Step by Step Guide to Understanding Inventory Management
A lack of inventory causes shortages, which can cause lost sales, customer
dissatisfaction, lower productivity and increased labor costs. Too much
inventory ties up working capital, increases carrying costs and increases
the risk of obsolesces and shrinkage.
This is the first of two articles on this subject. This article addresses basic terminology and principles
associated with inventory management. The second article specifically addresses inventory strategies.
Inventory serves two purposes:
 It acts as a safety mechanism to compensate for ordering, shipping and delivery lag times. It’s an
assurance that the company does not run out of parts, equipment or material while waiting for the next
order to arrive. It also acts as a buffer in case availability issues arrive.
 It allows a company to take advantage of quantity discounts by purchasing in larger quantities to get a
lower price. A manufacturer’s early season stocking program is one example of this.
Inventory Methods
There are three types of inventory methods. These include the periodic inventory method, the perpetual
inventory method and hybrid inventory methods. This section gives a brief write up on each.
Periodic Inventory Method
In the periodic inventory method, the company does not keep a continuous record of each unit item on hand
in inventory. Instead at the end of the period, the business makes a physical count of the on-hand inventory
and applies the appropriate unit costs to determine the cost of ending inventory.
The obvious disadvantage to the periodic inventory system is the need and expense of doing inventory
counts to determine the cost of goods sold.
Perpetual Inventory Method
In the perpetual inventory method, the company keeps a continuous record for each inventory item. The
records thus show the inventory on hand at all times. The company can determine the cost of ending
inventory and the cost of goods sold directly from the records without having to do a physically count.
The perpetual inventory method requires processes to track all inventory items from the time they are
purchased to the time they are consumed and are expensed. The following illustration highlights some of
the main elements in this process for a residential replacement job. The process is also very similar for
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service. The specific details for each step will vary per company but the overall flow should be about the
same.
Residential Replacement Material Flow
for a Conventional Perpetual Inventory System
7
2
1
Inventory
2
1
1
Purchase
Requisition
Purchase
Order
5
2
1
Installer
Material
Requisition
Job
Material
Requisition
3
Receive
Directly
for Job
4
2
1
6
2
1
Job
Costing
Explanation:
1. Larger companies may require a purchase requisition. This form is filled out and is then forwarded
to purchasing. Companies that use their Comfort Advisors to manage jobs they submit purchase
requisitions for the jobs they sell.
2. Purchasing creates a Purchase Order to either restock inventory or to go directly to a job. The
Purchase Order is submitted to the vendor usually by fax, by Internet, by email or by phone.
3. When the shipment arrives, the order is counted and checked for damage in the receiving process.
The system confirms the order has been received. If the order was for inventory, the newly arrived
items are added to the inventory count.
4. The Comfort Advisor fills out a Job Material Requisition identifying what equipment and materials
are needed from inventory for a job. Some companies incorporate this into a task sheet the Comfort
Advisor fills out on each sold job. The warehouse uses this information to stage the job.
5. Most companies equip their installation trucks with some basic installation materials. When the
installation crew uses material from the truck stock, they fill out a material requisition for the truck.
A copy is forwarded to the warehouse to restock the truck.
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If the Comfort Advisor omitted items that are needed for the job, the installation crew may need to
order additional materials. Each company does this differently. Some have their installers call the
warehouse to have the materials pulled from inventory and delivered to the job site. If this is the
case, the material must be added to the material requisition.
Sometimes not all materials that were pulled for a job are used. The excess materials need to go
back into inventory. Some companies use a restocking form that installers fill out to put materials
back into stock.
6. All material requisition forms are forwarded to administration for job costing. When the job closes,
all costs for parts, equipment and materials are relieved from inventory and are expensed to the job.
These costs now appear as a cost of sale on the income statement. The items purchased on a
Purchase Orders for a specific job are also ‘expensed’ in job costing.
7. When items in inventory drop below minimum stocking level (reorder point), a new order is placed
to replenish stock.
