Whitepaper on Inventory Management
for the Custom Install Industry
By Jonathan Knapp
March 2008
Even though most custom installers run their business with low levels of inventory, there are three big benefits to having a well-thought out inventory management process in place:
1. You will limit mistakes that can trainwreck a project and demoralize everyone, including your customers.
2. Your inventory has a real dollar value that you don’t want to lose, waste, or have walk out the back door.
3. A well-designed inventory process is a necessary part of an effective overall work process. You need it to satisfy existing customers, create profit, and put systems into place that will let you grow.
Don’t let overlooking your inventory process be the thing that prevents you from taking your business to the next level.
Here are some important principles and some quick tips you can implement immediately to get you on track to creating a good inventory process, across eight areas of your business.
These best practices are found in the most successful custom install businesses.
1. Purchasing Process
An accepted sales proposal should automatically generate the Bill of Materials needed for each job and drive the procurement process. Guessing sales levels of products creates twice the work for you, since you will have to fix it later, so you should only purchase what a customer has committed to with a signature.
For long term projects of months or years, the project manager must signal the need to order product for each phase. The Need-in-Hand Date derived from the construction schedule should drive the order request, and also factor in the lead time required for each product vendor.
Any inventory process will fail without accurate inventory counts. All inventory and physical locations must be known to the purchasing department. Remember, your vans are inventory locations since they carry stock of wires connectors and other parts used in an installation.
Physically count your inventory on a regularly basis to know what is available for new jobs. Put it in the calendar. If you aren’t already doing a complete count on a regular basis, divide your inventory by brands or location and do a partial count. What you find may shock you and motivate you into doing a complete audit.
You can also divide your inventory into “A”, “B” and “C” categories. The “A” category being your fastest moving items defined as the top 20% of you SKUs (stock keeping units) in sales. The “B” category is the next 20% of your SKUs and the “C” category is the balance or 60% of your SKUs. But if you don’t have a process in place already, you probably don’t know what goes into your A, B, or C categories, do you?
Give your sales staff an on-hand report of unallocated products. To maximize your inventory investment, you should always try and sell inventory that is already at your location.
All purchase orders should be in writing with current and correct pricing, payment terms and delivery information. A purchase order is a contract between you and your vendor. A verbal order lacks proper documentation and therefore can allow the terms of this contract to be determined by the vendor. Create all purchase orders in writing with the specific terms of payment, pricing, shipping etc. that fill in automatically where possible. This protects you from any changes in terms or pricing by the vendor.
Your proposal and purchase order systems should be linked and include all necessary details for creating an accurate purchase order, especially having up-to-date product pricing. Incorrect vendor costs mean incorrect purchase orders and disappearing profit on the installation if pricing is not current.
Since the dream of JIT (Just in Time) is still a dream, it will be necessary to stock some inventory items: wire, back boxes, preconstruction brackets and the numerous hardware items needed for installations that come up on short notice. Since the lack of a particular item can delay an installation, the recommended minimum level for inventory is a four week supply. (Any time an item falls below this four week supply amount, an additional four week supply is ordered. If lead times for any part exceeds this four week supply, then the amount must be increased so that you never run out of these key installation parts.) This simple "four week" rule of thumb will keep you from overthinking the small stuff so you can focus on the issues that will give you a bigger result in your business.
2. Receiving Process
Take the time to come up with a standard process for receiving that can be put on a checklist and kept in your receiving area.
As products are received, they should be referenced to a purchase order and allocated to the appropriate project.
Packing slips that come with product shipments need to be cross referenced to the order to confirm quantity, type, model, finish and all other details of the shipment. Obviously, any errors should be noted and communicated immediately to the vendor.
All products should be carefully inspected for damage. If damaged is noted at the time of receipt, the freight carrier and shipper should immediately be notified of the damage. Make sure to keep all packing material until a claim has been filed and any inspection requests by the freight company have been dealt with.
Packing slips and purchase orders should be then referenced to the vendor’s invoice to verify correct pricing and terms.
An automated system can generate bar code labels that include both product information (make and model) as well as project information (Client, Project, Room, & Discipline). This allows for easy tagging of products as they are received and avoids delays in delivery.
