Effective Inventory Management With MAS 500

As the competition for customers grows, distributors find themselves faced with shrinking profit margins. In this environment, carefully managing stock levels and understanding the true profitability of each product becomes critical. In this article, we examine best practices for analyzing inventory performance, and discuss the tools available within Sage ERP MAS 500 that can help you maximize profitability.

The Balancing Act
For every inventory item, an optimal stock level balances customer availability needs with net profit. Achieving an optimal stock level requires you to maintain sufficient levels of inventory to satisfy customer expectations of product availability. At the same time, distributors seek to stock precise amounts of each item to maximize net profits. Powerful and flexible reporting tools are needed to measure progress in achieving these goals. Without the right information, the distributor is at risk of either failing to satisfy the needs of the customer or stocking excess inventory and reducing net profitability.

The Four Metrics Of Inventory Performance
To get a complete picture of Inventory Performance, we look at four key areas: Customer Service Level, Inventory Turnover, Return On Investment, and Adjusted Gross Margin. Sage ERP MAS 500 tracks these metrics to assist managers in pinpointing successes and identifying areas for improvement. Here we discuss each in turn.

Customer Service Level – The customer service level measures how often items must be in stock when customers require them. The customer service level is calculated using this formula: Number of line items for stocked products shipped completed by the promise date, divided by the total number of line items for stocked products ordered.

This formula is applied only when the entire quantity ordered is delivered on or before the promise date. If the customer orders 10, and the distributor ships 10, they receive credit toward achieving the customer service level. If the customer orders 25, however, and only 24 units ship before the promise date, there is no credit. There is no partial credit for shipping 24 out of 25 because the customer will have to find that last unit somewhere else.

Inventory Turnover – If a distributor annually sells $10,000 worth of a product line, is it wise to purchase the entire $10,000 at one time? Or could a company buy some, sell it, and then buy some more with the money made selling the initial quantity?

In the first case, a substantial sum becomes tied up for a year. In the second case, the initial investment in inventory for the product line is less. The balance of the $10,000 not invested in stock for this product line can be used for other purposes. Inventory turnover measures the number of times the distributor sold or turned stock during the past 12 months. Inventory turnover is calculated with this formula: Cost of goods from stock sales and transfers during the past 12 months divided by the average inventory value.

If the total cost of goods sold for the past 12 months is $6 million and the average full inventory value is $1 million, the distributor has achieved six inventory turnovers.

Return On Investment – Many companies are fixated on the goal of maximizing inventory turnover. However, higher margins can make a distributor successful with fewer inventory turns. Take the example of distributors that specialize in stocking hard-to-find, slow-moving products. These distributors are successful because they command a premium price. Return on investment (ROI), calculated by multiplying inventory turns by the average gross margin shows us that high margins can compensate for low inventory turns. If an inventory item turns over four times a year and earns a 30 percent average gross margin on each sale of the product, a return on investment of 120 percent is achieved. However, the same return on investment value can be achieved if the inventory item turns only twice, but achieves 60 percent average gross margin:

4 turns x 30% average margin = 120% ROI
2 turns x 60% average margin = 120% ROI

On the other hand, lower margins reduce ROI if a higher number of turns do not make up the difference. All other things being equal, the item that achieves the target return on investment with the fewest inventory turns is the more profitable item. Carefully examining return on investment allows quick and easy comparisons of the overall performance of several product groups or product lines.

Sage ERP MAS 500 ROI reporting can help you analyze the balance between turnover and profit.

Adjusted Gross Margin – Gross margin is the most common measurement of profitability. Gross margin is calculated using this formula: Annual Sales Dollars, minus Annual Cost of Goods Sold, divided by the Annual Sales Dollars.

However, the true profitability depends on the average value of inventory the company must maintain to generate sales of the item. Adjusted Gross Margin takes inventory carrying costs into account. The following expenses are normally associated with carrying inventory:

• 40% of the material handling expenses
• 40% of rent and utilities
• Insurance and taxes on inventory
• Physical inventory and cycle counting costs
• Inventory shrinkage and obsolescence
• Opportunity cost of the money invested in inventory

Typically, the carrying cost of finished goods inventory is 25 to 35 percent per year of the average inventory value. For this reason, it is better to use Adjusted Gross Margin, because it takes inventory carrying costs into account, when analyzing inventory performance. Here is the adjusted gross margin calculation used by Sage ERP MAS 500: Annual Sales Dollars, minus Annual Cost of Goods Sold, minus (Average Inventory Value times Carrying Cost %), divided by Annual Sales Dollars.

Performance Analysis Report
To facilitate management review, Sage ERP MAS 500 lists all four of these evaluations on a single report. This report can be printed for product stocked in specific warehouses, assigned to specific buyers, included in specific purchase or sales product groups, or assigned to specific product ranks.

The report is available in detail or summary format. The detail version lists analysis information for each of the selected items. The summary version provides a one-line summary for each warehouse, buyer, purchase product group, sales product group, and rank selected. This single report can help you take control of what is probably your largest investment.

Is your inventory optimized for maximum profitability? Give us a call with your questions.