A perpetual inventory method can be very accurate. Most HVAC and plumbing computer systems support
a perpetual inventory system. However, to work properly, everyone must be very disciplined in filling out
the proper paperwork. This includes receiving documents, all material requisitions and restocking forms.
In the real world, this process often breaks down because the paper is not filled out properly or does not get
recorded properly in the inventory control system. When this happens, the perpetually inventory method
turns into a periodic inventory method and there may be some big adjustments to inventory and
consequently to the cost of sales. These types of adjustments make the financial statements questionable
and consequently make it difficult for a general manager or owner to manage the company.
Another concern of the perpetual inventory method is the amount of administration required to keep
accurate records particularly in regards to job costing. There’s a business philosophy that was introduced
in the mid 90’s called ‘Lean Thinking’. The basis of this philosophy is to question every process and every
step in a process to see if it adds value to the end consumer. Some companies are questioning the ‘value’ in
using a pure perpetual inventory method.
Technology is helping. Many companies use bar coding to help eliminate the need to fill out paperwork
and to streamline the administration. Inventory items are given a bar code when they are received into
inventory. The bar code is swiped when the items are removed from inventory.
Hybrid Inventory Method
Some companies use a hybrid inventory method. There are several variations of this approach, but the
common theme is based around not tracking each and every item that’s in inventory.
Expense at the time of purchase
A perpetual inventory system always expenses items as they are consumed from inventory. This is called
‘expense at the time of usage’. Another approach is to ‘expense at the time of purchase’. It’s very similar
to cash accounting. A hybrid inventory method allows you to ‘expense at the time of purchase’. This
eliminates the need for the job costing function to relieve items from inventory. It also eliminates the need
to address inventory cost of sales issues with FIFO, LIFO or average cost. This will be addressed later in
this article.
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Companies that use this method will set up a baseline for each item needed in inventory and then will
establish a value for this safety stock that appears on the balance sheet. As stock is replenished, the
purchase is charged to Cost of Sales for the appropriate department rather than to inventory. When
ordering stock that will be consumed by more than one department, the expense is allocated to the various
departments.
With the advent of Cookbook Pricing, companies have the means of setting prices up front for their sales
people. There’s no need for sales people to estimate their own jobs for most residential replacement
applications. These companies also have systems in place to detect if the Comfort Advisor makes pricing
errors or omits tasks needed for the job. Consequently, there is no real need to do job costing. This
eliminates some of the paper and saves on administrative costs. These companies do look at their Income
Statements closely to monitor cost of sales trends. They will also do spot job costing on jobs to confirm
that their estimated costs are correct in their Cookbook pricing.
The hybrid inventory method should accommodate tracking of expensive inventory items such as
equipment. You also need to track equipment usage to the particular home in case there are manufacturer
recall issues. Most companies using a hybrid inventory method track equipment as if it were on perpetual.
They also use the ‘specific cost’ method to determine cost of sales.
Flat-Rate Service
A hybrid inventory method can also be used to accommodate flat-rate pricing for service. Many of the flatrate pricing systems that are available tie to perpetual inventory methods. Every possible part is listed and
priced in a big thick binder, which the technician carries with him. It can be challenging for the service
technician to identify the specific code for each replacement part and for administration to expense out the
part when the service ticket is closed out.
For example, let’s look at a typical fan/limit control. The service technician may need to carry several
fan/limit controls on his/her truck to accommodate all the applications they may encounter. But when you
get down to it, how much difference is there in the retail price among any of them? Usually there’s very
little. Why not set a generic line in the flat-rate book and have both a common code and a common retail
price. It makes life much easier for the technician. With a hybrid inventory system there’s no need to
track each part separately like there is under the perpetual system. Using the same example, you can use a
weighted average cost for the various fan/limit controls to determine the retail costs.
Each company has a choice if it wants to ‘expense at the time of usage’ or ‘expense at the time of
purchase’. If it is done at the time usage, the weighted average cost can be used for the cost of sales.
