How much stock should I be holding?

The level of inventory you hold in your family business is often a great worry to the CEO and the family who own the business.

Simply put – stock makes you money and it doesn’t.

Often a family business owner will want a high level of stock as it simply means better service. If you want it we have it. And we have it now. The high level of inventory means that the business has a strategic competitive advantage over a business that simply cannot afford to invest in that much stock.

A big stockpile is also attractive to customers. A person sometimes does not actually know what they want until they see it. How often did you want to buy the cheaper stocked item – a car, a suit, or some bananas – and then fall in love with the bigger, better and shinier item sitting on the shelf.

Having the stock on display is an essential selling tool for many family business owners.

However the great value of stock is also a worry.

Stock goes down in value

Gone are the days when a stocked item could sit on the shelf for 6 months and then be sold as new. With life cycles of all products falling due to competition then falling value of the inventory on the shelf or in the yard is becoming increasingly high.

For food manufacturers the falling value of the inventory is obvious – the milk gets close to its use-by date and you have to sell it for half price or poor it down the sink. And for technology retailers the level of obscolescence of inventory held means that the family businesses in technology are losing (typically) 1% a week on the inventory they hold simply because newer items coming through and more attractive.

Inventory costs money to manage

If you want a large amount of inventory you need to store it somewhere. Somebody has to put it in the correct spot, inspect it every now and then, clean it, move it about and insure it.

The greater the inventory held by a family business the more rent they will pay, the more insurance they will incur and the more staff they will need to manage this big pile of “stuff”.

You will even pay money to get rid of it.

It takes cash to buy

It goes without saying that you have to buy stock before you sell it. And most manufacturers these days will want to get paid for their manufactured goods within 14 days of shopping them (there are always exceptions – and you pay a premium for this).

The more stock you have the more capital you have lost. That capital could be focussed on better customer service, better data mining capabilities or better price points for your customers to access greater sales.

The process of selling on consignment is almost dead and buried. We typically only see it for very high margin items like artwork.

Getting key performance indicators for your inventory management

A classical KPI to track your stock management is “the average days to sell stock”.

For example

Tom’s Tyers has $1,000,000 in stock and it has $12,000,000 in sales. On average the family business will hold onto it’s stock reserves for 30 days before it is sold.

The above numbers are quite intuitive. However for other family businesses (unless you’re an accountant) you will need to know how to calculate the outcome

Average stock on hand. x. 365
Total yearly sales

If the KPI was to be done monthly the above formula would simply use the monthly sales and then multiply the result by the number of days in the month as opposed to the number of days in the year.

If your family business is armed with this number you should then identify the benchmark you want to compare, or track yourself, against. The average days to sell for Woolworths is different than compared to Austral Ships. This number could be an internal benchmark against your own best practice or you could seek data from a competitor through industry groups, ASX charts or even your current staff.

Whatever the outcome – it is important to realise that stock consumes an inordinate amount of capital from your business. In the example of Tom’s Tyres – a 50% reduction in the inventory of the family business will allow the family to be a new investment property ($1m x 50% = $500,000).

“Just in Time” inventory management

Nearly every commerce graduate from university will talk to you about JIT management. This concept – famously applied by Toyota – prevailed that the only time an item was received for the next process was immediately prior to when you needed it. So the strong relationship with suppliers was critical.

And it all works on the premise that stock sitting in the yard is wasted cash (see above).

Sadly the JIT theorists came crashing to a halt in February 1997 when a key supplier for Toyota suffered a massive fire. And that company was the sole supplier of parts in a stage of the manufacturing process. So Toyota had to shut for 2 days and all the suppliers along the assembly line also had to shut as their parts were not needed.

So a family business needs to balance the wasted capital on their balance sheet to managing keys risks of a dependent supplier. There are always competing priorities and advice from an enlightened business advisor is sometimes needed simply to clear the “wood for the trees”.

Financing stock

If your business is required to carry a large amount of stock (like an agricultural machinery dealership) you should talk to your suppliers. It is not unusual for a supplier to offer a credit facility (or floor plan) where the dealership is given a line of credit with discounts if a certain sales volume is met.

As specialist family business accountants we see a diversity of opinions on the matter of financing stock. Some families (especially given the recent Perth market) are passionate to never carry debt and some families are passionate to use as much of other peoples money as they can in the business.

The decision on whether you should finance stock should be made by comparing the cost of finance to the targeted weighted average cost of capital in the family business. This is also then important when comparing this cost back to the businesses targeted dividend payout ratio (this is dry stuff but critical in a professional business family).

Tracking and managing stock

The management and identification of inventory in a family business is a delicate issue. It goes straight to the core of the operations and requires the family to focus on the culture of the business and the desire to understand key metrics of a business.

It is pointless to engage a smart accountant to create the world’s greatest stock control system if “Dad” is simply going to walk into the yard, grab some stuff, and then walk out without telling anybody. This culture that the family holds internally will roll out to the rest of the business so a decision will be needed by everybody in the family business about how serious they are to stock management.

Typically we see a poor accountant getting tasked with the job of tracking stock. And then everybody else in the business simply ignores everything and then wonders why it did not work. If the hard work is done upfront about the systems and processes of recording inventory then the resultant system – be it a paper punchcard thing or a cloud based bar coding – will work (although one will work more easily).

Failings in stock management

Sadly we see many family businesses attempt to, and fail, to implement an inventory management system.

The primary reason why is that their is a lot of initial passion and the day to day grind of entering data into the ERP is overwhelming.

At Westcourt FBA we are fans of doing as little as you can to get an answer. And this means automating the process and using technology and practical stock control levers in the operational floor that is simple. In effect stock control needs to be taken out of the hands of the accountants and given to the people who can make an impact.

The smart planning of process, together with an intimate understanding of the needs of the family business always takes precedence to the end solution provided. So yes we have helped families with MYOB, Unleashed, Exonet, Autosoft, Navision and the like. But at every stage the briefing to the software ERP representative is a complete and clear understanding of what is needed. This scoping is also critical at a later stage of the implementation plan when “scope creep” becomes a factor.

If you need an informed discussion on your inventory management platform, or the scoping of your ERP for your family business – simply have a chat. A three hour consult with a partner on the mistakes we have seen and how to start your journey costs a mere $1650 including GST.

And that is so much better than to terminate the implementation once you have spent $65k into the process.

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