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Inventory Reduction - A How To Guide

INTRODUCTION reduce the set-up portion of overall run
time is to increase lot sizes.- Labor
INVENTORY is the largest single asset on Content - Reduction of direct labor has
the balance sheet of many manufacturers been one of the few bright spots in
and distributors. It is usually the most American productivity improvements over
expensive asset to own and maintain as the years. The area to look at is labor
well, with estimates of carrying costs variances, due to down time, quality
typically running 25-30 cents or more on problems, material shortages, etc., and
the dollar annually. Therefore, any in indirect labor. In short, reduce the
useful suggestions to optimize INVENTORY overhead due to other factors increasing
investment and associated expenses would labor.The preceding sections should give
be most valuable.The paper addresses how you a better idea of the significance of
to manage INVENTORY investment to optimum INVENTORY, and what affects it. If you
levels, which means a reduction or major have been reading carefully, you have
redistribution of it in most companies. already seen opportunities for reduction,
Optimal INVENTORY levels come down as since knowing the question is frequently
management makes the operation more half of the answer. The next section will
efficient by improving processes, amplify and clarify some of these...
reducing lead-time, managing supply and
demand better.One can't "attack" HOW TO REDUCE INVENTORY
INVENTORY effectively, but only its
underlying causes, which will be Advice To The Boss
discussed. Most INVENTORY "problems" are
merely a reflection of management, Let's now discuss some specifics for
design, process or operational problems. helping to tame the beast. To begin with,
Current literature on Just-in-Time and let's first set up a program to do this
World-Class Manufacturing addresses how with little initial out-of-pocket costs,
inventory reduction is a by-product of a fast payback and subsequent return on
doing things right the first time. investment!Your controller will love
this.It sounds almost ridiculously
WHAT IS THE SIGNIFICANCE OF INVENTORY? simple, but there is a sequence that one
ought to address inventory reduction
Why is INVENTORY "bad"? activities in:- Don't bring it in. An
ounce of prevention is worth a pound of
INVENTORY is a major capital investment cure. Don't order what you don't need.
affecting cash flow and profitability. For existing commitments, cancel or
Inventory comprising one-third to reschedule where practical.
one-half of companies' total assets isn't - If you already have it, ship it. Work
unusual. There are significant expenses on eliminating constraints to getting
associated with possessing it. INVENTORY product shipped. Sell excess inventory at
reductions can do more to improve ROA full price/cost, if possible.
(Return On Assets) in most companies than - Try to rework or substitute. Attempt
most other factors. For instance, a 50% to rework, retest inventory, try to
reduction inINVENTORY will typically substitute it in place of parts that have
account for a 10-25% improvement in ROA! been specified.
Certain industries, such as aerospace and - Salvage it for cash at a reduced rate
defense, widely believe that INVENTORY is - Dump it. If all else fails and it's
a non-issue, because they receive really not needed, throw it away, because
"progress payments" from customers or the tax write-off and lower holding costs
because they "write-off" job-end alone will make it worthwhile.Try the
variances and leftover "residual" specific recommendations contained in the
inventories. The facts are that these sections following...
companies need to watch inventories even
more closely but first they need to be Short-Term Activities
made aware that there are INVENTORIES to
watch.Excess inventories subject the Since it is an "established" fact that
manufacturer to additional liabilities most managers think "only of short term
for things such as obsolescence, rework, profits," let's cover the stuff we can do
storage charges, etc. Most of these right away first. The author doesn't
ultimately end up "written off" and are believe that most top managers really
applied to "overhead", but this believe this but knows that in order to
eventually raises the overhead rate, keep a business going and to keep your
which increases costs of doing business, job, you do have to show short-term
which raises prices, which makes results.Assign responsibility
companies less competitive.Carrying Costs accountability for inventory reduction
Let's look at what goes into INVENTORY Not just to the materials people, but
"cost of ownership", frequently called production, sales and engineering also.
