One of the areas in which organizations can leverage their value of in their operating line is through the effective use of their inventory. Regardless of the type of organization, inventory exists in one form or another. We have all come to know inventory as shelves or pallets of ‘stuff’. However, inventory can take many forms. Organizations that are aware of the presence of inventory will become more aware of the inherent hidden wealth of the organization.
At a very high level inventory is either tangible or intangible with a finite shelf life. By way of an example a grocery store has tangible assets (food) that has a finite life (expiration date). Equally, a building a supply store has a tangible asset in marble floor tiles, which have a finite life. Yes, marble floor tiles have a finite life! Once market demands move away from marble floor tiles, their ‘life’ or value has diminished or expired. On a more theoretical perspective of inventory; accountants, attorneys, engineers represent intangible inventory. Hiring an associate, affords the organization with a potential inventory (hours per day) which can be sold. Once those hours have gone by and not billed, their life or value has expired.
This contribution is not meant to expound on the virtues of asset management as there are countless contributions on: TQM, Kaizen modeling, Six Sigma, Lean manufacturing and the like. With this contribution, I am only hoping to demonstrate the many values of an organization’s inventory and how the asset can quickly become a liability. Very simply, the diligent management of inventory; the movement of inventory to sales, is the very essence on which profitability is built. Organizations that can move inventory at a higher price than acquired easily demonstrate higher gross margins.
To continue from the previous contribution, ABC ltd. is securing its operating line with inventory and receivables. To the financing institute these entities are current assets. However, ABC is limited in receiving the full value of these assets. In restating the covenant, ABC is advanced based on 50% of the acquired costs of the inventory, valued using FIFO, excluding inventory in excess of 120 days.
If ABC were to dissect this covenant they could easily unleash hidden value in their inventory. The financier is excluding all inventories in excess of 120 days. Basically they are taking the position, if the inventory is that old it has lost its merchantability. This is similar to a grocery store with two week old lettuce or a retail store with winter coats remaining in July. To ABC, this inventory has $75,000 in value – to the rest of the world it has no value and $75,000 in cost. It has become an asset of no value – a liability! It is weighing down its borrowing base!
For ABC, this inventory has no value and is tying up capital. However, depending on the type of inventory they may be able to unleash some hidden value. If this inventory is made up of computer hardware, they could bulk-sell the inventory for anything between $0 and $75,000 and thereby gain immediate cash. This would immediately positively impact their borrowing potential from their financier. It would be toward ABC’s advantage to closely monitor its inventory and move out, at what ever price, those goods which will expire in the foreseeable future.
Some goods may have a long expiration or the organization isn’t faced with an age covenant on inventory, yet there still remains a cost of holding onto slow or defunct inventory. Recently, I had the opportunity of working with an electronics provider, who in order to gain a new customer, took 180,000 transformers it purchased from a competitor. This inventory was taken in to secure a new customer, however in doing so my client had this entire inventory – at no cost! As cases of this stuff sat in warehouses throughout the country, I had to lead them to the tremendous inherent value in this inventory and the tremendous cost they were incurring to keep it. There was no acquisition cost of this inventory, but it was taking up space in their warehouses, and was being insured under their policy. Although it had no ‘book’ cost, each day it cost them floor space. The potential value was tremendous – they could sell this inventory at what ever the market would bear! As it turned out, they converted this ‘valueless’ competition inventory for forty cents on the dollar and came away with approximately $100,000.
To ABC, the inventory valuation covenant provides a 50% valuation based on the FIFO method of valuation. FIFO or First in First Out, uses a perpetual inventory system which ensures that the cost of the inventory is most reflective of current market prices. The financing agent, however, only attributes 50% valuation to such inventory. This perceived restriction should be seen as a benefit. This should be a clear indication to management that using short-term, operating line funds isn’t a reasonable way to build up inventories. With rapid order to delivery, drop-ship, EOQ models, and the like there is no reason why organizations would need to build up inventory. The less amount of funds tied up with inventory is more funds to grow the organization.
There is tremendous value to be had in closely monitoring inventory. Organizations often stifle their potential by holding on to defunct, damaged or obsolete inventory. The single most important thing in managing inventory is to ‘move – it’. Moving inventory is acquiring it, and then moving it onto the end user as fast as possible.
It isn’t surprising that the current economic condition of the world has lead to some very progressive thought and actions on means of managing inventory. Aside from all of the technology employed in managing tangible inventory, several professional services organizations have moved to managing their intangible inventory. Emily Heller of The National Law Journal in her May 5, 2009 article, Downturn May have an Upside for Contract Attorneys, explains how many law firms are simply shopping on a per need basis, for specific legal talent. Lisa Solomon of Ardsley, NY has been operating as a ‘hired-gun’ since 1996. Solomon says “business is growing, there is a demand.”
The current economic climate may be the Ice Age of the 21st century which radically shapes professional services organizations into streamlined brokerage houses for ‘hired-gun’ talent. To the professional, this provides a strong motivation to be the best and at the same time, rewards of diverse engagements, possibly far greater than those possible at a single firm.
Inventory is all around, in every organization. With each passing minute some of its value is diminishing. It is no wonder that modern day ‘inventory’ comes from the Latin word Invenire – to find. There is value in all inventories, tangible and intangible. I urge you to find it, and use it for what it was intended – Sell it!