INVENTORY ACCURACY – DOES
THE NET TELL THE TRUTH?
“Across our six locations, our physical inventory
variance was zero and we’re proud of it.” - This tells
you exactly nothing.
A Tale of Jack and the Pride of it All…
Jack is the owner of an industrial products supplier
with five sales/inventory warehouses including one large
distribution center. Jack called me and asked if I could
spend a few days with him and review the overall
business. I could tell he had something on his mind.
arrived, we talked, and I suggested a tour of the
company. Met a lot of nice and hardworking people—and I
mean working so hard that I could feel the stress. It
doesn’t take long to see that something’s not quite
right. There was a chaotic feeling about the
organization; a sense of nervousness.
Jack turned to me with that deer in the headlights look
and said, “We lost near $300,000 last year.”
I said, “Jack, you have my attention.” I asked for more
details and that he keep the conversation at a macro
He said he couldn’t give me much other than that at the
end of the year, the company’s sales looked good and
inventory looked better than ever. I said, “Let’s focus
on the inventory. What portion of that $300,000 loss was
related to inventory?”
He said, “The company was up 10% in sales volume, so we
guess it was from the operations side of the business.”
I said, “So your sales were up and your operating
expense increased by no more than 2%, right?”
He said, “No—actually, operating expense increased much
more than that.” Jack’s team looks at Sales – Operating
Expense – Inventory.
I’ve been at this long enough to know what’s going on. I
asked, “So what was your physical inventory variance?”
Grinning ear-to-ear and proud as a peacock, he said, “We
don’t even have to look at that, as it was almost zero.
That’s why we’re sure it came from the operating expense
“Jack, what were your pickup and shrink percentages?”
He then said that it doesn’t matter. (Well, my family
will tell you that when I’m curious, I just don’t stop.)
I said, “It does matter, Jack; it matters a great deal.
Case in point: If you had an inventory shrink (loss) of
$200,000 and a pickup (increase) of $200,000, that would
be a net variance of…?”
Jack said zero. I said sure enough and that would look
pretty good—so good that it would make a business owner
happier than a fish in water. Jack smiled.
I posed this question: “If the $200,000 shrink related
to 1,000 part numbers, and the $200,000 pickup related
to 10 part numbers, would that be cause for alarm?”
He said, “Nope. It’s still a zero variance.”
I posed this
thought: “I’m afraid I can’t agree on that one, Jack. If
I had errors for twelve months on 1,000 of my part
numbers, I would suspect that a WHOLE LOT of BAD is
going on and that for sure the operating costs were very
high. Errors on 1,000 items clearly trumps errors on 10
items—that is, if you place your focus on what inventory
is really about—quantity. In fact, the human resource
and financial outlay to manage that type of discrepancy
would scare the dickens out of a guy.
“Your challenge is that you are focused on the dollars
and not the quantity. The net variance of quantity is an
alarming number where the variance of dollars is not.
You’re hearing what you want to hear.”
I then said: “When dealing with inventory, focus on the
pieces—not the dollars. You do not sell dollars. You do
not order dollars. You do not warehouse dollars. You
manage quantities of consumable assets.”
When is the last time one of your sales staff walked
into the warehouse and asked, “Hey Charlie, did my
$10,000 of nail guns come in yet?” Instead, it would be
much more likely that the salesperson asked if her order
of 10 Ramset nail guns has arrived. When is the last
time your customer called and said, “I’d like to order
$10 of utility knives”? My guess is that they said, “I’d
like to order 10 utility knives—what’s your price?” or
“I’d like to order 10 utility knives at $10 apiece.”
Jack said, “Dan, I get it and agree. We just never
looked at things that way. Heck, even everyone in my
peer group places focus on the dollars.”
Then Jack said, “Do you have some time to talk about my
The moral of the story is that you need to:
Look past what you want to see for what you need to
see…which is the truth and not the average.
Remove your blinders of desired bliss.
The School of Dan.