Inventory Control for Farm Supply Cooperatives

Phil Kenkel
Bill Fitzwater Endowed Cooperative Chair

Inventory investment represents over 50% of c rrent assets and !5% of total assets for the typical farm s pply cooperative" #any mana$ers fail to appreciate f lly the tr e costs of carryin$ inventory% which incl de not only direct costs of stora$e% ins rance and ta&es% ' t also the cost of money tied p in inventory" (hese cost total )0*+0% of the inventory val e for the typical farm s pply cooperative" (ypical contri' tions to holdin$ costs are ill strated 'elow"

(he inventory mana$ement inde& is calc lated as I#I /( rns & Earns (he r le of th m' is that the I#I for a cate$ory or prod ct sho ld e0 al or e&ceed )"0" (he 1( rns2 term in the e0 ation relates to inventory t rnover which is calc lated as, Inventory ( rnover / Costs of 3oods 4old56vera$e Inventory (he typical 'enchmark for inventory t rnover for the entire farm s pply department is 7*)0 times per year" 8owever inventory t rnover varies across prod ct cate$ories" (ypical $ idelines for t rnover are shown 'elow

(his fine line 'etween keepin$ too m ch inventory and not eno $h is at the heart of inventory mana$ement" (he $oals of inventory mana$ement are to, #aintain the proper mi& of inventory #aintain the efficient level of inventory -rder efficiently (rack inventory performance and make ad. stments

Cate$ory

6ccepta'le ( rnover 9times per year: Petrole m )5*); Propane !0*<0 -il =*; (ires <*7 Batteries =*; B lk fertilizer )*+ Feed )!*!5 (he 1earns2 part of the I#I e0 ation is the $ross mar$in percenta$e which is defined as, 3ross mar$in / sales price*cost of $oods sold Cost of $oods sold

Inventory Management Index (he inventory mana$ement inde& relates the t rnover of inventory and the $ross mar$in ret rn it creates"

(ypical $ idelines for $ross mar$ins are shown 'elow" Cate$ory 6ccepta'le 3ross #ar$in Petrole m )<*);% Propane 7*)!% -il )0*!0% (ires )0*!0% Batteries )!*!0% B lk fertilizer 5*)0% Feed <*;% Followin$ these $ idelines typically $enerates a 1( rns2 & 1Earns2 inde& of over )"0 4ome ' lk items s ch as fertilizer can 'e profita'le mana$ed with an I#I lower than )"0 while some cate$ories with hi$her la'or or o'solescence s ch as animal health may re0 ire an I#I of over )"0 (he I#I val e provides an indication as to whether yo have the appropriate level of inventory" If the I#I is over )"0 the inventory investment is payin$ its way" >hen the I#I for a cate$ory% a prod ct% or the farm s pply department as a whole is less than )"0 inventory levels sho ld 'e red ced nless mar$ins can 'e improved" The Purchasing Plan (he p rchasin$ plan encompasses two critical decisions, when to p rchase at item and how m ch to order" -ne of the $oals of inventory mana$ement is to have items in stock at the moment they are needed" (he 1re*order point2 is the inventory level at which the stock sho ld 'e replenished" (he re*order point is $enerally determined as ?e*order point / 9avera$e daily sa$e & lead time: @ safety stock

>here lead time is e0 al to the time it takes to receive an item after orderin$ and the safety stock is the amo nt the mana$er wants on hand in case act al demand is hi$her than avera$e or delivery is slower than anticipated" #any mana$ers se a r le of th m' for safety stock s ch as 50% of the lead time amo nt" 6s an e&ample% consider the re*order point for fence posts when the avera$e sa$e is ! ' ndles per day and the avera$e delivery time is 5 days" In this e&ample the re*order point wo ld 'e )5 ' ndles 9)0 ' ndles for the lead time sa$e and a 50% safety stock: and the mana$er wo ld re*order when the inventory on*hand reached )5 ' ndles" The Re-order Quantity (he second component of the p rchasin$ plan is the re*order 0 antity% which is the amo nt that is ordered" (he optim m order 0 antity is a 'alance 'etween orderin$ costs and holdin$ costs" (he more often yo order an item in small 0 antities% the more costly it is in terms time spent p rchasin$ and receivin$ and frei$ht fees" B t if yo order an item less fre0 ently in lar$er 0 antities the inventory carryin$ costs escalate" (here are form las to calc late the optim m order 0 antity 'ased on the orderin$ costs and holdin$ costs" #ost farm s pply mana$ers find these techni0 es too comple& and develop r le of th m' thro $h e&perience" For most prod cts 9' lk petrole m mi$ht 'e an e&ception: it doesnAt make sense to order more fre0 ently than once a week" For almost all items it doesnAt make sense to have more than a B0 day s pply on hand"

