The Bank Owns Half

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I recall a conversation I had with a CEO client about the fact that his company had more inventory than it needed. He looked at me and said, “What difference does it make? I don’t own it, the bank does.” I was speechless.

When banks provide lines of credit, they primarily lend on Accounts Receivable. For companies that have inventory, the bank will often lend on a portion of that as well. The primary consideration for the bank is how easily the inventory can be turned into cash, therefore, the maximum the bank will lend on inventory is usually limited to 50% of current value. Occasionally that might be higher or lower, but 50% seems to be the number in the current market. That means the company, owner, and investors own the other 50%.

To make matters worse, before the bank calculates 50% they’ll often eliminate the old or obsolete inventory from the total value. Normally this is anything more than a year old, but it could be a longer time horizon if the inventory is easily converted to cash. But it’s fair to say that the bank owns half, and it’s the good half. The owner owns the remaining (slow moving) half.

Do you own half of your inventory? Is it the bad half? Can it easily be turned into cash? If not, your half is slowly eroding and costing you profits and cash flow every day.

© 2017 – Rick Pay – All Rights Reserved

Too Many Suppliers Spoil the Soup

Consolidating the supplier base can result in dramatic cost reduction. In Rick’s Materials Management Manifesto, the sixth element is, Too Many Suppliers Spoil the Soup. Many companies have a proliferation of suppliers, with many providing the same part or commodity. While the buyers may not have intended to develop a large base of suppliers, using RFQ’s for competitive costing, allowing engineers to select suppliers, having different buyers buy the same thing, and lack of coordination across large organizations can result in a large number of suppliers that provide similar commodities and parts.

Here’s how consolidating your supplier base can cut costs:

  1. Concentrated purchase volume results in greater volume discounts.
  2. Avoid the trap of different part numbers for the same part bought from different suppliers, which results in more inventory, numerous part stocking locations, obsolescence and increased transactions.
  3. Maintain control of purchasing, to prevent Engineering and other non-purchasing related buyers from choosing suppliers that aren’t optimal for service, quality and cost.

 

To reduce the number of suppliers, first prepare a simple list of where the money is going for the current fiscal year. List the supplier, the amount spent, and the key commodities bought. Then look for duplicates and commodity consolidation opportunities. As a general rule in small and middle market companies, if more than a dozen suppliers represent about 80% of the total spend, you have opportunities for consolidation.

One final note, as you undertake a consolidation program, use the opportunity to negotiate higher volume discounts, early payment discounts, and development of VMI and Kanban processes to reduce inventory. The results can be dramatic and make for great soup!

 

© – 2017 – Rick Pay – All Rights Reserved

Reduce Complexity To Reduce Costs

Many executives ask me how to reduce costs more than the 3% – 5% often required annually by customers. Through many client engagements I’ve found that companies  can reduce costs exponentially by reducing complexity. Companies of all types complexify the simple by allowing numbers of parts, suppliers, employees and so on to increase over time without considering what that does to costs.

There are several things you can do to simplify processes and reduce costs:

  • Reduce the number of parts you carry – on an annual basis, eliminate those items that represent the least amount of sales in your portfolio. By developing a report on SKU movement, you can sort by number of units sold and see those SKUs that have low or no part movement. Eliminate the bottom 20% and you will reduce transactions in purchasing and accounting, warehouse space, cost of holding inventory, and obsolete inventory.
  • Reduce the number of suppliers you buy from – if you buy a particular part from more than two suppliers, not only are you increasing costs, but you’re also introducing variation in quality which can result in even larger costs. Properly reducing the number of suppliers per part does not increase risk as some supply chain professionals think. Conducting an annual supplier rationalization exercise provides opportunities to reduce costs and receive higher volume discounts, all of which can dramatically improve your materials costs as a percent of sales.
  • Improve product management through Ramp-down – this is the process of managing the backside of the product life-cycle curve. By managing older products and eliminating them in favor of newer products, not only do you keep your product assortment fresh, but you reduce the cost of obsolete inventory, reduce warehouse space taken by slow moving items and reduce inventory, thus freeing up cash.

Reducing complexity can have many benefits, not the least of which is dramatic improvement in profit and freeing up cash. Studies are easy to conduct which will show if you have overly complex processes and how to simplify to accelerate profit and growth.

