The problem of Inventory

Excess Inventory is a problem

Operations Manager of a manufacturing company who is a dear friend came to me and said, “ Our company recently underwent a major restructuring. During the process many people quit and few moved to different projects. I got promoted in the process but the problem is I find it hard to run the show with allocated budget.I am thinking of quitting.”

I told him to cool down and started with making them learn about basic financial statements. During the process we found out that this company had nearly $400,000 worth stock in the warehouse. They were still ordering more stock. Immediately I called the warehouse manager and asked him about the stock. He said that he had been given this position recently and was not sure what the previous warehouse manager was doing. He was not sure what needs to be done and just follows the orders from the operations manager.

This is when I told the warehouse manager to make a list of all the stock, whatever is in the warehouse. Then next to it you have to tell whether it can be used in the next production cycle. He had to tell whether the raw material in the warehouse could be used in the manufacturing process? If not could it be sold directly to the customers or some other company? Or could we exchange it with the supplier? This decision had to be made by the operations manager as they deal with the suppliers.

Within a week the warehouse manager came with this list and we found out that there was no need to order more raw material. There was enough in the warehouse for 6 to 8 weeks. After two months when we looked at the financial statement, the Bottom-Line had a positive impact and the company was making much profit. They said we had done magic. Of course it was no magic, it happened because we made sure that the company was making more money than it was spending. The stock that was in the warehouse we just used it.

Three things that happen with Profit

Profit

  • Reinvest – It gets reinvested in the business. That is the paradox in business, the more money it makes the more it reinvest. This is because the owners want to expand the business.
  • Repay – One of the things that business will do with Profit is to use it to repay the liabilities. Mainly it would be the current liabilities like payable and sometimes would include long-term liabilities.
  • Dividend – The owners and investors would take a part of Profit in form of Dividend.
  • In a previous chapter we have learnt that, When money goes out, it either becomes and Expense or creates an Asset.
  • We also know that, There are two kinds of Assets,
    • Performing Assets (PAs)
    • Non-performing Assets (NPAs)
  • It is suggested to use profit made by the business to spend on expenses if required. If a business needs a more comfortable and healthy working environment for the employees. If it decides to spend money on buying better chairs, latest gadgets, decorative items, better kitchen area; it is advisable to use the money from the profit of the business. The spending should not be from borrowings.
  • The borrowing (Liabilities) is the money business has borrowed from insiders and outsiders .It is suggested to use that money mainly on Performing assets than on non-performing assets.

I would suggest you to get in touch with your mentors, consultant or accountant or some advisors you may have in your business or use you common sense to ask this question.

Question:  The decision that I will make how will it impact the Bottom-Line of my organization?