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A Method To The Madness

Inventory control is a very important aspect to operating a healthy business, and several components must be considered before choosing which inventory method is right for your racing establishment.

By Tom Shay, Profits Plus

 

Walking through a store one day, it was pure enjoyment as I watched the owner looking over the inventory with a sales rep in tow. The rep was holding a note pad as the two of them walked down each of the aisles and scanned the bins of parts. The owner of the store would pull out a bin so he could see how many of that part he had, and with a brief hesitation would tell the rep, “Give me two of this.”

You could tell that thought was being given to how many of each he wanted, as he would occasionally correct himself: “Give me four of this,” followed by, “No, make that just two.”

In today’s world, many shops have gone to automation. As they sell parts, their point-of-sale system tracks when, and how much of, each item is sold. The system then calculates a frequency rate and produces a report telling the shop owner how many to reorder.

While this generally works, there is a problem when the shop has a customer that orders a sizable quantity. The system interprets this as being the “norm” and wants to reorder in advance of this sizable order happening again. When the excessive quantity is not sold, the shop finds itself in an overstocked position.

Inventory control is a very important aspect to any shop. In fact, for most shops, inventory represents the biggest investment of money—the only other comparable investment would be the building if it were owned.

Because of this, I’ve always made it a point to read about, study, and attend classes on inventory control.

In one of those classes, the teacher told a story of a small mom-and-pop business. The couple had started working out of their garage, and slowly grew the business to where they needed a shop and sizable warehouse for all of the products they had added to their selection over the years.

What started as a hobby while they worked their usual jobs grew to the point where they had both left those jobs and were working full time in their parts business. They had paid off their home, as well as the building they bought for the business, and were in the process of developing a sizable nest egg for retirement.

Their method of ordering was the same as the example previously described. However, when they added their warehouse, the couple said to each other, “Now that we have grown the business to this size, we don’t have to order on a ‘onesie-twosie’ basis. We can begin to order in case lots and get each item for a lesser price.”

The teacher in this class then asked us, “Why would a business that has profited so much from ordering in a conservative manner change to another manner?”

The other extreme was illustrated through a business owner we met that specialized in restoring Corvettes. As we were visiting, he mentioned purchasing a part that he used in quantities of four on every restoration. He had been purchasing the part as needed with a cost of just over $2. But he had also found a source for the part where it would cost just under $1. The catch was the quantity he had to purchase.

Without considering how much warehouse space this new order would take up, he determined that the order would provide him with enough quantity for the next 12 years! The question was whether he should place the order from the new source.

There’s a lot to consider when you are ordering merchandise. Beyond the consideration of a part becoming obsolete, you have to consider whether demand for the part could drop; in fact, this should be an important consideration with any order.

What’s more, the cost of the item is more than just the price you pay. Many vendors require a minimum quantity or minimum dollar amount for orders. And perhaps the vendor has a “service fee” for orders that do not meet this minimum. Either (or both) of these charges should be a component of what is referred to as the “landed” cost.

For example, say you are ordering air filters. If you do not meet the required minimum and are subject to this service fee, the cost of the service fee should be added to the cost of the item before you consider the selling price.

Landed cost also refers to an item once it has arrived and is placed on the shelf in your warehouse. Consider that there is an expense your business incurs with someone taking the merchandise off the truck, unpacking it, and placing it on the warehouse shelf. Add to that the freight factor and/or service fee, and you likely have a very different cost for that item.

In the example of the Corvette restorer, there are multiple considerations. Is there any chance a new product will enter the market that would supplant the item he had just ordered in bulk quantity? How much warehouse space does that new quantity of item take up? If you look at your storage area and consider all of the operating expenses for that area—the rent or mortgage payment—you can determine a “cost per cubic foot,” whether or not an item is sitting on the shelf. Traditional retail uses a “cost per square foot,” but because we have shelves with items stocked above each other, we could use a cubic foot consideration.

Another major consideration is the money being saved as well as the money being spent. Yes, there is savings you may realize by buying in quantity. However, you must consider what else that money could be doing for you if you didn’t buy so many.

In the case of the Corvette restorer, what if this shop owner found there was a sizable number of people in the area that were restoring Camaros? This could be a substantial addition of business for the shop, but only if there was money available to put the necessary parts on the shelves. Past the consideration of adding this new category of products, any inventory sitting on a shelf can become expensive.

Now, think about purchasing any part. Let’s say our vendor gives terms of 30 days to pay for the item. If the part is sold within the 30 days, our shop has received the item and received money for the item before having paid the vendor. We refer to this as “playing on house money” because the shop has no exposure.

But the opposite occurs when the shop pays the vendor with a credit card. If the credit card is charging interest from the time of purchase, then that interest should actually be a part of the cost of the item.

If the shop owner buys a dozen of an item and has that initial 30 days to pay for the 12, then any of those items still sitting on the shelf after 30 days are also incurring interest. While this interest may not be paid to a credit card, it is still interest that your money could be earning if it were doing something else for you. Think if you were to invest that money in a money market fund that earns 10 percent over the course of a year. Now that product that is sitting on your shelves after the 30 days is costing you the opportunity to earn that amount of money.

This is not meant to be a long and complicated calculation that you should be doing with each and every item that you order. Instead, these examples are intended to help you think about how you buy.

Once you have paid the vendor, or credit card, and it is not your money that is sitting on the shelf in the form of a product, you need to ask yourself if that is the best place for your money to be sitting.

If the answer is “yes,” then congratulations, as you have demonstrated some savvy buying decisions. If the answer is “no,” then as you sell down that inventory, look for other products, or ways, to get the most out of your monetary investments.

 

Tom Shay

Tom Shay of Profits Plus in St. Petersburg, Florida, is a fourth generation small business owner and manager with more than three decades of experience as a successful independent retailer. He has authored 12 books on small business management and a college textbook on small business accounting. He has also produced hundreds of articles on management for over 75 business publications worldwide.




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