Inventory Efficiency: Do the Math

Parts managers are using complex mathematical formulas to compute their optimal inventory quantities these days – though they might not be aware of it. Your DMS system is thinking through the process using calculus to create formulas and cost curves with the ultimate goal of minimizing the cost of ordering, stocking and holding the parts inventory.

Generally, the more of a part you order, the less expensive it is – not only is the part price reduced, but so are other costs, like transportation and labor. On the other hand, ordering in quantities that don’t sell in a timely manner, even to the point of obsolescence, raises costs, not just for parts that don’t get sold but for “frozen capital.” In essence, this leaves money sitting on the parts shelf that could be used in more productive ways. In the language of your DMS system, where the part cost and carrying cost curves meet is theoretically the optimal order quantity.

Of course, running the calculus is the computer software’s job, not the parts manager’s. But even without a computerized formula it’s important to think about where these curves meet, and what tools you have available to ensure you are inventorying intelligently.

Inventory and Turn Rates
Optimally parts inventories are going to turn four to six times a year. Accordingly, a dealership should retain 60 to 90 days of parts on hand. To compute your dealership’s turn rate, take your cost of goods sold for parts (sales minus gross profit) and divide that number by the cost of the parts inventory you have on hand. Then use your turn rate to determine how many days supply you have in inventory.

An example calculation:
The factors:
Parts sales for a year = $3 million
Gross profit on those sales = $1 million
Current parts inventory = $380,000

The calculation:
Cost of goods sold ($3 million minus $1 million) = $2 million
Parts turn rate ($2 million divided by $380,000) = 5.26
Current supply ($380,000 divided by $166,670 [$2 million divided by 12 months]) = 2.27 months or 68 days

Dealerships will necessarily find some inventory stale and not turning, while other parts are turning quickly. The only way to counteract the losses associated with the slow moving or obsolete parts might be moving the fast moving parts even faster. Understanding which parts are slowing the turn rate will help the dealer make adjustments to minimize losses.

So yes, there is real value in the math you learned in middle school that you thought you’d never use. Math makes for better parts management, a better return on your investment.

Three Key Reports
There are several DMS reports that can help to make your parts operation more efficient, but there are three that are essential to having the right parts on the shelves at the right time.

  1. Emergency Purchase Report. Buying from another dealer or suppliers as needed decreases net profit in both parts and service departments through higher initial prices, transportation costs, and service department downtime. Recording emergency purchases in your DMS as they occur and reviewing them regularly –at least weekly– will help you adjust your inventory accordingly.
  2. Lost Sales Report. If a sale is lost because a part is not in stock, it should be properly reported. A lost sale is defined as a sale that it is reasonable to assume would have been made if the part was on hand.
  3. Service Department Fill Rate Report. A weekly fill rate report gives parts managers a clear look at what’s going on in the shop. To correct fill rate inefficiencies, run the report by part number and same-day fill rate.

Take the following into consideration when reviewing these reports:

  • If the unit requiring the part is a new model – and could this be a trend?
  • Is the required part essential to operation of the unit?
  • Is an emergency purchase or a lost sale recorded for a part used in routine maintenance?
  • Does the parts locator section in your DMS indicate that other dealers are stocking a part you don’t stock?
  • Does the factory maintain a large quantity of a particular part?
  • Does my inventory reflect the population of models in my area?

Doing the math and reviewing your reports on a weekly basis will make for happier customers, more efficient employees and, by thawing out your frozen capital, a better bottom line.

About the Author(s)
Rex is a Principal of HBK CPAs & Consultants and directs the firm’s Dealership Group. He has worked extensively in the dealership industry since 1984 as a department manager, a general manager and an owner, as well as providing tax, accounting and operational consulting services exclusively to dealers as an independent CPA. This experience includes working closely with hundreds of dealers from coast-to-coast since 1987 on creative tax planning and financial statements issues. He provides clients with a wide range of transaction work services, and consults for them in specialty areas such as operations, government regulatory compliance, valuations and M&A feasibility studies. Rex is active in many professional associations. He is the current Chairman of the BDO Dealership Industry Group, contributes articles and commentary to dealership industry publications, is frequently called upon to speak to industry associations and conferences, provides expert testimony, and is regularly quoted by industry and the general media.
Hill, Barth & King LLC has prepared this material for informational purposes only. Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.

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