Inventory Management

Background

Ingredients are a vital building block of any food business. Without them, there is, quite literally, no product. In a burger stand, the ingredients required to make a burger include buns, ready-made patties, tomatoes, lettuces, etc. These ingredients, including unsold burgers and drinks, are collectively referred to as inventory. 

Inventory is both an asset and a risk. As an asset, sufficient inventory allows the food stand to meet customer demand and maximize profits. Being unable to produce because an ingredient has run out leads to unsatisfied customers and lost profits. On the other hand, the inventory is only potential revenue as money is not earned until after it is converted to burgers and sold to customers. Therefore, there is a real risk of tying significant cash down in a large inventory. Food stands, like all businesses, need cash flow to survive.

A large inventory also carries the risk of spoilage, damage, shifts in demand, or price fluctuation. Finally, in the case of a food stand sale, only a portion of the inventory's value is recovered as it is reduced to 50%. This is called an inventory write-down. 

Most businesses use a management system to maintain an appropriate inventory level and use the Inventory Turnover Ratio to measure inventory performance.

Simulation

Most businesses use a management system to maintain an appropriate inventory level and use the Inventory Turnover Ratio to measure inventory performance.

Inventory Turnover Ratio

Inventory Turnover Ratio (ITR) measures the number of times inventory is bought and sold over a certain period. It is a liquidity indicator because cash flow significantly improves when inventory is 'turning over' (moving in and out) frequently instead of sitting unsold in storage.

Although the appropriate turnover rate depends on the size of a business, a low turnover ratio generally indicates lower sales or too much inventory in storage. A higher ratio indicates higher sales and requires efficient inventory management to meet demand. 

Because the shelf life of food and its related stock is often short, food businesses aim for higher 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 included in the sales method, 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 

Management Systems

Developing an inventory management system for a food stand requires consideration of storage space constraints and the sales forecast. 

Storage Space

In the simulation, all inventory is stored on the food stand. Storage space is limited, and the goal is to balance maximizing cash flow and storage space. 

Bulk Purchasing

Maximizing storage space may sometimes mean bulk-purchasing some ingredients to reap cost savings. Before making a bulk purchase, consider the discounts on offer from vendors closely to be sure: 

a. The cost savings is worth tying up the cash.

b. There is sufficient space to store the items.

c. There are no potential expiration issues. 

Minimizing Waste

Properly managed inventory ensures minimal waste. Waste can be categorized as any ingredient or drink thrown away due to overstocking, spoilage, or expiration. In the simulation, wastage occurs when ingredients or drinks get thrown away because you ordered more than you could store. Any purchased item that exceeds the food stand's storage limit turns to a loss called Wasted Overstock. It is easy to overstock in a bid to reap some cost savings on bulk purchasing an ingredient.

Expiry Management

Expiration issues are a serious consideration when making bulk purchases. Although this might not be in the simulation yet, expiry management is an essential part of food inventory management and deserves mention.  Food safety mandates that safe and fresh ingredients are used in all consumable products. You need to use your stock well before its expiry date and ensure that no product that includes expired ingredients is sold to customers. One way to ensure effective expiry management is using the "First Expired, First Out" (FEFO) method. FEFO means that the ingredients with the earliest expiration date are used first. 

But FEFO will be unable to help if an item or ingredient with low demand is bulk-purchased. It is safer and more profitable to make bulk purchases of high-demand items and ingredients to avoid the loss of having some stock expire while in storage. 

To do this, however, a knowledge of how the food stand consumes each ingredient daily is required. And this knowledge is at the heart of sales forecasting. 

Sales Forecasting

Intelligent sales forecasting improves the inventory management process. Accurately estimating the food stand's future sales under varying conditions will help to avoid unnecessary inventory purchases. 

There is no single way of accurately estimating sales for a food stand. Still, you can use some information in the simulation to generate a decent estimate. The quickest way is to track the number of burgers and drinks sold daily and use that as an estimate for future inventory needs. This method, while easy, does not account for the different factors that impact sales. 

Performance Logs

To significantly increase accuracy, the following data can be logged:

• Daily or weekly number of burgers and drinks sold per stand.
• Amount of ingredients used (per recipe).
• Average population size during the period (including any event that caused an increase or decrease).
• Weather and temperature during the period.
• Any 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

Stock requirement estimates can be narrowed further to the ingredient level by combining the information in your logs with a Par System. PAR stands for Periodic Automatic Replenishment. While the name sounds complex, it is a straightforward system. It indicates the amount of stock needed to service your food stand over a fixed period. 

If you use 300 grams of burger patty in a particular recipe daily or weekly, that's your par for the period. You will maintain a par sheet where the amount of inventory left in storage is updated and compared with your par, and the difference is purchased accordingly. 

For instance, if the food stand uses 72 cans of sauce per week, the amount of sauce entered in the par sheet is 72. The sheet is reviewed at the beginning and end of the week, alongside the number of cans left in storage. Then, orders for the following week are placed to ensure the minimum par level is met. Par levels change based on season, weather, and events. You can easily use the information in your logs to predict appropriate par levels under varying conditions.