Are you constantly tasked to reduce inventory? Having difficulty explaining proper inventory levels to higher ups that only see dollars? Is it to the point whereas you’re reducing the good inventory along with the bad? It’s time to adopt Inventory Quality Ratio (IQR) approach to your inventory management toolbox.
Inventory Quality Ratio is a very effective tool that properly classifies inventory into strategic categories which aid in focused inventory reduction activities. In other words it separates good (needed moving) from bad (obsolete and slow moving) inventory. It will allow inventory managers to explain what inventory is doing not just how much it’s worth, which alone mean very little.
Compare this to the correlation of Accounting and Finance. These fields complement one another; just know the result of one without the other dilutes the results. Accounting tells you were the money is at while finance tells you what it’s doing. Think of Inventory Quality Ratio as the finance quotient of your inventory management.
Used in conjunction with inventory turns and COGS tools you should have all the needed weapons in your inventory toolbox.
This is how IQR works.
- Divide your inventory into four quality categories.
- Active- Items with future requirements and current usage.
- Slow Moving- Items with future requirements but no usage for 6 months.
- Excess – Items with no demand and no usage for 6 months.
- Obsolete – Items with no demand and no usage 12 months.
Using your current ERP system find the dollar amount for each category. A perfect IQR would be 100% however most manufacturing companies start around 40-45% range. IQR will allow you to drill down to the specific item and update order policies if needed.
IQR is quite simply is the percentage of your active inventory.
This is an excellent tool separate good inventory from bad. Looking at total inventory dollars alone doesn’t tell the full story. Plus this is actually a detriment as declining orders or market share would actually be a plus in companies where inventory dollars alone are measured.
Below is an example of two warehouses with 200K of inventory. IQR clearly identifies, which warehouse has better managed inventory and where to look for reductions.
Active Inventory – 80K (40%)
Slow Moving Inventory – 30K (15%)
No Moving Inventory – 35K (17.5%)
Obsolete Inventory – 55K (27.5%)
Total Inventory- 200K
IQR Percentage: – 40%
Active Inventory – 75K (37.5%)
Slow Moving Inventory – 45K (22.5%)
No Moving Inventory – 60K (30%)
Obsolete Inventory – 20K (10%)
Total Inventory –200K
IQR Percentage: – 37.5%
IQR again is simply the percentage of active inventory in the total. While it’s clear Warehouse 1 has more active inventory they clearly need to work on removing the obsolete inventory. Warehouse 1 for instance may take more discrete orders which generally generates (production overrun) obsolete inventory.
Warehouse B possibly needs to start monitoring “No Moving” inventory levels more closely now to reduce the amount that falls into obsolete.
Reading tea leafs with IQR in place becomes a much simpler process.
Additionally each month lean practitioners should look for trends in each category to determine if your organization is on correct path.
As demonstrated IQR (Inventory Quality Ratio) is a powerful tool that allows you to not only monitor inventory but also explain it!