Inventory Efficiency: Do the Math

Date October 9, 2019
Categories

Parts managers are using complex mathematical formulas to compute their optimal inventory quantities these days – though they might not be aware of it. Your DMS system is thinking through the process using calculus to create formulas and cost curves with the ultimate goal of minimizing the cost of ordering, stocking and holding the parts inventory.

Generally, the more of a part you order, the less expensive it is – not only is the part price reduced, but so are other costs, like transportation and labor. On the other hand, ordering in quantities that don’t sell in a timely manner, even to the point of obsolescence, raises costs, not just for parts that don’t get sold but for “frozen capital.” In essence, this leaves money sitting on the parts shelf that could be used in more productive ways. In the language of your DMS system, where the part cost and carrying cost curves meet is theoretically the optimal order quantity.

Of course, running the calculus is the computer software’s job, not the parts manager’s. But even without a computerized formula it’s important to think about where these curves meet, and what tools you have available to ensure you are inventorying intelligently.

Inventory and Turn Rates
Optimally parts inventories are going to turn four to six times a year. Accordingly, a dealership should retain 60 to 90 days of parts on hand. To compute your dealership’s turn rate, take your cost of goods sold for parts (sales minus gross profit) and divide that number by the cost of the parts inventory you have on hand. Then use your turn rate to determine how many days supply you have in inventory.

An example calculation:
The factors:
Parts sales for a year = $3 million
Gross profit on those sales = $1 million
Current parts inventory = $380,000

The calculation:
Cost of goods sold ($3 million minus $1 million) = $2 million
Parts turn rate ($2 million divided by $380,000) = 5.26
Current supply ($380,000 divided by $166,670 [$2 million divided by 12 months]) = 2.27 months or 68 days

Dealerships will necessarily find some inventory stale and not turning, while other parts are turning quickly. The only way to counteract the losses associated with the slow moving or obsolete parts might be moving the fast moving parts even faster. Understanding which parts are slowing the turn rate will help the dealer make adjustments to minimize losses.

So yes, there is real value in the math you learned in middle school that you thought you’d never use. Math makes for better parts management, a better return on your investment.

Three Key Reports
There are several DMS reports that can help to make your parts operation more efficient, but there are three that are essential to having the right parts on the shelves at the right time.

  1. Emergency Purchase Report. Buying from another dealer or suppliers as needed decreases net profit in both parts and service departments through higher initial prices, transportation costs, and service department downtime. Recording emergency purchases in your DMS as they occur and reviewing them regularly –at least weekly– will help you adjust your inventory accordingly.
  2. Lost Sales Report. If a sale is lost because a part is not in stock, it should be properly reported. A lost sale is defined as a sale that it is reasonable to assume would have been made if the part was on hand.
  3. Service Department Fill Rate Report. A weekly fill rate report gives parts managers a clear look at what’s going on in the shop. To correct fill rate inefficiencies, run the report by part number and same-day fill rate.

Take the following into consideration when reviewing these reports:

  • If the unit requiring the part is a new model – and could this be a trend?
  • Is the required part essential to operation of the unit?
  • Is an emergency purchase or a lost sale recorded for a part used in routine maintenance?
  • Does the parts locator section in your DMS indicate that other dealers are stocking a part you don’t stock?
  • Does the factory maintain a large quantity of a particular part?
  • Does my inventory reflect the population of models in my area?

Doing the math and reviewing your reports on a weekly basis will make for happier customers, more efficient employees and, by thawing out your frozen capital, a better bottom line.

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Typhoons & Tariffs: Dealers Need to Prepare for the Unexpected and Unpredictable

Date September 26, 2018

Just as you plan to protect your dealership from unpredictable events like storms and fires, you need to be prepared for what might happen to your business should the economy stall. In fact, current indicators for our industry are concerning. Interest rates are headed up, tariffs are driving prices higher, and housing starts, a leading economic indicator for our industry, are down.