Bar code scanners along with a printed inventory label affixed to the product's box can be a huge help in this process. Bar code scanners can also capture each products unique serial number for warranty tracking.
Bar code scanners can also be used to read the UPC codes on virtually all your incoming products, eliminating manual entry. Although UPC codes do not include specific details on a particular installation, they do contain brand and model information for each product.
3. Scheduling
Think about how you can schedule labor and product deliveries to achieve the greatest efficiency. Having product picked up or received too early increases the chances of damage as these goods needed to be moved and stored at your facility. Additionally, when product is just sitting in your facility, it ties up cash that could be used for other purposes in your business.
One strategy is to have a system which can determine the availability of products required to complete each work order and to signal when that work can be scheduled.
Most custom installers achieve a labor utilization of 45% to 55% of the billable hours in a work day. Increasing your labor utilization by as little as 5% can result in a 10% increase in bottom line labor profit dollars. Therefore your process must be able to coordinate your installations with product deliveries to achieve greater productivity.
Use Gantt Charts. The construction industry uses Gantt Charts to provide a timeline of the major phases for each job. An effective Gantt chart can also help your team see, at a glance, all the critical milestones to keep the project on track. Each member of your team can see the dates and deadlines related their role in the project.
4. Staging & Pre-racking
When a specific product is in limited supply the product can be moved from the general inventory area to a staging area designated for a specific project. This staging area is also used for pre-racking an installation. Don’t get stuck being unable to complete a particular project just because you lost track of a single component.
When staging goods, a corporate culture of respecting the staging area is required. This respect forbids the removing of staged goods from one job to another job without approval from purchasingand the project manager. If products are taken from the staging area, it is imperative that a process is in place to follow up and replace the products that have been 'borrowed,’ but, more importantly, if this is happening, it is a warning sign that you need to re-evaluate your inventory process.
Control and restrict who has access to the staging area to avoid changes or unapproved movement of products.
In some instances, staged areas might require limited access by using cages for products and having these products under lock and key.
All movement of products has to be documented. Either a bar code reader or written transfer reports that are signed by the person authorized to control the staging and warehouse area.
5. Delivery
The delivery process includes not only customer deliveries, but also deliveries back to distributors and manufacturers for stock adjustments, defects, repairs and stock balancing. Knowing when the product leaves your system also demands that you have a process for noting the changes in inventory in your system.
All products leaving your location should be recorded via bar code scanning (if available), written transfer reports, or delivery receipts. These documents or scans need to create an invoice or note the new location of the inventory if the movement of product is from one inventory location to another inventory location.
Generally there are two places where inventory is delivered or shipped.
-The first area is customer’s homes and this inventory should be invoiced or accounted for, even if it is replacement for a defective product.
-The second location is return to vendor. Typically this inventory should be noted with a debit memo to the vendor’s account. This vendor can be a manufacturer, distributor or even a repair station.
Your inventory process should demand that all products, when taken out of your system, are deducted from your asset base and replaced with another asset on your accounting system. This new asset can be a debt to your payables, debt to a vendor account, billing a vendor an invoice to the end user.
As you deliver the products for each job you are increasing your percentage of completion. Delivering products to your client allows you to recognize revenue for that equipment and also impacts the work in progress (WIP) calculation for each project. WIP is the difference, at your cost, between the portion of the project that you have completed and the portion of the project that you have billed. This number indicates the cost to complete ongoing projects and becomes a critical factor for setting the value for your business when you choose to sell the business or borrow money.
6. Invoicing Your Clients
For products that are part of an accepted proposal, or a change order, timely invoicing is imperative. These invoices can be:
1. Progress bills triggered with either phase or percentage of completion milestones.
2. Line item billing based on the actual list of products delivered.
3. Extras that are not part of the original proposal or a formal change order but are billed with line item billing.
Product deliveries can either advance the percentage of completion or drive account receivables directly with an invoice being issued.
Proper inventory tracking requires a process where inventory, when delivered, transfers the inventory asset to the customer’s account via an invoice and then becomes an account receivable. Invoices are created on an ongoing basis and need to be verified.