Between these two endpoints 9orderin$ a 7 day s pply and a B0 day s pply: the minim m amo nt re0 ired for favora'le frei$ht or delivery char$es sho ld 'e considered" 6 $ood r le of th m' is to order the smallest amo nt that will res lt in favora'le frei$ht char$es ' t never order so little that yo will have to order in less than a week or so m ch that yo will have a !*+ month s pply" (hese $ ideline can then 'e tweaked with information from the I#I e0 ation" For e&ample% if the item has a profit mar$in of )5% yo need 7") t rns a year to reach an I# I of )"0 which implies orderin$ and keepin$ less than a ! month s pply" -!-C nalysis 4elective inventory control% also called 6BC analysis provides a mechanism for identifyin$ items that will have a si$nificant impact on inventory costs" (he system reco$nizes the fact that a small portion of inventory acco nts for a hi$h portion of t rnover and reven e" (he most common version of the 6BC system classifies hi$h t rnover items s ch as do$ food% salt or feed in the 162 cate$ory" (hese items typically represent less than )5% of yo r total inventory ' t more than ;0% of yo r retail farm s pply sales" (he p rchasin$ plan sho ld always keep these items in stock d rin$ season" (he B cate$ory wo ld incl de items with lower sales and t rnover s ch as oil filters or lick t 's" (hese items may represent =5% of yo r inventory ' t only 5*)0% of sales" (hese items sho ld 'e monitored closely and the tradeoffs 'etween carryin$ costs and the shorta$es can 'e wei$hed"

Items in the 1C2 cate$ory have low t rnover and low importance" (his may incl de seasonal or specialty items or items that the p rchasin$ mana$er 9or perhaps the previo s mana$er: erroneo s tho $ht wo ld perform in the 6 or B cate$ories" 4trate$ies s ch as consi$nment sales or re0 irin$ a c stomer to p rchase a f ll case of special order prod cts can red ce this cate$ory" 4ome 1C2 items sho ld simply 'e eliminated" Managing Seasonal Items 6nother ;0*!0 r le is that seasonal items make p less than !0% of inventory ' t create ;0% of the headaches" (he first step in mana$in$ seasonal inventories is identifyin$ the seasonal items" 4ales from previo s seasons sho ld 'e e&amined" If ;0% of the sales occ rred in a = month period of time the item sho ld 'e handled as seasonal inventory" Cemand for seasonal items sho ld 'e 'ased on monthly sa$e in previo s years" (he p rchasin$ mana$er sho ld develop a stockin$ plan for seasonal inventory" (he plan sho ld reflect the lead time is needed to ' ild seasonal stock% when seasonal inventories sho ld peak% and the re*stockin$ c toff date" 6 key to mana$in$ seasonal items is realizin$ that it is accepta'le% and s ally desira'le to r n o t of these items prior to the end of the season"

Shrin"age Inventory shrinka$e is the difference 'etween the amo nts that were p rchased and availa'le for sale and the amo nt act ally sold or still held in inventory" (he avera$e shrinka$e for the D"4" retail ind stry is aro nd )"5% of sales" 4hrinka$e increases the effective cost of $oods sold and red ces the $ross profit mar$in" Ca sed of shrinka$e incl de dama$e% 'roken packa$in$% o'solescence% theft% and paper work or comp ter entry errors" In the case of ' lk prod cts shrinka$e also res lts from inacc rate meas rement% moist re loss% and handlin$ loss" Feed and fertilizer stored in three sided wareho ses can also e&perience shrinka$e from wind loss and from rain and snow enterin$ the stora$e" In the case of retail prod cts shrinka$e can 'e red ced 'y rotatin$ stock% datin$ prod cts and eliminatin$ slow movin$ or o'solete inventory" C stomer and employee theft can 'e addressed thro $h a portfolio of strate$ies incl din$ sec rity% monitorin$% code of ethics policies% whistle 'lowin$ mechanisms and more fre0 ent physical co nts" 3ood wareho se mana$ement can help red ce shrinka$e in ' lk commodities" (his incl des maintainin$ $ood wareho se condition incl din$ pest control and sanitation" Broken 'a$s sho ld 'e repaired or re*'a$$ed immediately as research shows that wareho se personnel are less caref l in a wareho se with one or more 'roken 'a$s" Eift tr ck trainin$ can red ce prod ct loss and also enhance safety"