the "carrying cost" and expressed in This should probably be a team, with ONE
terms of percent cost of INVENTORY person clearly in charge, who should a
valuation per year of ownership. For vice president, rather than a summer
example, a 25% carrying cost would intern.Get Control of The Checkbook
indicate that it costs about $.25 to own
each $1.00 of INVENTORY each year. These This is one of the first things that
costs consist of:- Cost of money - The "turnaround artists" always do to rescue
cost of capital to the company or, in a foundering company. Insist on getting
some cases the "opportunity cost" or justification for all new INVENTORY
return that could be earned on the money expenditures - especially "A" items (most
by applying it productively elsewhere. expensive ones). Sign all major approvals
The cost of money has ranged anywhere and checks yourself. This has an amazing
from 6% to 18% in the last 25 years. and rapid effect on INVENTORY and has
Obviously, cost of money has a very been practiced first-hand by the author
significant impact on investment and customers.Use this process to force
strategy.- Obsolescence - The risk of those responsible to justify what they
INVENTORY never being used, or needing are doing and why and to think through
rework to make it usable, needs to be these policies and their enforcement in a
factored into the cost of owning new light - that of investment
INVENTORY. In theory (and practice), the management. While you are doing this, use
larger the INVENTORY is, and the longer it to study the dynamics of INVENTORY
it is held, the more likely engineering planning systems and to decide what
changes, customer preferences and INVENTORY investments should be and what
technological changes will render that problems really are. You should develop
INVENTORY unusable.- Shrinkage - A a matrix of inventory days coverage
portion of INVENTORY becomes unavailable targets by commodity by product line by
to the owner due to loss, damage, theft planner. Then cost it out and track
or spoilage. The longer INVENTORY is actual performance. Be sure to track
there and the more there is, the more commitments and planned amounts.Conduct
likely this is to happen. Steps to basic indoctrination of people affecting
prevent it only raise carrying costs in INVENTORY most dramatically--planners,
other areas, such as security, air buyers, production management, sales,
conditioning, better control systems, customer service- establish some
recruiting policies, etc.- Quality temporary "edicts" and enforce them until
Factors - Allowances for yield, more formal policies/procedures can be
attrition, scrap and rework. This is established/changed later on. Make sure
really more of a function of the process you know what you are doing before you
than the amount of INVENTORY invested and establish these. Beware of mindless
is more related to throughput, but is "across the board reduction" edicts that
usually expressed as part of the could result in hurting service and
aggregate INVENTORY carrying cost.- profits.Have your people perform a quick
Technological or Price Obsolescence - "thumbnail" INVENTORY analysis
Prices don't always go up. In fact, in
industries such as electronics, prices Start with items currently on order, in
often plummet due to constantly improving process, or being planned. As Al Agosti
designs, product and process technology of IQR says, "first stop the bleeding.
improvements. Therefore, it is desirable Then take away the knife." It always
to minimize inventories in high-risk amazes me that companies will spend a
areas.- Taxes - There are two dimensions fortune to analyze INVENTORY, which is
to this: 1) In some areas, a tax is already there, but ignore huge impending
levied on inventories, so the more expenditures, which they can do something
INVENTORY, the more tax is paid. 2) about before disaster strikes. To do
INVENTORY is regarded as an asset by most this, perform a quick "ABC" analysis,
accounting and tax rules. Therefore, identifying only the expensive ("A")
building large inventories shows items initially. In most companies, these
"profits" and profits are usually taxed, are only 5-15% of the total items and can
usually by multiple government be leveraged to provide quick benefits in
entities.- Insurance - The cost of terms of investment management. After
carrying insurance on INVENTORY needs to this has been done, get together with the
be considered, as well as insuring the management team, do a quick brainstorm
space, equipment, people and other and put together a Pareto chart, showing
resources needed to control it.- Space problems in descending order of
- Costly storage space sometimes occupies importance.Start with a calculation of
25-30% of the total facility, when one what is actually needed:
considers raw material warehouses, - Go through all the arguments of why
stockrooms, work-in-process storage, people need more, sooner and then get
receiving, shipping, outside warehouses, people to agree on how they can avoid
MRB and residual storage areas. INVENTORY doing that.
reduction campaigns frequently help - Cut new INVENTORY scheduled to come in
companies avoid the need to move to large whenever possible.
facilities, or permit them to shut down - Determine right away what can be
or cut back existing facilities.- cancelled, rescheduled, returned to
Manpower - All of this INVENTORY needs vendor for credit or sold for salvage.
people to order, receive inspect, record, Balance the costs of doing this against
move, count, store, retrieve, post it to the relative benefits.
the ledger, etc. People are the largest - Work on getting product shipped and
or second largest expense (behind billed to get INVENTORY relief.
material) for most manufacturers.- - Try to match INVENTORY input closer to
Record Keeping Systems - Software, ship date (reduce lead times and carrying
procedures, equipment and paper must be time)
used to stay on top of INVENTORY.- - Determine if excess/obsolete finished
Material Handling/Storage Equipment - goods can be put on promotion or "fire
Conveyors, fork lifts, bar code readers, sale." Do so if appropriate.
