In a previous role, I oversaw the global inventory management strategy and risk for a $7-billion Information Technology and Networking distributor, reporting directly to the CFO. On a consolidated basis, the on-hand inventory balance was between $400 and $500 million at the time.
On the heels of the 2008/2009 financial crisis, management of working capital became critical for companies across many industries. Specifically, Days of Working Capital (or Working Capital Days) became perhaps the most important company metric for our organization after EBITDA. Working Capital Days is comprised of Days of Inventory On-Hand (DIO) along with Days Payable Outstanding (DPO) and Days Sales Outstanding. My particular focus was on Days of Inventory On-Hand. In this article, I will outline a few of the key metrics and communication strategies we implemented that enabled our organization to most effectively improve our global inventory management and risk profile.
Standardized Metrics & Processes
The first key consideration to most effectively manage global inventory is the establishment of the correct standardized metrics or key performance indicators (KPIs).
The metric most reviewed in our organization measured aged inventory. Similar to an aged Accounts Receivable report, we reviewed an aged inventory report in 30-day increments. Aged inventory is critical in identifying if you have excess inventory or the wrong mix of inventory. This was particularly true in the IT space, where products become obsolete as the technology evolves. In our case, inventory that had been in stock for over 90 days was considered old or aged inventory. On a weekly basis, we monitored the total on-hand inventory over 90 days old as well as the percentage of inventory over 90 days.
It’s particularly important to consider that global inventory management is complex for a multinational company, as business practices may differ throughout the world. Therefore, the percentage of aged inventory may be higher in an emerging market than in a more developed region. The size of your business, or market share, in a particular region or country can also play a factor in managing aged inventory. Similarly, the mix of vendors or products can also be a factor in how inventory flows through the company.
Days Inventory On-Hand
Days Inventory On-Hand (DIO) or Day On-Hand (DOH) is a metric which measures how many days sales of inventory you have in your warehouse. The key difference between this and the previous KPI is that it does not consider how old the inventory is, rather it focuses on how much inventory you have on hand. The challenge with this metric is that there are several ways in which you can calculate it. In our case, we used the formula:
DIO = Ending Inventory/ (Cost of Goods sold/90 days)
Some widely published formulas use the average inventory instead of ending. Some calculations use Sales or Cost of Sales rather than Cost of Goods Sold. In some instances, companies will use 365 days instead of 90 days. Our focus was quarterly performance, due to a seasonal component of the business as well as compensation related issues. Using 365 (or 360) days rather than 90 will smooth issues. You may want to align your formula to that of your competitors if they are public companies or have publicly available data. This will allow you to benchmark yourself against other companies in your industry.
The Importance of Communication
Even if you don’t plan on using the metrics for industry comparisons, you should clearly communicate to all the relevant parties how the metric is calculated, including each component. If you use COGS, the figure may include non-inventory costs like warehouse rent or operations labor. If you use sales in your denominator, do you use gross or net sales? If you want to be consistent with your DSO metric you would use Gross Sales, the amount to be collected from the customer. However, Net Sales will likely be the number reported in your financials. Clear communication on how and why each variable is used is important to its success.
Another critical process that was implemented was the standardization, documentation and calculation of inventory obsolescence. Developing a standard method reduced fluctuations in the reserve on a quarter to quarter basis and provided more transparency to corporate finance. Using a standard methodology can prevent regional leadership from manipulating performance or covering up inventory issues. The percent of obsolete inventory is also a useful competitive metric against companies in the same industry that publicly report.
Structuring Communication and Collaboration in Global Inventory Management
In a global or multi-national company, many business challenges can occur due to distance, local business culture and time differences. Having regular communication with leadership in the respective regions can help mitigate business risks and get ahead of problems. In our case, we developed a number of processes and procedures around communication and collaboration in global inventory management.
First, the company developed a Matrix of Authority (MOA) for inventory purchases. All purchase orders required approval by various levels of management. The matrix identified who within the company needed to approve based upon region, Purchase order amount and reason for order. North America, Europe, the Middle East and Africa (EMEA) were of similar size ($2B+ Annual sales) while the Latin America and Asia-Pac regions were at around $1B annually. Small stocking orders to replenish inventory to previous reorders points would generally only require approval from local or country management. In some instances, large vendors would request that we place purchase orders in the tens of millions as their quarter end approached. Requests such as these would often require approval of the global CFO. Occasionally purchase order requests were made for special or slow-moving stock where a sales deal was pending and time was of the essence but the customer has not yet issued their purchase order. The development of the purchasing matrix meant that multiple functional areas had the opportunity to weigh in and voice concern over how it affected their area. For operations that was Inventory management, for finance it was working capital, and for sales it was revenue and gross margin contribution.
The second major collaboration effort was the establishment of the Inventory Council. This was a monthly virtual meeting that I chaired that brought together the finance and operations members from each region along with the senior finance and operations leaders from corporate. The agenda for the meeting included reviewing working capital performance relative to targets, discussing inventory trends, and requiring the local leadership teams to review their current inventory profile and highlight risks. In a large company such as ours, the head of operations might work out of a different office or country than the regional CFO. As a result, the inventory council was often educational for people operating within the same region. It provided a forum for purchasing and inventory leaders from different regions to discuss the practices of the vendors or share information on new vendor initiatives.
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About the Author
David is a CPA with more than 20 years of diverse finance, accounting, and financial systems implementation experience across various industries. He is an alumnus of Grant Thornton and PWC. Prior to joining 8020, he was Finance Director for Westcon Group, a $7B global IT distributor, where he was responsible for global inventory and supply chain reporting, Capex, and net working capital. He has led implementations of Hyperion Financial Management, SAP BPC, and JD Edwards. He holds a Bachelor of Science degree in accounting from Binghamton University and a Master of Business Administration degree with a concentration in accounting from the University of Buffalo.