May 2017 - Inventory Management: "The Five Basic Essentials"

Imagine if you will, that you have just purchased an existing automotive dealership and you are assessing your Parts Department for the very first time. You are also in an area of the country that you are not familiar with as far as demographics, customer base, or even your own employees for that matter.

You may have some idea of the dealership's potential from marketing surveys, manufacturer information, financial, and Dealer Management System, (D.M.S.) information, in actuality, you are really starting from scratch.

In the area of the Parts Department, you have an existing inventory that was valued, (but not evaluated) at the time of the "Buy/Sell" Agreement.  The inventory may or may not have a lot of "Blue Sky", meaning that the parts inventory on the D.M.S. is actually worth more than what's on the first page of dealer financial.

The questions may now start popping into your head such as;

• How much of my parts inventory is actually obsolete?
• Is my parts inventory "over stocked" in value and amount"?
• How much parts inventory do I actually need?
• Do I have the "right mix" of parts to serve my customer base?

These may be just a few questions that one must wonder when evaluating the Parts Department for the first time. After all, the Parts Department is one of the top two assets in the automotive dealership in the first place. "Liquidity" and "Return on Investment" have to be the first concerns when evaluating this asset.

In our final part of this three part series on Parts Management Fundamentals, we will finish things off with Inventory Management. I've titled this last part of the series on Inventory Management, "The Five Basic Essentials" for a reason.

In my opinion, and as you will see as we read on, these essentials to having a successful Parts Department are not only crucial, but necessary.

Like anything else we choose to endeavor in, the best place to start is at the beginning. So, let's get started with taking a Parts Department over "from scratch" and making it a successful asset with "The Five Basic Essentials".....

Essential Number One: Proper Set Ups, Parameters & Controls

One of the most important tools in the Parts Manager's tool box is the Dealer Management System, (D.M.S.). The D.M.S. is where it all starts, and then moving forward in having the right amount and right mix of inventory. The way parts come into the inventory is determined by these Set Ups, Parameters and Controls.

Most importantly, the Parts Manager has to have the "right" Set Ups, Controls and Parameters in the first place. How a part phases in and phases out is crucial to measuring demand on what's selling and what's not selling.

Along with the proper Days Supply, these Set Ups, Controls and Parameters really set the tone on having the right parts at the right time.

In addition, in many dealerships today, we not only have our own Set Ups, Controls and Parameters to insure the right mix of parts, we also have the manufacturers Vendor Managed Inventories, (V.M.I.) to contend with.

If we are not utilizing the proper Set Ups, Controls and Parameters in both the D.M.S. and V.M.I. where they emulate each other, we could be setting ourselves up for an obsolescence nightmare. Obsolescence is not the only nightmare as "over stocking" the inventory can lead to an "over valued" inventory as well.

We also cannot overlook our D.M.S. stocking parameters, relying primarily on the manufacturers' V.M.I. Programs as we will not be seeing the whole picture. The manufacturers' V.M.I. Programs utilize demand derived from a collective of dealership parts demand, not just yours. 

Relying primarily on the manufacturers' V.M.I. Programs may lead to overstocking parts you don't sell as well as not having the parts you do sell if we aren't utilizing our own D.M.S. to generate stock orders. Both systems need to be run in unison in order to get the best of both worlds, avoiding stock out situations and over stocked, over valued inventories.

The right Set Ups, Controls and Parameters may vary depending on demographics and market share, whether in a metropolitan, suburban or rural market place. Customer demand is the driving force to what parts sell, what parts don't sell, and how much. 

Essential Number Two: The Right Amount of The Right Parts

Here's a simple question for all "Smart Parts" Readers....

"How much parts inventory should I actually have and how do I measure the value?"

That's actually a great question and one that I often get asked by Dealer Principle and Parts Managers. To answer the first part of the question, we have to look at the inventory gross and true turnover guidelines set by the industry.

The National Automobile Dealer Association, (NADA) says the parts gross turn guideline should be eight turns per year while parts true turn should be five turns per year.