scales, AS/RS, trucks, carts, bins, - Lean on customers who have cancelled
racks, shelves must all be purchased, rescheduled orders to your detriment. Try
leased, maintained and cared for.- to get them to pay for part of these
Physical Inventories, Reconciliations - costs, accept the INVENTORY, or use these
Must be conducted to ensure that incidents as levers to improve future
inventories are properly accounted for terms.
and maintained.- Transportation - Must - Look for obvious bottlenecks in the
be provided to move INVENTORY in and out planning and processing of orders such
of the facility, to vendors, within the as:
facility to different workstations and - Amount of lead-time and queue
storage areas.- Energy - Heat, light, permitted.
humidity control, air conditioning, - Lot size and cycle times.
refrigeration and fuel must be consumed - Scheduling assumptions
to make all this happen. - Major bottlenecks caused by improper
manning, defective or poorly maintained
WHAT AFFECTS INVENTORY? equipment, etc.
- Build-ahead and buffer policiesSet
One must "know thine enemy" to goals for inventory down to the level of
successfully deal with it. Now that we've managers and planners
discussed the significance of INVENTORY,
let's determine why it exists and what Do this "rough cut," for "A" items
makes it go up or down.INVENTORY is not first-- more detailed analysis comes
always evil. It usually exists for a later. Set targets by planner, buyer,
reason, however a reason is not always product line or any other meaningful
true justification. INVENTORY is political or production entity that will
frequently kept as a buffer and masks foster accountability, which you will
other problems.Major Reasons for want to later measure results against and
Inventory enforce.Go for the "easy wins" with the
best payback first. Don't fall into
- Net Demand - Demand derived directly "paralysis by analysis." You can do more
from customer requirements or internal in the first few months than you
demand.- Pipeline - INVENTORY needed to think.Establish formal problem solving
sustain the process over its cumulative methodology
lead-time through all operations and
holding points. Also included in the Use task teams, quality circles, natural
pipeline are paperwork operations, such work groups, tiger teams or whatever
as billing, which could increase they're calling them this month and have
inventory if not done timely these groups identify major problems,
enough.- Quality - Yield, attrition, opportunities and then address the
scrap, rework allowances impacting amount solutions.Perform "stock location audit"
of inventory and time inventory is in
process.- Lot Size - Lot size Simply go out to the shop and write down
considerations include vendor minimum only the identity (part number) and
order quantities, raw material and location of all storeroom and/or
manufacturing lot sizes due to setup and work-in-process and other inventories,
other nonrecurring, lot-related cost then compare to your records. Don't even
considerations and run time impact bother to count it (that's what takes the
considerations.- Supply Buffer - Extra longest).Take your "hits" for inventory
INVENTORY carried as a hedge against early
unreliability of vendor or factory
schedules, inaccurate records, As soon as you have some idea of the
unpredictable quality or other magnitude of excess/obsolete inventory,
fluctuations tending to reduce work on getting financial and general
reliability of providing materials on management to "write it off", in order to
demand.- Demand Buffer - Extra INVENTORY get the tax benefits, where
planned due to uncertainty of the true favorable.That depletes my INVENTORY of
requirement need date or quantity, which quick fixes. Now it gets a little
may vary due to poor forecasts, harder...Inventory Analysis/Target
transportation problems, or various Setting
contingencies.- Hedge - Inventory
acquired for speculative purposes with Joe Barcy of Inventory Performance
the exception that prices will rise Systems calls it the "Divide and Conquer"
later, justifying the earlier investment approach. What he meant is that a company
risk.Other Factors Affecting INVENTORY has to bring decisions and measurements
down to the level of accountability and
The reasons given above are those that below (to the person/part/number/cost
apply for a given set of circumstances or element level) and also aggregate this
basic assumptions about design, information up to meaningful levels for
processes, etc. The factors below are analysis by various levels of
more basic and can have a more profound management.First, group INVENTORY items
long-term effect on INVENTORY:- Product at the part number level into categories
Design - A product design that minimizes by responsible planner and/or buyer and
the number of parts, picks easily commodity. Do this in descending dollar
obtainable materials and components, sequence, preferably by projected usage
lends itself to manufacturing with the (historical usage, if that's all you can
simplest possible facilities and find, but it has its disadvantages). If
equipment will minimize INVENTORY costs you don't have the ability to do this by
over the long pull.- Materials Supply - computer, do it by hand for the A items
Specifying quality materials, well suited first - look up production plans, sales
to the process and application, with easy forecasts and buy cards, then extend
availability, low prices, reliability of quantities by approximate costs. Use
supply and short response time are all purchase history, quotes, accounting
big advantages that can facilitate department support, or whatever you can
INVENTORY reduction. Having the best get. Getting it done fast and
sources for key materials or changing approximately is much more important than
existing arrangements can do a lot to carrying it out to four decimal places.
