An accepted best practice in inventory planning is to adhere to the Pareto Principle, also known as the 80/20 rule. For inventory planners, this is also often referred to as product profiling, or ABC profiling. This makes intuitive sense. It’s natural to spend relatively more time in planning, analysis and management of the top-selling items, but what does it mean in financial terms?
One of our customers recently increased their cash flow by ~$270,000. Prior to our implementation, their active inventory was growing steadily eating away at their cash. They were able to reduce their active inventory by about $1M by analyzing inventory to determine what was truly driving sales and then focus improving that business as a priority.
This first example shows the incremental sales potential with focus on delivering a higher fulfillment rate on the first quartile, accepting that it may result in lower fill rate in the third and fourth quartile. The incremental sales gain is $825,000 with the fulfillment assumptions shown in this example. Plus, these are very profitable sales, considering all advertising and fixed costs are sunk at this point.
The same concept applies with cash flow management. This second example shows the cash flow impact of focusing attention on improving inventory turnover on the highest volume quartile — again, accepting that it might yield lesser results in the third and fourth quartiles. With the assumptions shown here, cash flow improves by $294,000.
This same concept works in virtually all metrics: sales, gross margin, returns, overstock liquidations, etc. Each business has its own set of facts, but adherence to product profiling with inventory management will deliver incremental sales, profit and cash flow gains for all businesses.