Sophmore Year: Basic Purchasing and Replenishment
Purchasing inventory can be a fun part of the business. Purchasing the correct quantity at the right price is necessary to preserve cash flow and margins.
While most companies maintain an online inventory system and have the option of creating purchase orders through a computer system, there are still some companies that walk the yard and “fill the bin.” What’s that? This is when you look at a bin and figure out what it will take to fill it to capacity. While this may work for some of you, I’ll focus here on automated purchasing.
First, some key data definitions:
Days on Hand (DOH): The number of days you keep an item in stock. Millwork assembly facilities or production facilities also refer to this as days on the floor. This can either be actual, where you know how many days you have on hand based on activity, or it can be a number that you try to achieve.
Lead Time (LT): The time it takes to receive an order from the time the order is placed. For example, if your vendor needs two days to process an order and five days to ship an order, the Lead Time will be seven days.
Turns: Cost of goods sold divided by average inventory. This measures the number of times the inventory stock is completely sold per year.
Gross Margin Return On Inventory (GMROI): Warehouse gross profit times 100, then divided by the value of the average inventory. GMROI measures the gross margin earned per dollar of average inventory.
Floor: The minimum amount of inventory that you must have in stock.
Ceiling: The maximum that you must have in stock.
Daily Sales (DS): The average quantity of sales per product for one day.
Quantity Available (QA): The amount of inventory that’s not already allocated for specific customers.
Quantity on Hand (QOH): Typically, what you have shipped. It should equal an inventory count.
Quantity On Order (QOO): The amount of inventory on order from your vendors.
Quantity to Order (QTO): The result of what you should order to fulfill the purchasing requirements.
Note: When you begin stocking new items that have no sales history, a dealer typically uses Minimum and Maximum in place of history when determining stocking levels.
Now let’s illustrate an efficient purchasing system. I will use roofing as an example. The process involves asking these questions:
?What is the Daily Sales volume of this product?
Let’s say 20.
? How long does it take my vendor to deliver the product from the time that I purchase? What is the lead time?
Let’s say LT is 14 days.
? How many days’ worth of stock do I want to hold?
This in essence is your Days on Hand. It’s a tricky one, because a truly efficient
operation may only want one day’s worth of materials. But we can’t run out of
stock. If the wholesaler is next door and you can pick up products same day, you
can push this number down. For this experiment, we’ll say we want 30 days’
worth of stock on hand.
? What is the minimum we want on hand?
For this test, we’ll say 100.
? What are the Quantity Available and Quantity on Order?
For this, we’ll say 100 and 225, respectively.
Put the numbers into a formula: DS x (LT + DOH) – (QA + QOO) = QTO
Or: 20 x (14 + 30) – (100 + 225) = 555
In other words, we should order 555 units.
As you develop the numbers to do your calculation, keep these goals in mind:
Keep the Order Pipeline Steady. On products where you feel confident about price and demand–locksets, for example, as opposed to studs–you’re better off buying a little at a steady rate rather than a huge quantity once a year.
Reduce Number of DOH. As I become better at managing the products flow, I can begin reducing the Days On Hand from 30 to lower numbers.
Minimums are Necessary. Establish a floor amount for those so-called C and D items that don’t move quickly but can bring you grief if you run out. For example, while the system may suggest that you stock 20 squares of shingles for a slow-moving color, you may decide that that you must keep 35 in order to cover a typical roof in your market.
Report by Department. For products like dimensional lumber, you might want to report by department since the vendor varies based on supply and demand. Commodity lumber is not typically purchased from one vendor.