Truck replenishment does not have to be tied to a perpetual inventory method. This can be accomplished
by setting-up common truck stock and having a means to identify when items have been consumed. Some
companies have the technicians identify the specific part that was used on the service ticket and will take
copies of all the service tickets generated for the day to restock the truck. Other companies have their
technician fill out a tick sheet, which identifies all the parts on the truck. The warehouse restocks the truck
based on the usage identified on the tick sheet.
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Inventory Costing Methods
Determining the unit cost of inventory is easy when the unit cost remains constant during the period.
However, unit costs often change during the month. The most popular costing methods include:
1. Specific Unit Cost
This method costs inventory at the specific cost of the particular unit.
2. Average Cost
This method is based on the average cost of inventory during the period. Average cost is
determined by dividing the cost of goods available for use (beginning inventory plus purchases) by
the number of units by the average cost per unit.
3. First-in, First-out (FIFO)
Under this method, the company must keep a record of each item purchased. The first costs into
inventory are the first costs out to cost of goods sold. Ending inventory is based on the costs of the
most recent purchase.
4. Last-in, First-out (LIFO)
This method also depends on keeping a record of each item purchased. LIFO is the opposite of
FIFO. Under LIFO the last costs into inventory are the first costs out to cost of goods sold.
Inventory Turnover
The inventory turnover ratio shows the speed at which inventory moves. This ratio indicates how quickly
inventory is converted back into cash. You can determine the inventory turns per year, per quarter or per
month.
The inventory turns can be calculated on total inventory, by subset or by individual component.
In general terms a turnover rate of 6 to 8 times per year for equipment and installation materials was
considered acceptable. The turnover rate of 8 to 12 times a year for service parts was also considered
acceptable. Whether an inventory turn rate is too low or too high depends on the ability of the supplier to
replenish the order. See this website for additional information on inventory management strategies. If
the inventory turn rate is too low, the inventory is moving too slowly and working capital is being tied up.
If the inventory turn rate is too high, there’s a probability the particular item may not be in stock. This
could mean a loss of sales or expensive emergency trips to the supplier.
Calculating Total Inventory Turns Per Year
Here is the basic formula for determining annual inventory turns:
INVENTORY TURNS
= Annual Cost of Parts/Equipment/Material Sold
Average Monthly Inventory
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For this example, let’s say these costs were $298,000 for the year and the Average Monthly Inventory was
$56,800. The total inventory turns is 5.2.
$298,000
$56,800
=
5.2 turns
Begin at the Income Statement and add up the costs of sales for all parts, equipment and material. Then
look at the balance sheets for each of the last 12 months, add them together and divide by 12 to find the
Average Monthly Inventory.
Calculating Quarterly Inventory Turns
Once a year is a long timeframe to manage inventory by. The above formula can be adapted to find the
quarterly inventory turns. Let’s proceed with the following example.
Monthly Cost of Sales
Monthly Inventory
Jan.
$26,471
$48,158
Feb.
$28,435
$46,438
March
$30,242
$51,372
Step 1 - Total the monthly cost of sales for the quarter to get $85,148.
Step 2 - Determine the average monthly inventory level for the quarter.
($48,158 + $46,438 + $51,373)
3
=
$48,656
Step 3 - Determine the quarterly turns.
$85,148
$48,656
=
1.75 turns
This can be converted into annual turns by multiplying by 4 ( 4 quarters in a year), which in this example is
7 turns.
Calculating Monthly Inventory Turns
The formula can be adapted to monitor monthly inventory turns as well.
Step 1 – Take the actual inventory value the beginning of the month and at the end of the month. Divide
this by 2 to get the monthly average. For example,
Actual inventory value on May 31 is Actual inventory value on June 30 is -
$108,342
2
=
$53,324
$55,108
$108,342 total
$54,171 June Average Inventory
Step 2- Go to the Income statement to find the total cost of parts, inventory and material for the month. In
this example, let’s put the expense at $27,086.
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Step 3 – Divide the cost of sales for the month by the monthly average inventory.
$27,086
$54,171
=
.5 turns per month
This can be converted to quarterly or annual turns by multiplying by 3.
(.5 turns per month)
x
3 months
=
1.5 turns
This can also be converted to annual turns by multiplying by 12.