Controlling Inventory #ost farm s pply cooperatives maintain perpet al inventories sin$ point of sales 9P-4: systems" (hese systems have facilitated more acc rate and timely information on inventory levels and t rnover" (he most common pro'lems with the P-4 system relate to employee error in recordin$ p rchases% codin$ sales and acco ntin$ for inter*company transfer 'etween 'ranches" In addition to providin$ contin o s information on inventory levels% P-4 systems provide the mechanism to monitor I#I ratios at the cate$ory and prod ct level" Information on t rnover and profit 'y item can 'e sed to ad. st p rchase decisions or pricin$ points" P-4 systems can also provide information on seasonal sales trends" 6 ditin$ proced res re0 ire physical inventories prior to the ann al a dit" #ore fre0 ent periodic physical inventory checks can provide a more acc rate indication of year to date cost of $oods sold and mar$in" Physical inventory checks also serve as a deterrent to employee theft" (wo common proced res for periodic inventories are vis al inventory control and ticker control" 6s the name implies% vis al control involves the mana$er or other assi$ned individ al to e&aminin$ the inventory vis ally to determine if additional inventory is re0 ired" (his simple method can 'e a $ood check and 'alance with the contin o s inventory level indicated 'y the P-4 system" (icker control involves the mana$er or staff physically co ntin$ a small portion of the inventory each day so that each

se$ment of the inventory is co nted every so many days on a re$ lar 'asis" In a wareho se% a $rid system can 'e sed with some section of the wareho se inventoried every day or every week" 6fter these physical co nts% the inventory val es in the acco ntin$ records can 'e reconciled to reflect the act al physical co nt" (his more $enerates a more acc rate estimate of cost of $oods sold and year*to*date profits" #ealing $ith #ead Inventory 6t times% inventory items or s '* cate$ories% stop movin$ and 'ecome dead inventory" For these items the I#I $ ideline are meanin$less" (he amo nt paid for the item is a s nk cost and is also not important" (he 'est strate$y is to li0 idate the dead inventory and reinvest the proceeds in inventory that will t rn at ade0 ate mar$ins" Consider an e&ample of an item p rchased for F+00 ' t is clearly not movin$" -ne alternative wo ld 'e to wait two years to sell the item for the desired F500 sales price" If inventory carryin$ costs% which incl de interest% ins rance% la'or% tilities% are +0% which is typical for hardware items% the profit is F!00 less F);0 carryin$ costs 9FB05year: for a total of F!0" 6lternatively% ass me the item co ld 'e sold immediately for F!50 and the proceeds invested in inventory that t rns over 5 times a year at a !0% mar$in" (he profit in two years wo ld 'e a F50 loss on the dead item @ F50 mar$in for each time the new item t rned over 9)0 times: less the carryin$ cost of F755year" (he total profit wo ld 'e F)50" (akin$ a

F50 loss netted F)+0 more over the two year period" %S& Research on Farm Supply Inventory Management ?esearch cond cted 'y -klahoma 4tate Dniversity e&amined the inventory mana$ement practices of a local farm s pply cooperative" (he case st dy cooperative had accepta'le inventory performance at the department level" (he $oal of the research was to e&amine p rchasin$ decisions% inventory t rnover and profit at the cate$ory and item level" (he research e&amined F+5# of farm s pply sales representin$ +00%000 transactions% 5%000 items and +0 'ranches over a !< month period" (he res lts indicated that I#I performance varied s 'stantially across cate$ories" Petrole m% fertilizer% feed and crop protectants cate$ories had the hi$hest performance while animal health% seed and hardware were the lowest performin$" (he more important res lt was the variation in performance within the cate$ories" In all of the cate$ories the I#I performance co ld 'e improved a'ove ind stry avera$es 'y eliminatin$ 5% or less of the total items" (he research also e&amined the p rchasin$ strate$ies" -verall% the act al p rchasin$ strate$ies 9re*order points and re*order amo nts: closely corresponded to the optimal least cost strate$ies" (he cooperative p rchased sli$htly too fre0 ently and held sli$htly too hi$h inventory levels" 8owever% the potential 'enefits from improved p rchasin$ were not as $reat as those of eliminatin$ non*performin$ items"

Summary Inventory is a necessary ' t costly aspect of a farm s pply operation" (he $oal of inventory mana$ement is to ens re that inventory items are $eneratin$ s fficient mar$ins to . stify the carryin$ costs" (he I#I provides a meas re of inventory mana$ement" (ools for improvin$ #I incl de the p rchasin$ plan% selective inventory mana$ement% shrinka$e control and periodic physical inventories"