© 2016 – Rick Pay – All Rights Reserved

Real Estate Costs Have a Broad Impact

The commercial real estate market has been somewhat flat for a long time. In Portland, Oregon, the cost of warehouse and manufacturing space has been about $3.60 per square foot for several years. Recently it jumped to $4.80. In a recent conversation with my friend Mark Childs of Capacity Commercial Group, Mark mentioned how the new cost increase is causing many companies to consider building rather than leasing when they need new space.

One of the elements of my operations and supply chain evaluations is to determine the costs of holding inventory. A vital component of that is the cost of inventory storage facilities. Many companies have 20,000 square feet or more of warehouse space dedicated to holding inventory. That very quickly approaches $100,000 per year of cost just for the space. On $1 million of inventory value, just the space cost is 10% per year. That together with cost of capital, obsolescence, handling, equipment, taxes, insurance, and adjustments often sends the cost of holding inventory upwards of 2.5% per month or more.

The cost of space is a capacity issue that companies need to watch closely. The question is, can you leverage your capacity without additional capital investment? I’ve seen companies “find” space they didn’t know they had by reducing inventory, getting rid of junk and rationalizing part numbers, which allowed them to accelerate growth without additional facilities costs. Watch your facilities cost and capacity and if you want to leverage your resources, give me a call.

© 2014 – Rick Pay – All Rights Reserved

What Obsolete Inventory Can Do to Company Value

I recently attended a presentation on business transitions presented by Schwabe, Williamson & Wyatt in conjunction with GeffenMesher and Cascadia Capital, LLC. Hugh Campbell of Cascadia shared a story about a company that was going through the due diligence process for a company sale. The buyer found that the company had a significant amount of obsolete inventory. The buyer had a GAAP (generally accepted accounting principles) standard of one year for inventory, and required a restatement of the financial statements for the previous three years to adjust for the obsolete inventory.

The result was a significant decline in EBITDA (earnings), which reduced the company’s sale value by millions of dollars. Most companies’ sale value is calculated as EBITDA times a multiplier. For manufacturers, the multiplier is usually around five. So if a manufacturing company had to adjust earnings by $1 million in obsolete inventory, the sales value of the company would be reduced by $5 million.

Do you have a significant amount of inventory that‘s over one year old? Have you adjusted your financial reports to reflect that? Do you have processes in place to prevent obsolete inventory from accumulating? Are you thinking about selling your company, or transferring it to family or management in the next five years? It may be time to implement a program to prevent or reduce your exposure to a significant decline in company value.

© 2014 – Rick Pay – All Rights Reserved

The Bank Owns Half

Recently I was sitting with a client CEO discussing the fact that the company had more inventory than it needed. He looked at me and said, “What difference does it make? I don’t own it, the bank does.” I was speechless.

When banks provide lines of credit, they primarily lend on Accounts Receivable. For companies that have inventory, the bank will often lend on a portion of that as well. The primary consideration for the bank is how easily the inventory can be turned into cash. Therefore, the maximum the bank will lend on inventory is usually limited to 50% of current value. Occasionally that might be higher or lower, but 50% seems to be the number in the current market. That means the company/owner/investors own the other 50%.

To make matters worse, before the bank calculates 50% they’ll often eliminate the old or obsolete inventory from the total value. Normally this is anything more than a year old, but it could be a longer time horizon if the inventory is easily converted to cash. But it’s fair to say that the bank owns half, and it’s the good half. The owner owns the remaining (slow moving) half.

Do you own half of your inventory? Is it the bad half? Can it easily be turned into cash? If not, your half is slowly eroding and costing you profits and cash flow every day.

© 2014 – Rick Pay – All Rights Reserved

Three Ways to Get More Space

Before

Many companies are trying to reduce their inventory to free up cash or create additional space for production or new products. Often, companies believe they need additional floor space or new technology in order to optimize storage and inventory processing. What I have found over my career (both in warehouse and manufacturing management) and working with clients in manufacturing and distribution is that you can uncover as much as 25% to 40% additional space simply by getting rid of clutter!

Clutter comes in three forms – first there is actual clutter: things you store that you don’t really need. This step is like cleaning out the garage and getting rid of old equipment, old computers, boxes of records, etc. One client found two barbeques buried under clutter that they had bought for an employee picnic, but forgot they had. Another had a couple of vintage cars parked in the middle of their warehouse.

