Inventory Management

Introduction

Ingredients form the lifeblood of every food-related venture, regardless of whether it's a street food truck or a bustling restaurant. The finished product, and everything that goes into creating it, constitute the inventory. The proper management of this inventory is crucial, ensuring businesses can satiate customer demands and optimize profits.

Poor Inventory Management Risks

Poor inventory management can lead to risks that can significantly impact a food business's financial health and operational efficiency. Here are some of the risks associated with poor inventory management:

1. Cash crunch: Too much capital invested in inventory reduces the money available for other critical business operations such as expansion, marketing, or even meeting day-to-day expenses. This can lead to a cash crunch, making it difficult for the business to respond to unexpected expenses or opportunities. The business might be forced to borrow more money to finance its operations, increasing debt and interest expenses.
2. Inventory bloat: This refers to a situation where a business has more inventory than it can sell in a reasonable time. This can occur due to over-purchasing, poor sales forecasting, or sudden changes in market demand. While having a large inventory might seem like a good idea, as it ensures that the business can meet any sudden increase in demand, it comes with its own problems.
3. Spoilage: If items aren't sold before their expiry date, they have to be discarded, leading to direct financial losses. This is especially relevant for food businesses, where many items have a short shelf life.
4. Damage: The more items a business has in its inventory, the higher the chances of items getting damaged due to accidents, poor handling, or even natural disasters. Damaged items can't be sold, leading to financial losses.
5. Unnoticed shifts in demand: When a business has a large inventory, it might continue selling items that are no longer popular, while missing out on new trends that could bring in more revenue.
6. Price fluctuation: The cost of items can change due to factors like changes in supply, changes in demand, or even geopolitical events. If a business has a large inventory of an item whose price drops significantly, it might have to sell the item at a loss.
7. Inventory write-down: In the case of a business sale, only a portion of the inventory's value is typically going to be recovered.

Inventory Performance Monitoring

Most businesses measure their inventory performance using the Inventory Turnover Ratio (ITR). ITR gauges the frequency of inventory buying and selling during a certain period. It is considered a liquidity indicatorbecause cash flow significantly improves when inventory is 'turning over' (moving in and out) frequently instead of sitting unsold in storage.

While the ideal turnover rate varies across businesses, a low turnover ratio typically signals lower sales or excessive inventory. Conversely, a high turnover ratio suggests robust sales and requires efficient inventory management to meet demand. 

For food businesses with perishable inventory, a higher turnover is desirable to prevent waste.

Copyright of Merchant Mavrick

Calculating Inventory Turnover

Inventory turnover can be calculated using either the cost of goods sold (COGS) method or the total sales method. The COGS method is preferred because it excludes the retail markup, which can falsely inflate results. 

Inventory Turnover COGS

This method uses the Cost of Goods Sold (found on the income statement) and Average Inventory to determine inventory turnover. The formula is: 

Inventory Turnover = COGS / Average inventory 

Average inventory = (Beginning inventory + Ending inventory)/2 

Most food businesses use a management system to maintain an appropriate inventory level. An effective inventory management system will require storage space optimization and accurate sales forecasts.

Optimizing Storage Space

Optimizing storage space may sometimes mean bulk-purchasing some ingredients to reap cost savings. Bulk purchasing may seem tempting due to cost savings, but it requires careful consideration. Before making a bulk purchase, consider the discounts on offer from vendors closely to be sure: 

• The cost savings is worth tying up the cash.
• There is sufficient space to store the items.
• There are no potential expiration issues. 

Strategies for minimizing waste and managing expiry dates

Effective inventory management incorporates two key elements: reducing waste and managing expiration dates. These strategies are crucial in optimizing inventory, especially for businesses handling perishable goods.

1. Reducing Waste: Overstocking or ordering more inventory than required can lead to waste. This is particularly problematic as it causes financial loss and can lead to space constraints. It is easy to overstock in a bid to reap some cost savings on bulk purchasing an ingredient. An effective strategy to avoid this is accurately forecasting demand and ordering inventory accordingly.
2. Managing Expiration Dates with FEFO: In the food industry, expiration dates are critical. Ensuring all ingredients are used before their expiry date is vital to maintain food safety standards and avoid wastage. Moreover, no product containing expired ingredients should be sold to customers. The "First Expired, First Out" (FEFO) method is a practical approach to managing expiration dates. FEFO prioritizes using the ingredients that will expire first. However, this method may not be efficient for low-demand items purchased in bulk, as they may still expire before being used. Therefore, it is recommended to apply a bulk purchasing strategy primarily to high-demand items. These items will likely be used before their expiry dates, reducing the risk of spoilage and waste

By effectively minimizing waste and managing expiry dates, businesses can ensure profitability while maintaining high food safety standards.

