Tuesday, November 6, 2018

November 2018: Inventory Amounts: "Too Much Or Too Little?"

As mentioned in my intro, picture if you will that you are an investor and you are interested in purchasing an existing automotive dealership. In the "buy sell" agreement, you notice that the selling dealer currently has a parts inventory amount of $249,387.00 on the latest dealer financial.

Next, you research a little further and find out the selling dealer's D.M.S., (Dealer Management System) "controlled" parts inventory amount shows a different parts inventory amount of $211,459.00, leaving a variance, or "discrepancy" amount of $37,928.00 between the controlled inventory and the dealer financial inventory.

Of course, this is an obvious concern to you as a potential buyer as this "discrepancy" has to be accounted for and adjusted to actual physical inventory count records. As a potential buyer, this would probably be primary concern when researching the parts inventory asset in the "buy sell" agreement.

This above situation is not uncommon for buyers and sellers of automotive dealerships when researching and considering the actual net worth of the selling dealers parts inventory.

The sad thing is that this above situation doesn't even hold a candle to what disasters may lie underneath when considering the actual net worth of this huge dealer asset.

In my opinion, when we consider these two varying amounts, I wouldn't be as concerned about the discrepancy as much as these amounts can be reconciled to the agreement of both parties, even though one of the two parties may feel they got the better of the deal.

Here's what would concern me more than anything...

As a potential buyer, wouldn't it be great to know how "liquid" this parts inventory is? Wouldn't it also be great to know how current, or obsolete this parts inventory is? Lastly, are these parts inventory amounts "too much or too little" to satisfy my customer base?

The biggest question even beyond the three mentioned above is...

What is the proper amount that I should have invested in my parts inventory?

This to me IS the question that we should consider as a buyer and most importantly when we are looking forward to the parts departments return on investment, (ROI). After all, if I'm the buyer, I could be looking at a parts inventory that could either "too much or too little" based on the previous dealer's monthly sales averages.

So, just how do we determine what I call the "desired" inventory amount that will satisfy my customer base? What will be my basic inventory value guideline going forward for my parts manager to manage and maintain?

The answer to these two questions will lead us to the correct and "desired" inventory level as well as potential answer to what may be causing these "too much or too little" inventory amounts. Lastly, the answer will give us a game plan to fix and manage either situation, whether "too much or too little".

The answer lies in a couple simple parts guideline set by NADA starting with recommended days supply of parts inventory amounts. As a matter of fact, these recommended days supply guidelines also apply to new and used vehicles.

We will then bring in the second NADA Guideline that will also play a part in determining our "desired" parts inventory amount. Actually, the "math" of this second NADA guideline will determine NADA's FIRST guideline!

Here are the NADA Guidelines that will determine our "desired" parts inventory amount along with an example;

The first guideline is NADA's recommendation for "days supply" of parts inventory, which is 45 days, or 1.5 months supply. This means, in a dollar sense that if I was unable to buy any more parts today, I would at least have enough "parts supply" in dollars to last the next 45 days, or 1.5 months.

So why 45 days, or 1.5 months?...

This is where guideline number two comes in with NADA's recommendation of parts inventory "Gross Turns" comes in. The parts inventory "Gross Turn" represents the number of times annually that the total parts inventory value sells, or "turns" and that guideline, or recommendation is 8 times annually.

So, if we do the math, twelve months a year, (annually) divided by eight recommended parts gross turns equals 1.5 months supply, or 45 days supply, whether we are talking parts, or new & used vehicles.

Next, in order to determine our existing parts gross turn number, we have to look at history and bring parts "cost of sales" into the picture. The formula for calculating gross turns is;

"Total Sales at Cost for the Last Twelve Months - Divided By - Average Inventory Investment for the Last Twelve Months"

Now, we have all the ingredients to determine our overall "desired" parts inventory amount. That being said, all I have to do now is bring in my "cost of sales" amounts and my guideline for gross turns into the picture to finally determine my "desired" parts inventory amount.

Here's the example utilizing an average monthly parts "cost of sales" amount for the last twelve months of $100,000.00;

$100,000.00 X 12 Months - Divided By - 8 Annual Gross Turns = $150,000.00 

As you can see based on the example, without even having to actually do the math, we can simply take our average monthly sales at cost and multiply the amount by 1.5 and we can determine exactly what our parts inventory amount should be.

"Now that we know the amount, what do we do if the amounts are "too much or too little?"

Having a parts inventory amount that is "too much or too little" can have ramifications both ways. Much like in new and used vehicle inventories, there are no real benefits to either situations, only undesirable results from either one.

First, let's take a look at what could happen if our parts inventory amounts are "too little"....

The biggest risks of having "too little", or a low days supply of inventory is the potential for lost sales and lower service productivity as "stock out" situations will happen more frequently.

Turning the inventory amounts at a higher rate does give a higher and more frequent return on investment, but what's "unknown" is the unrealized and lost sales.

Overall customer satisfaction and retention is also at risk as too many return visits or even extended service visits due to not stocking enough parts, or the right parts may have a substantial impact. Not having enough parts, or the right parts can also impact overall service sales and employee wages.

Next and lastly, let's take a look at the negative impacts and risks of having "too much"...

Having "too much" in the way of inventory amounts carry far more risks and dangers than having "too little". In this situation though, we have to not only determine how much is "too much", we also have to know where we have "too much".

For example, if our "desired" inventory amount is like our above example of $150,000.00, and we are carrying $200,000.00 in inventory, where is the overage coming from? This is where we have to do a little more research in determining where we go next to get it back to a "desired" inventory amount.

There are only two areas that can cause the situation where we have "too much" in area of parts inventory amounts. Those two areas are parts obsolescence and overstocked parts inventory within the current, active parts inventory and each can be determined quite easily.

If we use the above example again with a "desired" parts inventory amount at $150,000.00 and an actual inventory amount of $200,000.00, we are "overvalued" by $50,000.00 in obsolescence and "overstocked" inventory.

If my obsolete inventory is $30,000.00, (parts with no sales over 12 months), the remainder would be "overstocked" parts that may be active, but carry more parts days supply than necessary. Both can be managed by the "Smart Parts" Manager.

In the area of obsolescence, we not only have to come up with a game plan to eliminate the amount, more importantly we have to "stop the bleeding" so obsolescence doesn't return year after year. Solving the problem is one thing, managing it from coming back is another.

As far as the overstocked amounts, those can be managed by proper Source Ranking, Low and High Days Supply, or Best Reorder Points, (BRP) and Best Stocking Levels, (BSL) until these "overstocked" parts reach their proper stocking levels.

In my opinion, the biggest danger and/or risk if our parts inventory amounts are "too much" is the fact that some of the same risks that apply in "too little" inventory amount category can apply in the "too much" category as well.

Excessive obsolescence and excessive overstock amounts can actually overshadow the "desired" inventory amounts. It is quite possible, once I do the math, that I could have "too much" and "too little" at the same time.

For example, if my "desired" inventory amount is $150,000.00 and my actual inventory amount is $200,000.00, but with $100,000.00 of that amount considered obsolete, my net "active" inventory amount would be $100,000.00.

This would leave me with $100,000.00 in active inventory...$50,000.00 less than the "desired" amount.

Having the right parts and the right inventory amounts go hand in hand. The right combination of the two can only lead to gross and true turns at or above guide, expected return on investment and a high level of customer service.

Are Your Parts Inventory Amounts "Just Right?"....Or, Are You "Too Much, To Little, Too Late?"

Dave Piecuch is the Vice President of Automotive Consultants Group Inc. and is the Head Coach for Smart PartsTMThe 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