The object of maximizing free cash flow through inventory planning is to commit cash to purchases as close to the demand date as possible. With 30 or 60 day payment terms to vendors, the most successful working capital managers may achieve the ultimate goal: paying cash for inventory investments after the sale date.
Cash outlays too far in advance of expected sale dates tie up excesss working capital that could be used for other purposes. If demand is expected to occur at year-end, paying for inventory at the beginning of the year and holding it ties up cash and storage space, and invites losses to spoilage, damage or obsolescence.
Each inventory item, or family of items, has a unique Demand Date, the date of expected sale.
Volumes at expected demand dates can be plotted as a percentage that adds to 100% for the year. These plots, I term “demand curves”.
Figure One shows demands at the end of each quarter:
Figure Two shows demands that are even throughout the year:
Figure Three shows demand only at year end:
Figure Four shows year-round demands that are seasonally higher in the third quarter:
Any annual usage pattern can be represented using this simple plotting of demand curves.
Using percentages instead of fixed values allows an inventory planning and procurement system to easily scale for different annual usage volume forecasts.
Expected volume x demand curve percentage = amount to purchase.
Demand Date – Lead time = Date of purchase.
Illustration of use:
Given a Demand Date of March 31, expected volume is 25% of 4,000 in forecast annual usage and a supplier lead time of one week and 30 day payment terms, an order placed on March 24 (March 31 less 7 days lead time) will be available for sale on March 31. With 30 day payment terms, cash for that inventory will not be used until April 23 (March 24 plus 30 days).
Cash investment in inventory is actually negative.
Making your working capital work for you is an Innovation for Business that gives your company a competitive edge.