help minimize inventories.- Processes - Remember: money is being wasted while you
Good, reliable processes will help reduce delay!Analyze INVENTORY on the following
INVENTORY, because they will help reduce suggested parameters:
scrap, rework and attrition, and also
provide a more reliable flow of supply, 1. ABCD classification (by annual usage
which will help reduce buffer stocks, value)
safety stocks, safety lead time INVENTORY 2. Turnover/investment performance
and eliminate much accumulation of 3. Highest dollars committed
INVENTORY on the production 4. Highest dollars in INVENTORY
floor.- Facilities Layout/Design - 5. Most longest period coverage planned
INVENTORY may be increased significantly available
if this is not done properly. Widely 6. Items with coverage/commitments
scattered plants, multi-story buildings greater than policyOnce you have all this
with inadequate material flow data, set targets, measure and control
capabilities and processes distributed performance.Data Accuracy Program
over many different departments, all
increase the amount of part travel, Set up a formal, ongoing program to
possibility of loss, delays and need for clean up and maintain accurate records
manpower and extra equipment to support for inventory, bill-of-material, routings
the process.- Service Objectives - The and planning data. See my article:
required response time and reliability of Inventory Accuracy in 60- Days!Policies
service to customers has a big impact on Procedures
INVENTORY costs. For instance, if
industry standards allow making to Write/update policies and procedures to
customer specifications from scratch, guide your operation. Conduct an ongoing
there may be less need to maintain education and training program to ensure
finished goods inventories. If customers that people know what to do and how to do
or distributors carry stock, that reduces it.How to Optimize inventory Levels
pressure upon the supplier to maintain
inventories and reduce them If you're expecting a neat formula here
quickly.- Planning/Control Systems - to plug in your numbers, you're sadly
Systems employed to manage supply and mistaken. It doesn't exist and if someone
demand and control the production process tells you it does, it probably doesn't
have a large effect on INVENTORY.The work. Here are a few ideas that have
systems we refer to are: worked for me:- Estimate target days
coverage using the team's best judgment
- Front End for each commodity/product line.
- Forecasting Obviously there will be some exception
- Production Planning items.
- Master Production Scheduling - The "one less" approach: Try reducing
- Capacity Requirements Planning inventories in doubtful areas a little
bit at a time. Pull back when you get in
- Engineering trouble or when you spot a constraint.
- Bill-of-materials Continue after you have relieved the
- Change Control constraint(s) some.
- Routing/Process - The lead time/cost build up chart:
Construct a graph per product showing the
- Material Planning time phased cost buildup in cost of goods
- Time Phasing Tools sold amount. Have the team meet to see
- Requirements Calculations/netting where lead times, lot sizes, attrition
factors and buffers can be reduced.
- Shop Floor Control - Modeling tools, Advanced Planning
Systems (APS), have some potential for
- Data Integrity optimizing certain situations, but they
- Bill-of-material have been a bit oversold and are not easy
- MPS to set up and maintain.Key Points
- INVENTORY, PO, RM, WIP, QA, FG
- ProcessCost To summarize some important points for
your future reference:- Inventory
- Material Costs - Material cost reduction is one of the cheapest ways to
increases (obviously) raise INVENTORY. improve profits
Lowest unit cost does not necessarily - Get control of the "checkbook"!
mean lowest cost of doing business, or - Use Pareto's 80-20% principle to
even lowest cost of material, for that leverage your time and investment -
matter. These can be deceptive, because choose your battles - biggest bang for
as material costs go up, turns do not the buck.
decrease, because they are being measured - Once of prevention = pound of cure
on a new and higher base.- Overhead - - Set targets - "divide and conquer"!
Burden rates of 300%, 500% or more are - Force accountability- Set up a
not uncommon. Having a high overhead rate responsible team- hold it accountable.
is not "bad", only total costs that are Include in performance appraisals,
too high are "bad". Your overhead rate is incentives
a reflection of cost distribution and - Question assumptions - eliminate waste
accounting techniques as well. However, - Doing business right will
if overhead is going up without attendant automatically reduce excess inventory in
drops in other areas and if other most cases, but still needs monitoring
industry competitors are doing better, and control.This article is also
then it's "bad."- Setup and Other available on our website: PROACTION -
Nonrecurring Costs - In most companies, Generating Best Practices. It is an
these are either part of direct labor or excerpt of a paper originally written by
buried in overhead. I broke them out George Miller, Founder of PROACTION. It
separately here because of their has been modified and updated by Paul
differing characteristics. Many Deis, PROACTION CEO.
manufacturing people feel that the way to




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