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Inventory shrinkage is like having a hole in your pocket

The rule of thumb that I use for the amount of annual inventory attrition a business can live with is 1/2 of 1% of sales. A $20 million full line building supply business with the lion’s share of sales going to professional contractors, will likely carry an inventory somewhere in the neighborhood of $1.7 million in value. If the business achieves my benchmark, it will have controlled inventory shrinkage to around $85,000.

While holding inventory shrinkage to 1/2 of 1% of sales is an acceptable job, we’re still looking at a loss of $85,000, which is not an insignificant amount of cash most managers would much rather see on the bottom line.

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Let’s explore a couple of ways managers might improve the amount of cash they lose each year to shrinkage:

Inventory shrinkage is caused by two primary factors: the first is because some degree of shrinkage is a byproduct of the way we do business in the building supply industry, i.e., substituting an 18′ board for a 16′ board because you are out of stock on 16s, and charging the customer the price of a 16′ board rather than the 18′ board that was loaded on his truck. Computers don’t know what we fail to tell them.

The other factor is sloppy inventory-handling procedures. One of the first abuses that comes to mind is the way returned merchandise is often handled:

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A sales rep asks a driver to pick up some leftover material the builder wants credit for. The driver spends a couple of hours rounding up the merchandise and loading it on his truck. When he returns to the yard, he is told he is late for making a delivery that has been promised before the end of the day, so he hurriedly dumps the returned merchandise on an uncluttered spot in the yard, quickly hands the list of material he picked up to an inside salesperson to issue a credit to the builder and then dashes over to pick up his delivery and drop it before the end of the day.

The returned material sits in the yard for over a week before the yard foreman, not taking time to determine the source of the returned material, asks a forklift driver to re- stock the resalable material and take the remainder to the “bone pile.”

In this scenario nothing was done “by the book.” Virtually every inventory control procedure was violated. When it comes to inventory control, this company must assign a qual- ified person to document some well-thought-out systems and procedures and diligently follow them or else they are headed into a collision with disaster.

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Key ingredients in a sound credit return policy
  • No pick up is to be made without an authorization from the yard foreman.
  • The driver is not to make any credit commitments to the contractor.
  • Returned material is to be placed in a designated area of the yard.
  • The driver returns the authorization form to the yard foreman along with a list of the material that was picked up and brought back to the yard.
  • Only the yard foreman is allowed to make a decision as to whether the returned material is resalable.
  • Only the yard foreman is authorized to issue a credit.
  • The material is returned to inventory or taken to the bone pile ASAP.

Ideas to recoup losses from D.O.G. merchandise

  • On slow days, assign someone to go through the material in the bone pile and make recommendations as to whether any of the products are sellable.
  • Perhaps cut some of the lumber into stakes.
  • Assign someone to price and date each item in the bone pile.
  • Quarterly, assign a responsible person to pick up all D.O.G. items that are more than 90 days old and transport to the dump.

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