asks.
“It has already dropped to forty days and continues to rapidly shrink. Of course, as time goes by this rapid decrease will slow down. Remember, we were so much out of control that in some of our warehouses, for some products, we had more than nine months of inventory.”
“Not bad,” I conclude, “not bad at all. So you increased on-time delivery from thirty percent to the nineties, while reducing inventories from ninety to forty days, and you are still going strong. Nice.”
“Forty days is what he currently has in the regional warehouses,” Stacey unnecessarily reminds me. “To guarantee that the replenishment time to the regional warehouses is only dependent on transportation and not on availability, Bob must also hold additional finished goods in the plants, his central stocks, as he calls them.”
“Yes, of course,” Bob laughs. “I wish my total finished goods inventory would have been only twenty days. As for the plant stock, I do the same thing. The replenishment time in this case is determined by the ability of the plant to produce its full range; the improvements we made last year shrunk this time considerably. I have roughly twenty days’ finished goods inventory in the plants. This is sufficient.”
“I see,” Stacey summarizes. “Before, you were sending products the minute they were produced, relying on a forecast that is three months into the future. No wonder you ended up with the wrong products in wrong places. Now you ship to a specific region only when the shops have actually consumed the product. That’s smart. I have to think more about it,” Stacey is trying to digest. “Can I get the detailed, logical trees?”
“No problem,” he beams, “I’d be delighted.”
Don looks totally puzzled. I don’t believe that he understood it all. He didn’t go over the logical trees with Bob, and he is not a logistical expert like Stacey.
“Do you have any questions, Don?” I ask him.
“Many. But I’m particularly curious as to what happened to the transportation costs?”
“We’re now replenishing regional stocks on a constant basis,” Bob patiently explains. “This enables us to ship only full truckloads. Moreover, we never need to air freight a small quantity to a regional warehouse, and the warehouses don’t have to ship to each other. No wonder transportation costs went down.”
“This was heavy stuff,” I say, “let’s break for lunch. Stacey, after lunch we’ll discuss your company, okay?”
“Sure thing, Boss.”
7
I don’t go to lunch with them. I need the time to think. Bob has already reduced his inventory by thirty days, and he will continue to reduce it. Operationally it makes perfect sense, but there’s a problem. A huge problem. Reducing finished goods inventory has a bad short-term impact on the bottom line.
We hold inventory on our books at its cost value—cost as calculated by cost accounting. This means that the finished goods inventory is not registered as raw material cost but rather as raw materials plus added value—the labor and overhead. During the period we reduce finished goods, all the added value in the portion we have reduced hits the bottom line as a loss.
I try to figure out the numbers in Bob’s case. He will reduce his inventory by about fifty days of sales. His company is now selling about $180 million a year; so fifty days means approximately $25 million. On the books I won’t see the inventory reduced by $25 million, since on the books we carry the finished goods at cost value rather than sales value. I will see the inventory reduced by about $17 million. And the impact on profit? For that I have to subtract from this number the money that we paid for raw materials, let’s say about $7 million. My God, his loss will grow by $10 million.
I’m trying not to panic. Of course this is just funny money, cost accounting distortions; and yes, later it will be more than compensated for by real money, by the real savings
“It has already dropped to forty days and continues to rapidly shrink. Of course, as time goes by this rapid decrease will slow down. Remember, we were so much out of control that in some of our warehouses, for some products, we had more than nine months of inventory.”
“Not bad,” I conclude, “not bad at all. So you increased on-time delivery from thirty percent to the nineties, while reducing inventories from ninety to forty days, and you are still going strong. Nice.”
“Forty days is what he currently has in the regional warehouses,” Stacey unnecessarily reminds me. “To guarantee that the replenishment time to the regional warehouses is only dependent on transportation and not on availability, Bob must also hold additional finished goods in the plants, his central stocks, as he calls them.”
“Yes, of course,” Bob laughs. “I wish my total finished goods inventory would have been only twenty days. As for the plant stock, I do the same thing. The replenishment time in this case is determined by the ability of the plant to produce its full range; the improvements we made last year shrunk this time considerably. I have roughly twenty days’ finished goods inventory in the plants. This is sufficient.”
“I see,” Stacey summarizes. “Before, you were sending products the minute they were produced, relying on a forecast that is three months into the future. No wonder you ended up with the wrong products in wrong places. Now you ship to a specific region only when the shops have actually consumed the product. That’s smart. I have to think more about it,” Stacey is trying to digest. “Can I get the detailed, logical trees?”
“No problem,” he beams, “I’d be delighted.”
Don looks totally puzzled. I don’t believe that he understood it all. He didn’t go over the logical trees with Bob, and he is not a logistical expert like Stacey.
“Do you have any questions, Don?” I ask him.
“Many. But I’m particularly curious as to what happened to the transportation costs?”
“We’re now replenishing regional stocks on a constant basis,” Bob patiently explains. “This enables us to ship only full truckloads. Moreover, we never need to air freight a small quantity to a regional warehouse, and the warehouses don’t have to ship to each other. No wonder transportation costs went down.”
“This was heavy stuff,” I say, “let’s break for lunch. Stacey, after lunch we’ll discuss your company, okay?”
“Sure thing, Boss.”
7
I don’t go to lunch with them. I need the time to think. Bob has already reduced his inventory by thirty days, and he will continue to reduce it. Operationally it makes perfect sense, but there’s a problem. A huge problem. Reducing finished goods inventory has a bad short-term impact on the bottom line.
We hold inventory on our books at its cost value—cost as calculated by cost accounting. This means that the finished goods inventory is not registered as raw material cost but rather as raw materials plus added value—the labor and overhead. During the period we reduce finished goods, all the added value in the portion we have reduced hits the bottom line as a loss.
I try to figure out the numbers in Bob’s case. He will reduce his inventory by about fifty days of sales. His company is now selling about $180 million a year; so fifty days means approximately $25 million. On the books I won’t see the inventory reduced by $25 million, since on the books we carry the finished goods at cost value rather than sales value. I will see the inventory reduced by about $17 million. And the impact on profit? For that I have to subtract from this number the money that we paid for raw materials, let’s say about $7 million. My God, his loss will grow by $10 million.
I’m trying not to panic. Of course this is just funny money, cost accounting distortions; and yes, later it will be more than compensated for by real money, by the real savings
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