Like the weather, you want to know what it’s going to be like out there, and have a plan for dealing with it. Unlike the weather, there are many factors to concern yourself with in forecasting the future for your dealership, more variables with much greater impact.

Expenses
A good place to begin preparing for an uncertain future is to take a hard look at expenses. Start with the big five – data processing, insurance, personnel, advertising and interest – but don’t ignore the small stuff. You will be surprised to see how much expense you can cut by attending to the littlest things – paperclips, notepads, etc. Examine every line item for efficiencies. We recently found a half million dollars in savings for a dealer by doing a cost study that addressed every expense item.

Work with your managers to determine what can be done to control and reduce costs, everything from utility bills to workers comp claims. Inventory your fixed assets to determine if there are assets on your books that you no longer own. If so, take the tax related deduction, but also notify your insurance provider so they can adjust your premiums – no sense in protecting assets you don’t have.

Forecasting
Forecasting is vital. Look to your future with a critical eye. Get your managers’ views on what they think will happen in their departments in the coming year, then determine what you can spend. You need to match your expense structure to expected income, then convert that to a cash flow analysis. As cash flow is the lifeblood of the dealership, examine your needs in detail – mortgage, credit, capital loans. In a recent engagement we were able to save a dealership in excess of $300,000 in annual cash flow simply by renegotiating the terms of their loans.

Forecasting sales and cash flows is neither easy nor an exact science – and the uncertainty on our economic horizon makes the process even more difficult. Here are a few things to do to help you develop a forecast you can use to plan your year:

  • Personnel. Look at doing more with less. We recently surveyed our dealer-clients and learned that many are cutting staff, increasing their gross profit per employee per month. They are also implementing new technology to improve efficiency.

  • Plan for the worst but also forecast for the best. We typically develop two or three forecast versions for our dealer-clients. We have a plan for what to do in a worst-case scenario, but also enough product and staff to support best-case scenarios.

  • An annual forecast is helpful, but predictions go stale. Your plan should be revisited periodically throughout the year. The economy can turn on a dime, as we were reminded so vividly in September 2008. We saw the signs – in particular, too many unqualified buyers getting loans – but who could have predicted the magnitude and scope of the downturn. Consider the potential impact of a tariff war, which is already driving up the cost of steel. Plan to revise your forecast at least quarterly; it has to remain valid for you to run your business accordingly.

  • Interest rates. We might not know when, but we do know interest rates are on their way up. That’s a double whammy for dealerships, increased operating costs you and higher monthly payments for your customers.

  • Set goals. Goals play an important role in every part of your business, not only for departments, but for marketing, sales, succession planning. They provide direction and motivation, and measure your forward progress. They allow you to stay focused on the big picture. Involve your mangers by having them identify one or two SMART (Specific, Measurable, Attainable, Relevant and Time-based) goals for the coming year. Brainstorm the possibilities, but also consider what is realistic and what you can afford to support.

  • Identify obstacles and assign responsibility. Determine the resources you need to accomplish your goals. Set steps along the way and meet with your managers to ensure a steady climb. Prioritize goals by their importance to your bottom line. Chart your progress and share the results with staff; it’s important to all because that’s where their bonuses will come from.

  • Create an action plan. Focus on today. What are you and your managers going to do today to move your dealership toward achieving your goals. You need to work on tasks at hand. Convert goals into an action plan then to tasks.

  • Know your business and your customers’ businesses. The more you know about your customers’ businesses, the more accurately you will be able to forecast, and set achievable goals.

Expect the unexpected. Plan for a best-case scenario, but be wary of typhoons and tariffs. Your bottom line, even your survival, depends on it.

The HBK Dealership Industry Group helps dealers identify costs and savings strategies with customized cost study programs. The group typically provides dealers with a 20:1 ROI when performing these customized cost study programs. If you would like to talk to us about doing a cost study for your dealership, contact Rex by email at rcollins@hbkcpa.com; or by phone at 317-504-7900.

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