(.5 turns per month)
x
12 months
=
6 turns
Average Days in Inventory
Some managers like to convert turns into average days in inventory. To do this, take the number of days
for the period (annually, quarterly or monthly) and divide by the number of turns. For example, let’s say
the annual inventory turn was 6.
365
6
=
60.8 days
Tracking Inventory Turns by Subset or by Individual Part
If your Balance Sheet breaks down inventory into service parts, equipment and materials, its possible to
track inventory turns by subset. For example, to find the annual inventory for service parts, adapt the
formula is adapted as follows:
INVENTORY TURNS
= ____
Annual Cost of Service Parts Sold
Average Monthly Service Parts Inventory
For example suppose the annual cost of service parts was $49,400 and the monthly average inventory for
service parts was $8,233. The service parts turn rate would be 6.
$49,400
6
=
6 turns
You can adapt the preceding copy to get the turn rate per quarter or per month.
If your inventory system gives you this information on individual parts, it’s also possible to calculate
individual component turn rates. The part inventory turn rate is automatically calculated on some computer
systems.
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Inventory Turnover versus Invested Inventory Capital
Companies must continually compare inventory turns versus the consequent capital inventory investment.
Keep in mind that there’re are two objectives in managing inventory. The first is to have the item available
when needed, within guidelines, and to minimize the amount of capital required for inventory. To
illustrate, let’s look at the following scenario. Company ‘A’ has 4 inventory turns per year. Company ‘B’
has 8 inventory turns per year.
Company
A
B
COST OF ANNUAL PART SALES
$100,000
$100,000
INVENTORY TURNS PER YEAR
2
8
INVENTORY REQUIRED
$50,000
$12,500
r
C o m p a n y ‘ A ’ with 8 turns per year, only requires $12,500 inventory, compared to Company ‘B’
which requires $50,000 in inventory because of their 2 turns. Company ‘B’ also has higher overhead costs
as shown below.
Required inventory for Dealer ‘A’
$50,000
Required inventory for Dealer ‘B’
$12,500
$37,500
*Assume 30% factor for the annual cost of inventory
x
30%
$11,125
Combined investment difference
$48,625
* Note: Inventory costs are discussed in the following section.
Inventory Costs
Inventory is one of the most important assets a company has. Companies incur expenses in maintaining
their inventory. Parts, equipment and materials must be purchased, stored transferred, insured and
protected from theft and damage. There’s also shrinkage and possible obsolescence. Depending on the
inventory control system used, inventory records must be maintained and the administration may need to
input all of the transactions. This requires people to perform this work. There’s also the cost of warehouse
space. If the local municipality or state taxes inventory, there’s also that expense.
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All of these costs can easily total up to 20% or more of the annual inventory value. These funds could be
just as easily invested in other high return-on-investment areas. When considering the raw costs in
maintaining inventory plus the lost investment opportunity, this can easily be 30%, 40% or more of the
value of the actual inventory.
Inventory Costs Versus Inventory Turns
As mentioned in the preceding section, carrying costs can easily be 30% of the value of the inventory.
Depending on the inventory control system and on the quality of inventory management, this could be 35%
or even 40%. The 30% figure is fairly conservative.
Let’s see how the inventory rate affects inventory costs by comparing 4 different scenarios with different
inventory turns and a total parts cost of $100,000.
Company ‘A’
Company ‘B’
Company ‘C’
Company ’D’
Turns /
Year
Inventory
Amount
Carrying
Costs
(30%)
Total
Inventory
Investment
Total
Difference
From ‘A’
1
4
6
8
$100,000
$25,000
$16,666
$12,500
$30,000
$7,500
$5,000
$3,750
$130,000
$32,500
$21,666
$16,250
$0
$97,500
$108,334
$113,750
This is an extreme example, but suppose Company ‘A’ only has 1 turn per year. This means the company
has $100,000 in inventory. Based on a 30% carrying cost factor, the company has an additional $30,000 in
carrying costs for a total investment of $130,000.
In contrast to this, Company ‘B’ has 4 turns per year. This drops the inventory down to $25,000 and the
carrying costs to $7,500. The total inventory investment is $32,000.
