Inventory Management with the COVID-19 Part 5
In this issue, we begin to explore how to best manage large vendor purchase requirements. Vendor requirements may refer to an individual item (e.g., the supplier sells an item in cases of 48 pieces) or an entire order (e.g., in order to get free freight or an extra discount we have to place a $10,000 order).
Let’s say a vendor will sell you a case of 48 pieces of item #A100. If you sell 96 pieces a month, 48 pieces represents about a two-week supply. But if you only sell four pieces per year, a case of 48 pieces will last for 12 years. While ordering full cases of the product from the vendor usually results in a lower net cost per piece, you have to consider the cost of carrying inventory during the time it takes to sell the entire quantity in order to figure out whether it truly represents your “best buy” opportunity. You might be better off transferring smaller quantities from another company location or finding another replenishment source where you can buy less at a higher cost per piece.
To determine whether it is best to order full cases from the vendor, we suggest you follow these procedures:
1. If you have not yet calculated your cost of carrying inventory, access the questionnaire in the resources section of our web site, www.EfffectiveInventory.com. Typically, inventory carrying costs now range from 14% to 25% per year. That means that it costs you 14 to 25 cents to maintain a dollar’s worth of inventory in your warehouse for an entire year. Note that inventory carrying costs significantly vary by industry and region. For our example, we will use an inventory carrying cost of 18% per year or 1.5% per month.
2. You can buy individual pieces of product #A100 for $5.25 each. If you buy a case of 48 pieces of product #A100 the cost drops to $5.00 each (or $240 for a case of 48).
3. Determine how many month’s supply is provided by the vendor’s case quantity. Let’s say the forecast of the product is 12 pieces per month. Therefore 48 pieces represents a four-month supply (4 months x 12 pieces = 48 pieces). The average amount of inventory you will have during the time it takes to sell 48 pieces will be half that amount of 24 pieces. The value of the average amount of inventory will be $120.00 (24 pieces * $5.00 per piece).
4. Your total cost of carrying the case of 48 pieces is calculated with the formula: Average Inventory Value * Months Supply You Have to Buy * Carrying Cost per Month:
$120 * 4 months * 1.5% = $7.20 or $0.15 for each of the 48 pieces you are buying
5. Therefore, your total cost for the case quantity is $5.15. This is far less expensive than paying $5.25 for individual pieces.
6. But what if you only sold four pieces per month? The case of 48 pieces would last 12 months. The carrying cost for the shipment would be $21.60 ($120 * 12 months * 1.5% = $21.60). Divided by 48 pieces would add $0.45 to each piece. Your total cost of each piece would be $5.45. Far higher than the cost of buying individual pieces for $5.25.
In challenging economic times, you must be sure you are making intelligent buying decisions. Assess the cost of carrying inventory to ensure that you are maximizing your corporate profitability. Perhaps it would be best for one of your warehouses to buy full case quantities and then distribute them as needed to other locations.
In the next issue, we will continue our discussion of evaluating vendor offers by adding the cost of issuing replenishment orders to our analysis.
Effective Inventory Management, Inc.