic and I hope this series will assist first time entrepreneurs who are not always aware of the challenges of managing their inventory correctly. The concept of inventory should not be restricted  to physical stock, it includes any sort outstanding payments that maybe causing a liquidity crunch for the business. The sooner we become adept at managing our inventory cycles, the faster we will be able to grow and scale our business. I hope you enjoy this series and I look forward to your comments and feedback.