Company ‘C’ has 6 turns per year. This drops the inventory down to $16,666 and the carrying costs to
$7,500. The total inventory investment is $21,666. Notice that this is $10,334 less than Company ‘B’.
Company ‘D’ has 8 turns per year. This drops the inventory down to $12,500 and the carrying costs to
$3,750. The total inventory investment is $16,250. This is $16,250 less than Company ‘B’ and $5,416 less
than Company ‘C’.
Other Cost Considerations
Too little inventory can result in lost sales or too many expensive emergency trips to supply houses. By
maintaining proper inventory levels, technicians are able to complete a higher percentage of their calls the
first time. This builds customer confidence and greater customer satisfaction.
You must also consider the extra labor costs of waiting at jobsites for the delivery. There is also extra labor
used for emergency pick up and delivery time.
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For Example if you pay hourly wages:
Consider a company with 3 installation crews:
6 people @ $15/hr. wage
.
6 people fringe benefits (approx. 30%)
6 people total labor cost/hr
=
=
$90.00/hr
$27.00/hr
$117.00/hr
Losing 1/2 hour productivity per day due to a lack of parts or materials costs you $58.50 ($117/.5) per day
or $292.50 per week ($58.50 x 5). Over the course of a year, this could cost you as much as $15,210 (52 x
$292).
If you pay on task-based pay you have unhappy employees because the lack of inventory affects their
ability to earn wages.
TOO MUCH INVENTORY also increases overhead costs. Too much inventory consumes additional
warehousing space. There are additional insurance costs, handling expenses, interest costs, and taxes. Too
much inventory also generates obsolescence.
Minimum Stocking Levels
Determine how many working days it takes to receive an order from you your vendor once the order is
placed. Consider:





Time needed to generate a purchase requisition if a company incorporates this process.
Time to generate a purchase order.
Time needed to send purchase order to vendor (mail, fax or email).
Time needed by vendor to process and ship order.
Time needed to receive shipment and to place into inventory stock.
This replenishment time is also called the Supplier Cycle Time. Once you have determined the
replenishment time period, the next step is to determine the quantity of stock needed for each inventory
item during this. Begin by determining the quantity used per day for each stock item. One easy way to do
this is by determining the monthly usage, then the weekly and finally the daily usage.
Monthly Part Usage
Number of Weeks in Month
=
Weekly Part Usage
Then:
Weekly Part Usage
Number of Working Days in Week
=
Daily Part Usage
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Multiply the average daily usage by the number of days needed for replenishment to determine the
minimum inventory stocking level.
(Daily Parts Usage) x
(Replenishment Days)
=
Minimum Stocking
Level
This is your safety stock, which allows you to fill your daily needs until the next vendor shipment arrives.
Here’s a graphic representation:
Parts
Stock
Quantity
Minimum Stocking
Level
Safety Stock
Time
The left hand side of the chart indicates the individual part stock quantity count. The bottom line indicates
time.
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Maximum Stocking Levels
To determine the maximum stocking level, add the ‘safety stock’ quantity to the ‘reorder quantity.
Maximum Stocking
Level
Reorder
Quantity
Parts
Stock
Quantity
Minimum Stocking
Level
Safety Stock
Time
But what determines the reorder quantity? There’s no set rule for this and each company must make its
best decision based on:








Quantity Purchase Prices
Supplier Promotional Stocking Programs
Seasonality
Distance From Supplier and Supplier Replenishment Capabilities
Current Cash Flow Available Working Capital
Part Usage History & Obsolescence
Part Cost
Taxes on Inventory
Quantity Purchase Prices
Most suppliers give discounts to customers who purchase an item in quantity. Consider the amount of
savings, the carrying costs, the available warehouse space and the company’s working capital situation in
determining how much to purchase of an item. For example, when purchasing an extra four months
quantity of an item, the last item could cost an additional 6% in carrying costs.
