A contracting company is in the business of prospecting, selling, installing, and servicing work for their targeted customer base. Inventory of needed materials is important. But, is it wise for a contractor to maintain a large inventory?
Many inventory gurus argue a contractor should only stock materials that will be installed within a normal business cycle. For the Green Industry that would be one week to a month. Some argue that no inventory should be maintained at all, buy as needed. A minority argue that having a lot of stock is good, if great buys and terms are negotiated.
In this first part let’s dive a little bit deeper into the idea of buying as needed.
Buying As Needed
The concept for this is, you buy today what you need tomorrow. Practicality usually means you buy a few days to a week in advance. Daily purchasing consumes too much labor for planning, ordering, and paperwork.
Reasoning is to preserve cash flow. Since the only investment is for stock that will be billed within days a or a week or two, more cash is available for other purposes. Growing companies appreciate having cash available! Companies in cash flow problems have to keep cash available.
One other thought, not investing into inventory that may sit 1 ,3, or 18 months is always wise during economic or industry downturns. Cash is king when top line revenues slip. Your bottom line might look awful, but you won’t be struggling so hard to pay bills. And, you’ll be in a better position to harvest business when the market starts growing again. Your cash strapped competition will be trying to rehire all the people they had to let go to survive. You might be able to pick up the good ones!
A good supplier(s) relationship in required. First, to trust they will have what you need right now. Second, to trust they can work within your procurement system. Trust is so important. Which requires working with your supplier to set up systems that benefit both of you. Because the amount of held stock is so small, inventory management is simple, easy, and almost unnecessary.
A cycle is typically defined as the normal billing timeframe. For new installations, what is the timeframe from once the job commences to when you bill the customer. For service work, it is how long do you know about the service job to when you bill it.
Such definition means you hold only the stock you need to do the work you have within your current billing cycle. This may manifest as weekly buying, however in our industry it usually means a monthly stock order.
Planning is always difficult. You don’t know if jobs will be completed in the time you estimated, weather may cause delays, and there is always little bug-a-boos that pop up. Most like to know the materials they need are at their shop for the next two to three weeks worth of work.
Otherwise, the strategy is the same, preserve cash inside the business. Don’t convert it to pieces of plastic and metal sitting in your building.
Since a stock will be sitting at your shop, inventory management now comes into play. Your stock must be secured and tracked. Care must be given to use leftover items so they don’t build up into excess or dead stock.
First decision is to determine if you have available cash to risk investing into inventory that you may hold for many months, if not for a year or two.
Second decision is what stock to buy. Which means your forecasting must be good. You must have a good handle on what items and how many of them you will use.
Third decision is whether the savings of buying and holding large inventories produces a return on investment (ROI). In other words, can you buy it cheap enough to overcome the cost of money (interest), the lost opportunity cost for your cash, shrinkage (theft and mistakes), obsolescence, lack of need, risk, and the labor and facility investments needed to maintain the stock?
Buying Big means inventory management is critical to see an ROI. You must have an inventory system. Your inventory must be secured, tracked, and analyzed. Failure on any of these actions means your holding costs will likely exceed whatever discounts you gained. Thus you end up paying more for your materials.
To be Continued…
There are many minute details to holding inventory. Every detail must be thought of and considered when making an investment in your company. The holding cost, risk, taxes, proper stock, pricing and purchasing program must be deliberated when considering holding inventory. Click her to read Part 2-What Inventory is Good Inventory?; Investigating Inventory.