To start with, the gross turnover rate illustrates the gross "dollars" in parts inventory turned over the course of a year and not necessarily parts inventory actually on the shelf.

This inventory gross "dollar" turnover rate is where we determine just how much the inventory dollar amount should be. Using existing "cost of sales" information, we can now determine just how much inventory should be on hand.

Example:

Average Monthly Cost of Sales = $100,000.00 X Twelve Months = $1,200,000.00 Divided by 8 Gross Turns = $150,000.00 Suggested Inventory Value.

From this example, you can also see that this Suggested Inventory Value of $150,000.00 also represent a 45 Days Supply, (1.5 Months), the recommended amount suggested and recommended by NADA. This example, or formula can easily illustrate if our parts inventory is over stocked, or under stocked in value and amount.

A high gross turn rate indicates an "under stocked" inventory value and amount, which is turning at a high rate, with lower Days Supply,  while a low gross turn rate indicates that the inventory is "over stocked" in value and amount, turning at a lower rate, with higher Days Supply.

Many would think that a higher than suggested gross turn is a good thing as the inventory value is turning at a higher rate, but don't be fooled. If the parts inventory is turning at a higher rate, let's say at a gross turn of twelve times a year, that would reduce the actual Days Supply of inventory to 30 Days.

The second part of the above question on how to measure the inventory "value", (not amount) is determined by a couple of other industry guidelines called "true turn" and "sales activity cycles".

The NADA Guideline on True Turn is set at five, while the "sales activity cycle" category is set at 75% parts inventory cost of sales movement in the 0 - 3 month category.

As in calculating gross turns, true turns is similar, with the exception that the formula utilizes "sales of stocking parts" versus overall inventory "dollar" sales, which include all parts sales, whether in stock or not. The guideline of five annual true turns is also a measurement of "normal stocking" inventory value and not just the amount.

Essential Number Three: Proper Accounting & Reporting

In order to maintain this balanced inventory, the Parts Manager must also have steady and accurate accounting practices. This means that the Parts Manager must also have an accounting background in the first place.

Knowing the difference between inventory and expense accounts, debits and credits, as well as payable and receivable accounts is extremely important.

In my opinion, one of the most important accounting practices is conducting monthly inventory reconciliations. With multiple inventory accounts such as the the parts, tire and oil inventories, it's not that difficult to have multiple accounting errors any given month.

It is very common to see tires and oil receipted in the parts inventory and then sold out of the tire and oil inventories which causes improper inventory debits and credits in accounting. 

Often times, the tire and/or oil invoices from the manufacturer are credited to the main parts inventory instead of the tire inventory, thus resulting in what I call a "crossfire" effect. Parts receipted into one inventory, but sold from a different inventory resulting in an inventory variance.

Conducting monthly parts inventory reconciliations as opposed to annual reconciliations makes it much easier to control and maintain these variances.

Annual inventory reconciliations can be quite costly and much harder to determine the origin of these variances, thus making it much harder for the Parts Manager to control inventory assets.

Monthly parts inventory reconciliation also requires the Parts Manager to incorporate "daily" accounting practices such as proper posting and receipting outside purchases, inventory adjustments, discounts and allowances, and billing practices. 

In addition the Parts Manager must have a direct line of communication with the accounting office each day, maintaining proper paper flow on packing slips, receipts and invoices.

Proper accounting and reporting also includes accurate reporting in the Dealer Management System, (D.M.S.). The Parts Manager must have a proper "belief system" in honestly posting and receipting information into D.M.S.

Properly and accurately reporting Lost Sales and Emergency Purchases are extremely important and necessary to maintaining a well balanced inventory. Improper, inaccurate, or even the lack of reporting can actually lead to increased obsolescence and a lower level of service.

We can initially have the best Set Ups, Controls and Parameters, but if we don't maintain an accurate and honest reporting system after the fact, it won't matter in the long run.

In my opinion, it will not be possible to have the "right amount of the right parts" without having the proper, accurate and honest reporting "belief system".