4 months
12
=
(18%) x 30% Carrying Cost Factor
=
6%
Using this logic, you can quickly evaluate to see if the savings is enough to offset the carrying costs when
determining to purchase in quantity. Also consider the increased risk of obsolesce and shrinkage when
ordering in larger quantities.
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Supplier Promotional Stocking Programs
This is really an extension of the previous bullet. Sometimes manufacturers create early season stocking
programs for their customers. The promotion usually includes variations of pricing discounts, special
payment terms, trip participation, etc. Keep in mind that the reason the manufacturer is making the
promotion is because of their inability to provide the right product at the right time during the busy season.
Remember there is no ‘free lunch’ or in this case a free trip. Those promotional costs are built into the
product cost. Many owners or general managers would rather be in control of their own vacations and
would rather negotiate for things that will help their business like better service or lower prices.
The flip side to this issue is having the manufacturer run out of product during the times of the year that
you need it most. Your history with the manufacturer will help you decide if you need to participate or not.
If you have to stock for availability reasons, recognize that your inventory turn rate will be lower.
If you decide to participate, negotiate a return policy where you can exchange the unused product at the end
of the season for other products you’ll use in the next season. This way you minimize the chances of
equipment sitting in the warehouse for several months.
Seasonality
Usage on a particular item may change with the heating or cooling seasons. You will want to change the
maximum inventory level to accommodate for seasonality.
As mentioned above, negotiate a return policy with your suppliers. If you find you are stocking slowmoving parts, arrange to exchange them for faster moving items. It’s not financially advantageous to hold
on to parts until the season rolls around again.
Distance From Supplier and Supplier Replenishment Capabilities
The distance from the supplier definitely impacts stocking levels. Shipping costs also affect the decision.
Some suppliers will absorb shipping costs when placing a minimum size order. If you have to stock extra
to accommodate shipping time or shipping costs, recognize that your inventory turn rate is going to be
lower.
In contrast to this situation, many suppliers provide excellent customer service and will deliver orders.
Depending on the frequency of delivers during the week, this lowers the need to stock additional items to
accommodate shipping time or shipping costs. Some distributors even deliver product to the job site. Still
others deliver parts and materials in plastic tubs to replenish individual service and installation trucks. The
supplier’s ability to provide these types of services affect reorder quantities. These types of services can
allow you increase inventory turn rates, which is a very good thing.
Current Cash Flow and Available Working Capital
There’s an old accounting saying that ‘cash is king’ and this is very true. Most HVAC companies that go
out of business failed because of cash flow problems rather than because they were losing money. They
did not have the cash to pay their bills. Cash flow is off particular importance for growing companies or
companies who are not liquid because they’ve sunk the cash into things like fixed assets and inventory.
As an owner you also want to get the best possible return for the equity you have in the business. The only
reason to have inventory is to have an item on hand when you need it. Inventory provides no additional
value. It makes much more business sense to invest capital into areas that deliver more return on equity.
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Parts Usage History & Obsolescence
This really speaks for itself. The more you know how an item has moved throughout previous years, the
more likely you are able to predict future usage. Keep in mind however that it is possible to change
historical trends. A couple cases in point, if you know a part is going to become obsolete, you will not
want to continue purchasing the part based on past trends. Likewise you may be able to eliminate the need
for some OEM parts purchased in the past by purchasing generic parts instead.
Parts Cost
It’s one thing to order extra elbows or nipples. It’s quite another thing to order several extra 5-ton
compressors. The cost of the part obviously affects reorder quantities.
Taxes on Inventory
If you are located in an area that charges taxes on inventory, this will affect the decision on the setting both
the reorder quantity and the maximum stocking level. The larger the inventory, the greater the taxes
obligation.
Other Replenishment Issues
If there are other issues, which could affect replenishment, such as a labor strike or a price increase, this
will affect reorder quantities.
The Restocking Cycle
Here’s a hypothetical example of a restocking cycle.
A
1
Maximum Stocking
Level
Reorder
Quantity
Parts
Stock
Quantity
Minimum Stocking
Level
B
A
1
Safety Stock
Time
Starting Point ‘A’
In this example, point ‘A’ represents the maximum stocking level.
