Journey of a Serial Entrepreneur

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How to get from where you are to where you want to be

5 Steps to Better Inventory Management

“Every company has metrics that track performance. The key question is whether these metrics really provide visibility to performance as viewed by the customer.” Steve Matthesen

Inventory management is an aspect of business which needs to be given more attention than what it currently receives. It is certainly not the most glamorous aspects of running a business. Inventory management is a basic business building block like marketing, sales or finance. Simply put, inventory management deals with how efficiently an organization manages it stock cycles. Stocks in inventory, relate to aspects of business that are exposed to risk when accumulated beyond certain thresholds. In the case of a service business, it is the amount of outstanding payments. Efficient inventory management helps a business to maximize its existing assets by increasing turnover. Listed below are five steps to assist your business in managing inventory cycles better:

1. Inventory Velocity: This is an essential metric, which measures 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. 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. To learn more about the importance of measuring inventory velocity please click here.

2. Forecasting: Mistakes made by forecasting incorrectly will impact directly on the level of inventory at the end of a financial period. There are three important aspects to be considered when constructing forecasts. The forecasts need to be based on data acquired from the market, sales channels and the current pipeline. Based on these aspects, we can construct forecasts for multiple scenarios which enable us to put measures in place, for the best and worst case scenarios. It is important to remember that forecasts are only as good as the assumptions they are based upon. To learn more about how to forecast revenue for your business please click here.

3. Communication Channels: When there are insufficient channels of communication between the producer, distributor, retailer and customer inventory, management becomes challenging. The information gap needs to be bridged by implementing several communication channels which include, allocated representatives, conference calls, real time stock levels and feedback channels. When information is allowed to flow freely from the customer to the producer, changes can be made faster and everyone in the chain stands to benefit. To learn more about the various communication channels please click here.

4. Technology: Organizations such as Walmart and Dell have shown the power of technology to optimize inventory management. Today, entrepreneurs have access to several tools such as bar coding, inventory management  and billing management software, which can help give small businesses an edge in managing their inventories optimally. To learn more about different types of technologies available for inventory management please click here.

5. Internal Policies: Policies and controls need to be selected carefully. Their main objective should be to facilitate bottom line growth for the business. These objectives act as guiding principles, and policies are intended to facilitate reaching those goals. Proper inventory management can impact bottom line figures and results for the business substantially. Policies pertaining to ordering, review and collections need to be mapped out in detail to ensure proper management of inventories. To learn more about internal policies relating to inventory management please click here.

Operations and supply chain management are the nuts and bolts of all businesses. Without smooth operations and proper controls, we could have a great website, killer marketing strategies and still come up short. When a customer does not get the product in time, or at the right price, we lose the customer. It all comes down to execution, and ensuring that we have systems in place to manage each order optimally. Inventory management is a critical aspect of this chain, and I recommend all business owners review their inventory cycles and work out ways to optimize them.

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Inventory Management Internal Policies

Policies are many, Principles are few, Policies will change, Principles never do. John C. Maxwell

A common answer I get when I ask individuals why they chose to become entrepreneurs is, “We did not want to get buried in bureaucracy and policies which stop us from performing optimally.” I completely understand where they are coming from. It is true that in some larger organizations policies and controls become so complex that it leads to much frustration. However, I do not advocate running a business without any control measures. Policies and controls need to be selected carefully. Their main objective should be to facilitate bottom line growth for the business. These objectives act as guiding principles, and policies are intended to facilitate reaching those goals. Proper inventory management can impact bottom line figures and results for the business substantially, and is an area where entrepreneurs need control measures to ensure that things move smoothly. Listed below are a few policies which may be helpful:

1. Ordering: If your business depends on manufacturers to produce your product, it is best you have documented your specifications in detail. It is also advisable to get quotes from a number of manufacturers before deciding to go with a particular vendor. This not only helps gather market information, it enables you to get the best price as well.

2. Inventory Review: I recommend setting up a policy to review inventory stock levels periodically. This helps determine current worth, idle stock alternative strategies to be offloaded can be discussed, and it provides management with a holistic view of the level of risk they are currently exposed to. For a service based business, this can identify customers not paying on time, and adjust their credit lines accordingly.

3. Collections: This is an area where entrepreneurs face a lot of challenges. If you have outstanding payments for products sold through retailers or for services rendered, it is essential that a mechanism is in place to receive this payments as soon as possible. I would recommend setting up periodic reminders through, email, phone calls and personal visits to speed up this process. Depending on your business model, having a collection policy which is adhered to closely, can increase short term liquidity substantially.