Essential Number Four: Inventory Maintenance

Protecting the inventory investment is also a key essential to the basic fundamentals of Inventory Management. Protecting the inventory investment requires maintenance that goes well beyond just good housekeeping practices.

Inventory maintenance is an on-going, daily function of the Parts Manager and his/her staff to insure that the parts inventory is performing at peak levels. To start with, the parts inventory count needs to be as accurate as possible to insure stocking levels are correct.

It's crucial for the Parts Department to perform daily bin checks as part of performing an on-going Perpetual Inventory. The inventory adjustment "Rate Of Change" coming from from posting positive and negative adjustments should not exceed 5%.

Often overlooked, the Parts Department's "Rate Of Change" calculation is as follows;

Total posting adjustments, (positive & negative) divided by the total part numbers in inventory.

This "Rate Of Change" percentage is also a quick "snapshot", or indicator of potentially excessive inventory variances to come once the annual inventory is performed. Performing daily bin checks as part of the Perpetual Inventory process can minimize these overall adjustments, keeping the "Rate Of Change" withing guidelines.

Another key element to maintaining the parts inventory is monthly inventory reconciliation as mentioned earlier. Adjusting and maintaining variances on a monthly basis as opposed to annually exposes these variances at a much lower and manageable rate.

Our number four basic essential would not be complete without proper housekeeping and security practices. I can't tell you how many Parts Departments that I have visited over the years where anyone could just walk in at anytime as doors are unlocked, and shipping and receiving doors left wide open.

Another indicator that negatively reflects these housekeeping and security practices is parts laying on the floor or hanging out of the shelves and warranty scrap parts in a pile.

It doesn't take much to get an overall view on how the Parts Department is managed just by walking in and taking a minute to look around. 

Essential Number Five: Controlling Obsolescence

It pretty much goes without saying that if we are going to choose five basic essentials of Inventory Management fundamentals, we must include the ability to control parts obsolescence. After all, parts obsolescence is a huge indicator to an inventory's overall performance, whether positive or negative.

Going back to our introduction scenario as to purchasing an automotive dealership, I'm quite sure that if we are looking at evaluating the parts department and inventory, reviewing the parts obsolescence would probably be one of the first things we look at.

The key to controlling obsolescence is to avoid it in the first place by implementing all our resources available before we take that year end "write off". In addition, if we do eventually take that year end "write off", we want to also make sure that we aren't right back in the same situation next year.

We have to have an obsolescence management plan that initially avoids or reduces obsolescence by having the right "phase out" parameters in the D.M.S.

The proper criteria will alert the Parts Manager when a particular part has hit the timeline set for lack of movement and to take appropriate action to return, sell or write off the obsolete part(s). 

Our obsolescence management plan also needs to include outside vendors in addition to the manufacturer's return and accrual programs. Companies and options such as Dealermine, OEconnect, Ebay, Cobalt, (Now part of ADP/CDK), Parts Voice and others need to utilized, if necessary to manage obsolescence.

In my opinion, the biggest problem and the biggest reason so many dealerships still carry obsolescence well above accepted levels is the fault of the dealer. So many dealers just won't part with their obsolescence because they think it's already paid for and it has to be worth more than just $.50 cents on the dollar.

What they may not realize is that there are costs to holding obsolete inventories such as acquisition and holding costs, insurance, personnel, etc. Industry analysts say these added, unnoticed costs can be as much as 25% - 30% of the entire inventory value each year.

In the end, carrying obsolete inventory negatively impacts the overall inventory performance and reduces the dealers' return on investment.

Even though it's number five on our list of "The Five Basic Essentials" on Inventory Management, obsolescence just may be the number one essential that if not managed properly, will negatively impact the first four essentials.

Dave Piecuch is the Vice President of Automotive Consultants Group Inc. and is the Head Coach for Smart PartsTM. The only "Results Based" High Return Training, Coaching, and Consulting company in the world!  Dave can be reached at Cell 786-521-1720 or E-mail at dave@smartservicetraining.com Vist our Website at www.smartpartstraining.com