February 2015

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February 2015 | Construction Equipment Distribution | www.cedmag.com | 51 >> PROBLEM SOLVED TROY OTTMER Parts Turns and Aged Inventory – Keep on Top of the Nonmoving Parts How to calculate and manage this perennial, pernicious problem. I nventory aging is something that every equipment business will face. If le unchecked, aged inventory will rob your operation of profitability. How do we measure, track or otherwise manage what we have on our shelves? Do you know what your parts turns are? Do you know what your percentage of nonmoving inventory is? Do you know what your 24-, 36- or 48-month aged inventory value is? How many days since last order date versus last sell date? e list could go on and on. e message here is that you have to track these various metrics. Please keep in mind that there are different stocking criteria for different industrial busi- ness models (equipment, li trucks, automotive, trucks, etc.), so for the purposes of this conver- sation I will use a simple inventory example. Let's say at year-end we have $1 million in total inventory and we want to determine what our current turns are. For this we will need to know a couple of more basic things. For example, we already know what our total inventory is; however, for this calculation we need to determine what our average inventory is. You can do this on a month-to-month basis over the 12-month period, or you can use your beginning inventory and ending inventory for that year. In either case, you will simply divide by 12 or by 2. You will also need to find out what your parts Cost of Goods sold were for the same period. In this case, our Cost of Goods sold were $3,500,000 for the period. Our beginning inventory was $750,000 and our ending was $1 million. Your average inven- tory for the year was $875,000. Your Cost of Goods sold is $3,500,000. Divide Cost of Goods sold by Average Inventory and your turns are 4.0 for the year. Formula for this is on le: Now that we know our turns, we need to calculate our nonmoving inventory. For this you will need to know how much of the $1 million in inventory has not had any sales over a specific period of time. In this case, we will use 24 months as our metric. We will also use the ending inventory for this measurement. In this scenario, we have $195,000 in inven- tory that has not had any sales activity within the last 24 months. is will equal 19.5 percent of your total inventory. In most circles, this ratio is too high. at said, my suggestion is to keep this at 5 percent or less on an annual basis, or no more than a 10 percent maximum. I call this the 5/10 method. Now, there are many things to consider when measuring your aged inventory – such as type of parts, season- ality, and acquisition cost. Take the entire list of nonmoving parts. Break it down by vendor first, and then sort by extended cost, largest value to smallest. If you are a large multilocation group, then you will need to compare sales history across the group. In this case, you may transfer parts between locations. If you are a smaller group or single location, then you can do a variety of different things to dispose of the parts in a manner that mitigates your exposure to a full write-off. You can have your parts staff target these parts for movement at a predetermined pricing, or you can source to various services that are in the business of processing obsolete inventory via the secondary market. e idea is not to have parts on your shelf beyond "X" period. Any part on the shelf that does not sell costs you money (in property tax, shelf space, handling, shrinkage poten- tial, obsolescence, etc.) and this cost, over a period of a few years, can kill your profit- ability. Regardless of the size of your organi- zation, you have to pay careful attention to your parts inventory on a daily, monthly and yearly basis. TROY OTTMER is vice presidentof Fixed Operations at Doggett Heavy Machinery Services, LLC, in Houston, Texas, a John Deere construction equipment dealership serving the greater Houston metro area including Beaumont and surrounding market. Doggett Machinery Group also serves South Texas and Louisiana. Ottmer has worked in the equipment and automotive industry for 24 years. He can be reached at troy.ottmer@doggettmachinery.com Any part on the shelf that does not sell costs you money...and this cost, over a period of a few years, can kill your profitability. Inventory Turnover = Cost of Goods Sold Average Inventory 4.0 = $3,500,000 $875,000

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