Inventory management is definitely not the most exciting aspects of business. It is however, a critical function which needs to be given a lot more focus. Through appropriate policies and control measures, we can achieve optimal inventory velocity and increase the likelihood of turning in even greater profit.

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Inventory Management Technologies

The first rule of any technology used in a business is that automation applied to an efficient operation will magnify the efficiency. The second is that automation applied to an inefficient operation will magnify the inefficiency. Bill Gates

Technology has played a massive role in optimizing inventory management. Examples of companies which stand out are, Walmart and Dell, they have used technology to make the most of their inventories and maximize velocity. Both these companies have used technologies such as RFID (Radio Frequency Identification), web based systems and software automation. Take Walmart for example, they track inventory levels throughout their stores continuously, and are able to transfer inventory from one geographical location to another, based on demand changes or how they use RFID to streamline pick-ups and deliveries from their warehouses. These represent massive infrastructure costs, which eventually lead to cost savings and efficiency. Most start-up companies will not be able to afford such systems. However, they do need to think of creative ways to use available technologies to optimize their own inventories.

Some ways to incorporate simple technologies into your business are:

1. Bar Coding: With specialty printers and software available quite reasonably, I recommend tagging your stock to keep track of movements. We implemented this in one of the companies I was consulting at, and it gave management a holistic view about stock levels and usage patterns. Using this information, they were able to make better inventory based decisions.

2. Inventory Software: These programs help keep track of key metrics regarding the usage of your inventory. They have the capability to provide future trends based on past usage, and can identify areas where the business is taking unnecessary exposure by ordering too much or too little. The fact that your stock inventory can be viewed holistically is a great benefit in itself.

3. Billing Management: For service based businesses, I strongly recommend using an invoicing and billing management software. These are critical to ensure that invoices are issued in time, and payments made accordingly. One can easily find metrics such as, how long your billing cycles are, and which customers need to be given stricter terms. Some tools have inbuilt email reminders, a very handy feature, to remind customers on a periodic basis. I find a lot of younger business owners take this function too lightly which can severely damage cash flows.

A constant aim should remain to increase inventory velocity. Technology provides us with a multitude of tools to help reach this goal. Some technology tools available, can unnecessarily complicate processes which can backfire. It is important to always keep simplicity and some specific goals in mind when integrating technology tools.

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Communication Channels

The single biggest problem in communication is the illusion that it has taken place. George Bernard Shaw

A major reason for inventory mismanagement is a lack of appropriate communication channels of information. When a producer has insufficient contact with the distributor, unrealistic expectations are formed. By the same token, if the distributor has insufficient communication channels with the retailers, there is also a massive information gap. To minimize surplus inventory stocks and form realistic expectations, all the parties involved need to play an active role to allow for real time feedback and communication. For example, a company I have invested in, distributes a particular type of spray paint can. It is a high end product, with many lower priced competitors. When we began a relationship with the producer, the producer’s expectation was to clear inventory at a certain speed. The ground realities however, were very different from what was expected, and it was primarily our fault for not doing sufficient research. This strained the relationship with the producer.

Eventually, we devised a model through which we began to clear the goods at a much faster pace, but it was not through the traditional retail model. When the producer came to visit our operations, he had very different expectation, and it took a lot of effort to clear communication channels. The lesson to learn from this example is, there have to be multiple communication channels for a business, to help them acheive their inventory turn targets. First the producer and the distributor must allocate an individual on each side to communicate the feedback received. There also needs to be periodic conference calls with management to talk about issues from a macro level, and to temper expectations and goals. Stock levels and pricing strategies should be constantly monitored. Next, if the distributor used multiple retailers, the same structure should be set up for communication between them. Lastly, constant customer feedback must be available through the web or surveys.

Creating a holistic model, where communication between all involved parties becomes transparent and fluid, will help fill the information gaps which are a result of faster inventory speeds. In my personal experience, it has not only created a stronger relationship with our principal, it has helped us tap into the potential of the product itself. This is done through constant feedback and strategies, which are developed when all the individuals involved work together to push the product harder. A lack of communication channels will result in stock piling of inventory, unhappy relationships and unrealistic expectations. It is therefore critical that communication channels be set up as soon as possible.

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Forecasting

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.

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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.

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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.

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