Inventory needs to be in your location, shown as job cost, or appear on a customer’s invoice.
All line item billing should be done within 24 hours of delivery. This will eliminate many of the problems of tracking and collection that can occur if billing is delayed. Your billing system should facilitate timely invoicing; this will positively impact cash flow.
On a continuous basis, all inventories should be accounted for whether at your warehouse or shipped to your client. All products delivered to a client should be recorded by bar code scanner or paper documents to support client accurate invoicing and project job costing.
Change orders must be implemented in advance or within 24 hours of the change. Your inventory control system should require that all products should be listed on the proposal or on a change order before the products can be delivered.
Your invoicing process requires total accuracy. Only after doing a physical count will you truly be able to reconcile your inventory. If the inventory is no longer at your facility has it been invoiced? If a discrepancy exists, work on it quickly. The product may have been returned to a vendor, out for repair, or again, delivered but not billed out to a client.
Items that were not originally included in the design proposal but are required to complete the job must also be listed on a charge order even if it is a zero dollar change order.
7. Paying Vendor Bills
It is imperative that you have a process for paying vendor bills for products received. This process is time sensitive since you should never miss a cash discount for a payable. Even if the cash discount is only 1 or 2%, this discount on an annualized basis is significant. You will lose substantial pure profit dollars when these discounts are not taken.
Have a time sensitive system for paying vendor bills within their discount terms.
All bills should be matched to a receiving report. If using bar code scanners, these reports can be automatically generated. Paper receiving reports need to be hand matched to the vendor invoice.
All terms and pricing should be double checked against terms and pricing on original purchase orders. The importance of having sent a written purchase order via email, fax, mail or in person to the supplier means that your pricing and terms are accepted when they ship the order.
All pricing discrepancies should be corrected with the vendor or the purchase order should be adjusted to indicate the correct price. These changes should be reflected in the material job cost for each project.
Make sure that all credits for products, advertising or any other promotional allowance is taken on the next available invoice after the credit is received.
8. Auditing and Preventive Measures
Knowing what you have and preventing loss of inventory are measures that all companies should follow. The loss of inventory is not only the loss of revenue, but the loss of pure profit dollars in a business since the inventory has to be replaced. Loss prevention and monitoring levels is important for all dealers, even for those that use a JIT system.
When conducting a physical count in your warehouse, staff should use preprinted worksheets that list products by vendor, category or location. These physical count worksheets should NOT indicate the current stock level (prior to counting). This will force a count on each item rather than just confirmation that a particular count is on the shelf.
Periodic reconciliation of the inventory value as stated on your balance sheet with the value of your actual physical count. If items that are shown in your inventory control system can not be found, you need to find out where that merchandise is and if not at your facility where did it go. It may be as simple as being delivered to a customer and mistakenly not billed.
Develop a corporate culture in your company that demands respect for inventory. This respect includes: - Making sure that all inventories are handled properly. Nothing is worse then going to an installation and having hidden damage exposed at the site. - Moving inventory from one location to another without accounting for this movement makes everyone’s life miserable. All movement of inventory needs to be noted in the system. -All staged products are not to be changed without authorization from the project manager and purchasing manager of the installation.
All product delivered to a job site should be kept in a controlled location (locked room, construction trailer, van etc.) until installed or should be signed for by the client or client representative. This is particularly critical when delivering to a third party as when lighting control products are delivered to the jobsite electrician.
Location of inventory in your facility is extremely important. Small valuable items, for example remote controls, should not be stored near exit doors or loading docks. Preferably, all small goods should be stored in locked areas that are secure.
Proper documentation creates a paper trail that is necessary for auditing your inventory.
Conclusion
While some of these processes may seem like overkill, the thing to remember is that once these processes can be clearly communicated or automated in a system, they can be delegated.
Whether you are the owner of the business or the manager of a team, you need to be able to create processes that work even when you aren’t there to offer your experience and expertise.
Systems that require you to be in the middle of every process or decision are not systems that can grow a business to the next level or support it once it gets there.
Addressing your inventory process is part of the larger work of creating processes throughout your business to free your time and energy to focus on the parts of your business that are the most challenging, profitable, and fun.
And making that transition is the path to success.