I had the privilege of working with a rural electrical contractor to help him fine tune his small business. He was an exceptionally competent contractor and a sharp businessman besides. In fact, he was an example of someone smart enough to appreciate the value of an outside set of eyes, someone with new insights to make recommendations.
This article is about how I plugged inventory leaks in one small business’ profits. In actuality there were several little ways that caused profits to dribble away.
Failing to Invoice for All Parts Used
Their journeymen failed to invoice all the parts they used on their jobs. Because most of his jobs were contract based on a bid, my client didn’t think about the importance of this. However, it affected them in several ways:
– Failing to take all of the parts out of inventory and applying them to the job made job costing virtually impossible, which means he never got accurate figures on how much he made or lost on a given job. This information would enable him to adjust his bids.
– The other cause of profits dripping away was that the electricians got sloppy on the contract jobs so they were careless on time and material (T&M) jobs, which were billable for parts and labor.
It’s amazing how dribs and drabs add up over a year’s period of time. Look at this conservative calculation:
– $2 cost for parts missed x 4 jobs/day x 5 jobs per week x 50 = $2,000 per year.
– Look at its real impact. I have found most small businesses I worked with had low profit margins, maybe even negative. Say this is your business. Your net profit is 5%. Here are the Sales you need to make up for this loss.
Sales x net profit margin = profit
Profit / net profit margin = sales
$2,000 / 5% = $40,000 in sales to recover that inventory shrink
Failing to invoice for parts used on the job means you also lose out on the profit you should have made. If you plan on a parts profit margin of 20%, here’s how much profit you failed to make:
Cost / (1 – % profit margin) = Selling Price
$2,000 / (1 – .25) = $2,000 / .75 = $2,667 in lost revenue
$2,667 – $2,000 = additional $667 lost profit
These are conservative calculations for a really small business. If you have crews doing 40 jobs per day, the same numbers mean $20,000 per year in costs not recovered and $5,000 in profit missed.
Being a Parts House for Some Employees’ Independent Jobs
When we looked at is inventory control, it was an honor system. If you needed certain parts for the job that day, you pulled them yourself. While many people thrive on being trusted, there is always someone who views your company as their own parts house for jobs they do on the side. Obviously, this is a much more serious leak in the dike.
The solution to this is to limit access to your parts and have someone trustworthy sign parts out and back in.
Miscellaneous Areas of Inventory Shrink
Using this kind of inventory control should eliminate the problem of people putting the wrong parts back in a box. Some employees also didn’t care where they put the parts so no one could find them despite their being returned. The bigger problem occurs when you are counting on that part, you find you don’t have it. This delays a job, irritates a customer, and chews up labor hours and gas to go get it.
Altogether, I recommended changes to save $56,000 lost by inventory shrink. This client sold less than $3,000,000 a year. They maintained an inventory valued at 10% of sales.
These three simple examples show how I plugged inventory leaks in one small business’ profits. Had his business relied more on T&M, failing to invoice for all parts used could have been a much more steady drip rather than the dribble it was. Being a parts house for some employees’ independent jobs was a much bigger impact though I don’t recall how much of the total shrink it accounted for. Nevertheless, I found it extremely satisfying to help a solidly run small business find ways to plug leaks in their profits.
More from this contributor:
What is the Effect of Simple Interest Versus Compound Interest?
First Person: The Value of Customer Satisfaction Interviews
First Person: The Value of ‘No Charge’ Invoices