Once we have segmented the inventory, the next question to ask is, "Are we confident that these numbers are correct?" This is the core issue to the paper. A popular answer still being provided is that the annual physical inventory will correct the records. Even worse, many companies do not know their record accuracy. Other companies are dependent on cycle counting to correct the balances. In these cases the records are simply being adjusted after the count. This is not necessarily making the records more correct. The issue with cycle counting with many companies is that they are stretching out the process of an annual physical to be a continuous year-round event and are missing the entire APICS concept of cycle counting. That is the element of investigating the cause of an inventory record error at the time of cycle counting and correcting the cause at that time, thus reducing the reasons why a record is wrong. So the answer to the physical inventory question is emphatically, "NO, physical inventories are not the answer to correcting inventory records." Their purpose is to simply attest that the financial statements are fairly stated from an aggregate dollar perspective, allowing the positive variances to offset the negative variances. If companies can demonstrate that their cycle counting
accuracy is in the high nineties, then a physical inventory does not have to be taken.
CYCLE COUNTING DONE RIGHT
So if cycle counting is the solution, should it take a complete cycle, which could be as long as a year, to complete the process? I believe that the answer to this question is, "Absolutely not!" The alternative I propose is described as "the 19-step quick fix to inventory record accuracy." Figure 2 lists these 19 steps for your reference. The first 18 steps are designed to count the same control sample repeatedly to determine what type of mistakes are being made in transacting inventory receipts and issues. Steps 19 and 20 are designed to ensure that the accuracy will continue and provide the counting cycle to ensure that all classes of inventory are accurate.
Now that I have mentioned the ABC classification methodology, let's make sure we all understand this age-old but very effective process. Even though this classification method has been around for a long time, it is my impression that many do not understand its source and usefulness. APICS teaches this concept in the Inventory Management review course. Its source is Pareto's 20/80 law. The rule of thumb is
• 20 percent of the items will equal 80 percent of the total value.
• 30 percent of the items will equal 15 percent of the total value.
• 50 percent of the items will equal 5 percent of the total value.
The 20/80 rule. How many times do we hear somebody say, "Go perform a 20/80 analysis." What does that really mean? Well it usually is at the heart of establishing a way of managing a whole lot of something very well, while only spending time reviewing a few items.
Many different criteria can be used to determine ABC classifications. Figure 3 demonstrates the most popular method, unit cost times annual usage.
Other criteria that can be used are CostS Revenue $ Storage space Supplier lead time Inventory turnover Figure 4 reflects the calculation for artist popularity. I have seen this method used to determine what shelf level to store items causing "A" items to be stored at eye level, the "B" and "C" items either higher or lower on the shelf. This allowed the warehouse pickers the ability to minimize their reaching up or stooping down when picking the most active items.
ITEM MASTER REVIEW
The last solution to achieving inventory reduction through accuracy is to review the data and logic integrity of the item master driving the ERP system. As companies employ continuous process improvements, the item master information needs to be updated to reflect current data.
Item Master Data Integrity
Often there is a strong tendency to hedge in determining the various policies within the item master. For example
Lot size policies: The first step is to determine how many lot size policies are fixed order quantity. The more items coded as such, the higher the inventory. Effort should be taken to limit use of this lot size policy to "C" items only. All "A" and "B" items should be a discrete policy, such as lot-for-lot.
Safety stock: Certainly a popular hedging area. First, make sure only independent demand items have safety stock requirements. Second, calculate a level of safety stock based on the variability formula.
Lead time: Another popular area of hedging is to buffer the lead time data too much. I suggest that all vendors providing "A" and "B" items be reviewed as to their delivery performance to quoted lead times and the item master set to that level. Scrap allowance: Scrap is waste. As the Just-in-Time philosophy suggests, efforts should be taken to eliminate scrap. When scrap has been eliminated from the process, the item master scrap allowance should be adjusted in line with the current scrap levels.
Item Master Logic: Bill of Material (BOM) Levels
The number of levels in structuring a bill of material can influence inventory levels. Often in manufacturing, each subassembly at a lower level will be produced and stored in inventory awaiting the release of the higher-level assemblies. This logic builds inventory. As companies review and change their methods of production towards a more flexible make-to-order strategy and continuous production, the BOM will become flatter, thus allowing fewer subassemblies in inventory.
When top management issues an inventory reduction target, they are met with innovative practices and not always the smartest business decision. An ongoing item inventory management methodology that continuously keeps the item master hedge in check by maintaining the data is a better solution.
One conclusion is that reducing inventory and maintaining data accuracy is everybody's job. Examples include: Top management is responsible for setting policies as to inventory levels. Sales is responsible for preparing a forecast of demand that can be measured for accuracy. Purchasing is responsible for managing vendor lead times. Process Design is responsible for reducing cycle time and the structure of the bill of materials.
Finally, inventory accuracy is essential to reducing inventory. To obtain such, cycle counting done right needs to be employed!
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