Accurate Sales Forecasting

Intelligent sales forecasting improves the inventory management process. Estimating future sales accurately allows businesses to avoid unnecessary inventory purchases, ensuring optimal use of resources.

There is no single way of accurately estimating sales for a business. The easiest way is to track the number of products sold daily and use that as an estimate for future inventory needs. This method, while quick and easy, does not account for the different factors that impact sales. 

Using Performance Logs

To significantly increase the accuracy of their sales forecasts, businesses can log the following data consistently:

• Daily or weekly number of products sold.

• Amount of ingredients used (per recipe).
• Average population size in the are during the period (including any event that caused an increase or decrease).
• Weather and temperature during the period.
• Any relevant news events or occurrences during the period.

These logs can serve as historical performance data to guide daily or weekly sales estimates and hence, stock purchasing decisions.

Using a PAR System

Businesses can further narrow down their stock requirement estimates to the ingredient level by combining the information in their performance logs with a PAR System. 

Periodic Automatic Replenishment (PAR): This is a system that helps businesses determine the amount of inventory needed to operate efficiently over a specific period.

Take, for example, a restaurant that typically uses 72 cans of sauce every week. In this scenario, 72 cans is the "par level," a benchmark indicating the amount of sauce the restaurant needs to keep on hand each week.

To maintain this par level, the restaurant uses a record-keeping document known as a par sheet. This sheet documents the desired par level (in our example, 72 cans of sauce). At the start and end of each week, the number of cans actually left in storage is compared against this par level.

Suppose at the end of the week, the restaurant only has 20 cans of sauce left. To reach the par level for the following week, it would then need to order an additional 52 cans.

Par levels aren't static, though. They can change based on various factors, such as seasonality, weather, or special events, which might influence customer demand. By regularly updating and analyzing their performance logs, business managers can predict the appropriate par levels under varying conditions and adjust their inventory orders accordingly.

Case Study - Rosa's Pizzeria

Rosa's Pizzeria had hit a rough patch. Despite a heartwarming menu, loyal customers, and a lively ambience, profits were flatlining. Their inventory was brimming with fresh ingredients, but spoilage was rampant. "Our cash was tied up in heaps of tomatoes and cheese, which eventually ended up in waste," recalls Rosa, the owner.

The Challenge

Managing a diverse inventory was a struggle. "Our storeroom was always packed to the brim," says Antonio, Rosa's son and co-manager. Ingredients with varying shelf lives and fluctuating demand led to over-purchasing and subsequent waste.

Driven by an ambitious plan to open another branch across town, Rosa realized that they could not scale their business successfully without first getting a firm handle on their existing inventory struggles.

The Solution

Rosa's thus opted for a robust inventory management overhaul, viewing it as the key to mastering the current operations and paving the way for future expansion.

1. Inventory Performance Monitoring: They began tracking their Inventory Turnover Ratio (ITR) using the COGS method. Rosa's ITR was 4, much lower than the industry average of 6, signalling overstocking and sluggish sales.
2. Storage Space Optimization: Rosa's reduced bulk purchases and assessed whether the storage space and cash investment were justified.
3. Managing Waste and Expiry Dates: They implemented the "First Expired, First Out" (FEFO) method, putting a check on spoilage.
4. Accurate Sales Forecasting and PAR System: Performance logs were introduced to record daily sales, ingredient usage, and external factors like events or weather. These logs and the PAR System helped manage ingredient-level stock requirements efficiently.

Implementing these strategies wasn't without hurdles. "We initially struggled with maintaining performance logs consistently," shares Rosa, "But we persevered, and it eventually became a habit, proving invaluable."

The Results

The effects were transformative. Over six months, Rosa's Pizzeria cut its wastage by 35%, and the ITR improved to 5.7. Free cash flow increased by 40%, and a more organized inventory led to smoother operations.

A regular customer, Sarah, noticed the change. "They never run out of my favourite Margherita pizza anymore, and the service is faster," she comments.

Conclusion

Rosa's Pizzeria's journey illustrates how intelligent inventory management can revive a struggling food business. In Rosa's words, "With just our beloved pizza recipe and loyal customers, we weren't making ends meet. But efficient inventory management turned things around for us." Rosa's story shows that in the food industry, a delicious menu and excellent service need to be complemented by savvy inventory management.