 

After

Second, there is old inventory. Many companies hold on to old inventory because they might be able to sell it sometime. They claim it really isn’t obsolete, so they hang on to it. I call that “GSM” – glacially slow moving inventory. Since the cost of holding inventory is typically north of 2% per month, there is a cost to sitting on it. Get rid of it.

Third, consolidate suppliers. Having multiple suppliers often means having multiple parts that do the same thing. The more part numbers, the more space is required to store it. By getting rid of suppliers (supplier rationalization), you’ll reduce part numbers, probably lower your materials costs and release space for other needs.

Clutter comes in many forms. Do you have clutter in your warehouse or manufacturing facility? Can you see it? Do you know how to get rid of it?

© 2014 – Rick Pay – All Rights Reserved

Slow Moving Inventory – What’s the Big Deal?

Over the years I’ve seen many companies, both manufacturers and distributors, with very low inventory turns, due in part to slow moving or obsolete inventory. Slow moving inventory can have many causes:

  • Poor planning
  • Poor quality
  • Long set-up times
  • Poor materials flow
  • Unreliable processes
  • Unreliable suppliers
  • Inaccurate inventory
  • Unresponsive information systems

However, the number one contributor to large quantities of slow moving or obsolete inventory is what I call Ramp Up/Ramp Down. This is the process of bringing new items into inventory and removing old ones. Many companies are pretty good at bringing in or developing new items, but pretty bad at getting rid of the old ones. It’s hard to get rid of old products because someone might want them some day.

I refer to that as “glacially slow moving inventory,” and one big danger of having a lot of it is that your banker will become concerned about the “quality” of your inventory – and loan you less and less for your working capital needs as a result.

It takes discipline and resolve to keep your inventory turning fast. Contact me to develop a strategy to reduce – or prevent – glacially slow moving inventory.

© 2014 – Rick Pay – All Rights Reserved

Is Inventory Devouring Your Cash?

A few days ago I spoke with a CEO about his company’s inventory. He has quite a lot, and inventory turns of less than two. That means it’s turning over less than twice per year or, put another way, he has over 180 days of inventory. I asked if he was concerned about the amount of money that was tied up and he said, “no, it isn’t my money; it’s financed.”

This is a very bright person who is running a successful company and apparently doesn’t understand the covenants with the bank. Most banks will lend only around 50% on the value of the inventory in the bank line of credit, so in his case 50% of the money is in fact his. The bank loan 50% is accumulating interest at 4%, which, in his case, is over $100,000 per year. His money (the other 50%) is accruing 0% return on assets. What a deal!

The sad thing is that if he could reduce his inventory just one turn, even by selling it at a discount (but still at a profit) he would free up a great deal of cash to:

1) Pay down the line and recover some of the interest expense

2) Invest in the business

3) Return a dividend to the owners (in this case him)

As long as he communicated his actions to the bank, they wouldn’t be too concerned about the margin erosion so long as the company took action to prevent slow moving inventory from building up in the future. Slow moving inventory not only eats up cash that could be better spent elsewhere, but it grows bigger over time.

Do you have very slow moving inventory? Do you have a plan to prevent it from growing? Do you have a happy banker? Would you like more money to invest in your company’s growth? Visit my web site or contact me to discuss how to free up some capital and have a healthier company.

© 2014 – Rick Pay – All Rights Reserved

15 Ways to Get Rid of Obsolete Inventory

One of the challenges many manufacturers and distributors face is what to do with the mountain of obsolete inventory that’s languishing on their shelves, taking up space and consuming cash. The cost of sitting on it can range from 2% to 3% per month or even higher. Most companies may try to sell it over time (a long time!) or finally throw up their hands in disgust and pitch it in the trash.

But there are other options, some of which can actually yield cash:

  • Return it to your supplier, even if there is a restocking charge, since it’s already costing you just to hold it; sometimes if you take the return as a credit, they will forgo the charge to help out a good customer.
  • Enlist your suppliers to help you get rid of it through their channels
  • Sell a large block to one of your customers at a deep discount
  • Hold a tent sale in the parking lot
  • Develop a “close out counter” either near your will-call area or on your web site

For a more complete list of 15 ways to dispose of dead stock, see the Tools page.

© 2014 – Rick Pay – All Rights Reserved