Do You Keep Track of Your Leftover Inventory?

Last week, I went to a large manufacturing company to look at their inventory management policies and practices. Their understanding and the mechanisms they put in place amazed me. "How does our inventory turnover compare to others in our industry?" 

I was asked often when I spoke with various department managers. Why did they pose this question in the first place? To assess their planners' and purchasers' performance.

I remained defiant. Not because I didn't know, but because there was no other firm in their field with a turnover comparable to this one's. Why? Because of the uniqueness of this company's supply network. Many of its components and raw materials came from a parent company's overseas affiliate. 

The parent firm mandated the source of supply, which could not be modified by local management.Therefore it was in a unique position for acquiring material. To compare its turnover to any other company, or to the industry at large, would be comparing apples to oranges.

As a result, we began exploring alternative metrics to use in evaluating their planners and purchasers. When a replacement shipment arrives, one of the things I recommend is measuring the day's supply of a product on hand. 

Residual stock is the phrase we use to describe inventory that has been left on the shelf. This may appear to be an odd measurement, but consider why it is significant.

When refilling a product's stock, a buyer must answer two questions: when to place a replenishment order and how much of a product should be reordered. 

Economic lots, price break analysis, and the economic order quantity formula can help you figure out how much to order while keeping your inventory costs low. The new metric, day's supply on-hand when a replenishment shipment arrives (residual stock), aids in ensuring that we order at the appropriate time.

Before we issue a replenishment order, we don't want an item's replenishment position (ON-HAND – COMMITTED + ON ORDER) to go below the order point. 

When calculating the order point, there are three factors to consider:

• Demand - The amount of product that is expected to be used.
• Expected Lead Time - The time it will take to receive and prepare the replenishment cargo for usage or sale.
• Safety Stock - Safety stock protects you from running out of an item due to unanticipated demand or vendor shipment delays during the expected lead time.

The order point is calculated using these three components:

(Demand/Day x Anticipated Lead Time) + Safety Stock = Order Point

One or more of the following circumstances are likely to exist if the residual stock is more than "x" days' supply at the time of the last three stock receipts:

• Forecasted demand routinely exceeds actual usage, necessitating a review for accuracy.
• The projected lead time is longer than the actual lead time that has been encountered.

The quantity of safety stock retained surpasses the amount required to protect customer service — that is, lead times and demand do not vary significantly from month to month.

We can reduce inventory levels to achieve the aim of "x" days supply by adjusting demand or the estimated lead time, or by keeping less safety stock on hand.

Our goal order from the vendor (i.e. free-freight amount, truckload, lot size, etc.) may be too large to optimize the company's turnover and net profitability if demand, estimated lead time, and safety stock are adequately maintained for the item.

One or more of the following criteria are likely to exist if the residual stock is smaller than "y" day's supply at the time of the past three stock receipts:

• Demand forecast forecasts are consistently lower than actual usage, and their accuracy must be assessed.
• The projected lead time is shorter than the actual lead time that has been encountered.

The maintained safety stock quantity is insufficient to protect customer service – that is, lead times and/or use vary significantly from month to month.

We need to adjust demand or the expected lead time, or keep more safety stock on hand.

The day's supply parameters "x" and "y" have no set values. The residual day's supply target for each item is determined by considerations such as the item's value to the company's sales or procedures, as well as its general availability.

While residual stock analysis does not provide a metric that can be compared to the results of other companies, it does alert buyers to products that have the potential to improve turnover or that may be impeding customer service – in other words, it is a useful tool for the company to achieve its goal of effective inventory management.

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