{"id":2397,"date":"2016-04-06T23:04:08","date_gmt":"2016-04-07T04:04:08","guid":{"rendered":"http:\/\/flevy.com\/blog\/?p=2397"},"modified":"2016-03-22T23:10:51","modified_gmt":"2016-03-23T04:10:51","slug":"inventory-variances-does-the-net-tell-the-truth","status":"publish","type":"post","link":"https:\/\/flevy.com\/blog\/inventory-variances-does-the-net-tell-the-truth\/","title":{"rendered":"Inventory Variances: Does the Net Tell the Truth?"},"content":{"rendered":"

Across our six locations, our physical inventory variance was zero and we\u2019re proud of it.<\/p><\/blockquote>\n

This tells you exactly nothing.<\/p>\n

A Tale of Jack and the Pride of It All\u2026<\/strong><\/h2>\n

\"Modern_warehouse_with_pallet_rack_storage_system\"Jack is the owner of an industrial products supplier with five sales\/inventory warehouses including one large distribution center. Jack called me and asked if I could spend a few days with him and review the overall business. I could tell he had something on his mind.<\/p>\n

I arrived, we talked, and I suggested a tour of the company. Met a lot of nice and hardworking people\u2014and I mean working so hard that I could feel the stress. It doesn’t take long to see that something\u2019s not quite right. There was a chaotic feeling about the organization; a sense of nervousness.<\/p>\n

Jack turned to me with that deer in the headlights look and said, \u201cWe lost near $300,000 last year.\u201d<\/p>\n

I said, \u201cJack, you have my attention.\u201d \u00a0I asked for more details and that he keep the conversation at a macro level.<\/p>\n

He said he couldn\u2019t give me much other than that at the end of the year, the company\u2019s sales looked good and inventory looked better than ever. I said, \u201cLet\u2019s focus on the inventory. What portion of that $300,000 loss was related to inventory?\u201d<\/p>\n

He said, \u201cThe company was up 10% in sales volume, so we guess it was from the operations side of the business.\u201d<\/p>\n

I said, \u201cSo your sales were up and your operating expense increased by no more than 2%, right?\u201d<\/p>\n

He said, \u201cNo\u2014actually, operating expense increased much more than that.\u201d Jack\u2019s team looks at Sales, Operating Expense, Inventory.<\/p>\n

I\u2019ve been at this long enough to know what\u2019s going on. I asked, \u201cSo what was your physical inventory variance?\u201d<\/p>\n

Grinning ear-to-ear and proud as a peacock, he said, \u201cWe don\u2019t even have to look at that, as it was almost zero. That\u2019s why we\u2019re sure it came from the operating expense side.\u201d<\/p>\n

\u201cJack, what were your pickup and shrink percentages?\u201d<\/p>\n

He then said that it doesn\u2019t matter. \u00a0(Well, my family will tell you that when I\u2019m curious, I just don\u2019t stop.)<\/p>\n

I said, \u201cIt does matter, Jack; it matters a great deal. Case in point: If you had an inventory shrink (loss) of $200,000 and a pickup (increase) of $200,000, that would be a net variance of\u2026?\u201d<\/p>\n

Jack said zero. I said sure enough and that would look pretty good\u2014so good that it would make a business owner happier than a fish in water. Jack smiled.<\/p>\n

I posed this question: \u201cIf the $200,000 shrink related to 1,000 part numbers, and the $200,000 pickup related to 10 part numbers, would that be cause for alarm?\u201d<\/p>\n

He said, \u201cNope. It\u2019s still a zero variance.\u201d<\/p>\n

I posed this thought: \u201cI\u2019m afraid I can\u2019t agree on that one, Jack. If I had errors for twelve months on 1,000 of my part numbers, I would suspect that a whole lot of bad<\/em>\u00a0is going on and that for sure the operating costs were very high. Errors on 1,000 items clearly trumps errors on 10 items\u2014that is, if you place your focus on what inventory is really about\u2014quantity. In fact, the human resource and financial outlay to manage that type of discrepancy would scare the dickens out of a guy.<\/p>\n

\u201cYour challenge is that you are focused on the dollars and not the quantity. The net variance of quantity is an alarming number where the variance of dollars is not. You\u2019re hearing what you want to hear.\u201d<\/p>\n

I then said: \u201cWhen dealing with inventory, focus on the pieces\u2014not the dollars. You do not sell dollars. You do not order dollars. You do not warehouse dollars. You manage quantities of consumable assets.\u201d<\/p>\n

\u201cIf you focus on the quantities, the dollars will follow along.\u201d<\/p>\n

When is the last time one of your sales staff walked into the warehouse and asked, \u201cHey Charlie, did my $10,000 of nail guns come in yet?\u201d Instead, it would be much more likely that the salesperson asked if her order of 10 Ramset nail guns has arrived. When is the last time your customer called and said, \u201cI\u2019d like to order $10 of utility knives\u201d? My guess is that they said, \u201cI\u2019d like to order 10 utility knives\u2014what\u2019s your price?\u201d or \u201cI\u2019d like to order 10 utility knives at $10 apiece.\u201d<\/p>\n

Jack said, \u201cDan, I get it and agree. We just never looked at things that way. Heck, even everyone in my peer group places focus on the dollars.\u201d<\/p>\n

Then Jack said, \u201cDo you have some time to talk about my operating expense?\u201d<\/p>\n

The moral of the story is that you need to:<\/p>\n

Look past what you want to see for what you need to see\u2026 which is the truth and not the average.<\/strong><\/p>\n

Remove your blinders of desired bliss.<\/p>\n","protected":false},"excerpt":{"rendered":"

Across our six locations, our physical inventory variance was zero and we\u2019re proud of it. This tells you exactly nothing. A Tale of Jack and the Pride of It All\u2026 Jack is the owner of an industrial products supplier with five sales\/inventory warehouses including one large distribution center. Jack called me and asked if I… Inventory Variances: Does the Net Tell the Truth?<\/span><\/a><\/p>\n","protected":false},"author":12,"featured_media":2398,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"neve_meta_sidebar":"","neve_meta_container":"","neve_meta_enable_content_width":"","neve_meta_content_width":0,"neve_meta_title_alignment":"","neve_meta_author_avatar":"","neve_post_elements_order":"","neve_meta_disable_header":"","neve_meta_disable_footer":"","neve_meta_disable_title":"","footnotes":""},"categories":[82],"tags":[510,308],"class_list":["post-2397","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-operations","tag-inventory-management","tag-warehouse"],"_links":{"self":[{"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/posts\/2397","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/users\/12"}],"replies":[{"embeddable":true,"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/comments?post=2397"}],"version-history":[{"count":2,"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/posts\/2397\/revisions"}],"predecessor-version":[{"id":2400,"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/posts\/2397\/revisions\/2400"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/media\/2398"}],"wp:attachment":[{"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/media?parent=2397"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/categories?post=2397"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/tags?post=2397"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}