Point ‘B’
Normal depletion takes the stocking level down to the minimum stocking level. At this point a stocking
order is placed. The total order is the sum of the safety stock and the reorder quantity.
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Stocking Cycle Example
A
1
D
1
Maximum Stocking
Level
Reorder
Quantity
Parts
Stock
Quantity
E
1
B
A
1
C
A
1
Minimum Stocking
Level
Safety Stock
Time
Point ‘C’
The stock continues to be depleted until the order arrives at point ‘C’.
Point ‘D’
The total order which replaces both the safety stock and reorder quantity puts the parts stock quantity at the
maximum stocking level.
Point ‘E’
Normal depletion brings the stocking levels down once again. At point ‘E’ another order is placed.
Determining Reorder Points
Most HVAC and plumbing computer systems include inventory modules, which accommodate perpetual
inventory systems. The computer program identifies when the inventory level drops below the minimum
stocking level and reorder point.
For years prior to computers, most HVAC inventory systems consisted of a visual card system. Each item
in inventory had its own card that was kept with the inventory item. Minimum stocking levels were
identified on the card as well as additional information about the part such as its part number and its
location. When the items stock quantity dropped below the minimum stocking level the card was pulled
and was given to purchasing to initiate an order.
Then in the late 80’s and 90’s a manufacturing phenomenon called Kanban swept the country. Kanban is a
Japanese term meaning ‘signal’. It signals a cycle replenishment for production and materials. It maintains
an orderly and efficient flow of materials throughout the manufacturing process. Kanban usually uses a
printed card that contains specific information such as the part name, description, quantity, etc. It’s a
simple concept that’s been recycled from the past.
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Kanban is being reapplied to HVAC and plumbing inventory control systems. The principle is pretty much
the same as with the old card systems. These days the card includes all the information needed to reorder
the item. When the stock quantity reaches the minimum stocking level the card is pulled just as in the past.
However, the card itself is now faxed directly to the supplier. Some companies even include bar codes on
the card. Once the quantity drops to the reorder point, the bar code is swiped off the card and the order is
placed electronically.
Physical Inventory Counts
A physical inventory should be done a minimum of once a year. The actual inventory is counted. Most
companies generate count sheets that show the location and description of each item in inventory. On
perpetual inventory systems the expected inventory may be printed on the count sheet as well. The actual
count is entered on the count sheet.
The following description shows what happens to a hybrid inventory system. The count sheets are
forwarded to the comptroller or accounting person where the value of the actual inventory is calculated (the
count multiplied by the item cost). If the inventory value is less than what’s shown on the Balance Sheet,
this is called ‘shrinkage’. Adjustments are made to the Balance Sheet and to the cost of sales on the
Income Statement. If the company experiences excessive shrinkage, physical inventory should be done
more than once a year until the problem is corrected.
Basic Guide for Taking a Physical Inventory
 Conduct training sessions with personnel involved.
 Prepare count sheets for all items in inventory.
 Limit or discontinue receiving during the count.
 Do inventory counts on all service, maintenance and installation trucks.
Why is this Critical to Your Success?
Having a good understanding of Inventory Management principles:

Allows you to evaluate your current inventory method.

Allows you to monitor and manage your inventory turn rate to optimize your
inventory investment.

Allows you to evaluate inventory turnover verses invested inventory capital.

Allows you to evaluate inventory carrying costs.

Allows you to calculate minimum stocking levels to determine safety stock needs for
each item in inventory. These calculations minimize the possibility of running out of
the item while it’s being replenished.
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Most of a company’s current assets are tied to inventory. Likewise, one
of the biggest expenses a company has is in cost of sales for parts,
equipment and materials. How a company manages its inventory and
material flow contributes to its success and profitability.
Do you know your inventory turnover rate?
Do you know your inventory carrying costs?
Do you know how your inventory turnover rate affects
your invested inventory capital and carrying costs?
Do you know how to establish minimum and maximum
stocking levels?
Do you experience excessive shrinkage after conducting
a physical inventory counts?
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