Why is this particular method so beneficial? What particular types of inventory should utilize this method? How does it work? And finally, if I decide to use the specific identification method, how do I implement this process.
Benefits and Value to the Business Operation
I’ve always looked at inventory as equal to cash. Think about it for a minute, your goal as an owner is to turn the inventory into a sale and ultimately into cash. You use cash to purchase this inventory, so it really isn’t much different than having cash in the bank account. Do you monitor your cash daily in the bank? If you don’t, you should! Anyway, you should treat your inventory no differently than the cash. Basically, inventory is a liquid asset in the current assets section of the balance sheet.
The specific identification method works extremely well with the higher value ticket inventory items. The following are examples of the types of inventory that definitely require specific identification for inventory purposes:
- Appliances (Refrigerators, Dishwashers, Stoves/Ranges, Microwaves) not the lower value homogeneous appliances like coffee pots, can openers, blenders etc.
- Automobiles, RV’s, Boats, Motorized and Titled Items
- Jewelry (not cosmetic types)
- Heavy Equipment/Farm Equipment
- Expensive Tools and Tool Sets
- Electrical/Hydraulic/Pneumatic Pumps, Motors and Gear Systems
- Electronic Devices and Equipment
- Industrial Tools
- Medical Equipment & Tools
In general, if the item is more than $200 and comes with a serial number and an associated model number; you should seriously consider using the specific identification method of inventory management. Sometimes though, the item is broken down into sub pieces for sale to multiple customers. A good example includes carpet and flooring. In this case, the specific identification method is not as valuable because of the heartache involved in tracking the division of the product down into smaller pieces exceeds the benefits derived from this method.
Up in my example list I mention homogeneous items of lower value and how they should not be tracked in inventory using the specific identification method. Well, what about the more expensive similar items? Think about exterior doors such as garage doors and exit doors? Many of them come with models and believe it or not, serial numbers. Should they be tracked using the specific identification method? The answer is mostly contingent on the serial number existence. I would tell you that this system works best when the items have a serial number. This is the specific identifier needed to formally track the item. If they don’t, you will have to improvise in your tracking in order to monitor the item. I’ll use doors as an example:
Doors are not normally serialized when they are produced. However, they do come in what is referred to as LH and RH (left hand and right hand) presentation. In addition, doors have certain sizes and referring to the opening size, a 3’0 door means a door that will fit into a 3 foot opening. Then the identifiers get into the hinge systems, closure devices and threshold mounts. Typically these more sophisticated doors (think of exterior doors to a school) will not have serial numbers but definitely cost more than a couple of hundred dollars each. If your business supplied these types of doors, then you should track them in some way and the specific identification process is best. By the way, the simplest solution is to own inventory software that once the features of the door are loaded, it can prepare a specific identifier and a corresponding serial number and print a tag to attach to the door.
Now that I have illustrated the types of inventory best served by the specific identification method, I want to explain the benefits and value to the owner/manager of the business.
Above I mentioned the similarity to cash. In accounting we actually refer to inventory as a cash equivalent. Think about tracking your cash. If you have a $100,000 inventory on your books and I mentioned the minimum value for this method at $200 per unit, we are talking about monitoring 500 units (100,000/200). If all the units are stored in a common location such as a warehouse, I’m willing to bet that I could inventory the entire value within one day of work. I would be willing to venture that I could do it in half a day especially if the items are organized.
There are really three distinct advantages the specific identification method brings to inventory management over other forms of inventory management. They are as follows:
Minimum Inventory Losses
It is one thing to lose a $2 widget, it is an entirely different impact if one losses a $2,000 item. By tracking and conducting regular inventory (note with specific identification an inventory can be accomplished within a few hours and at a low cost); management can pinpoint the circumstances of misplacing an item. For example, how does one lose a car? Or misplace a refrigerator? When everyone knows that the inventory is monitored frequently, the items have a higher tendency to exist and not disappear. Furthermore, losing a $2 widget doesn’t greatly impact the bottom line; whereas a $2,000 item can cause some heads to roll.
Cost Accumulation for Better Financial Management
One of the best benefits that exist with the specific identification method is the ability to assign costs to each item. Often inventory in general has additional costs beyond the initial purchase price. These costs include interest used to purchase the items, delivery costs, preparation of the items, storage and maintenance costs. Using the specific identification method allows management to accumulate these respective costs to the identified item. In turn, at the final sale, management can determine the true profit margin associated with this one item. The following is a good example:
A small equipment retailer purchases commercial grade lawnmowers. Each lawnmower costs $1,300 from the manufacturer. The delivery fee is $97 per unit. Once received, a technician assembles the unit and does a test drive. The associated cost is around $58 for labor and supplies. Once the unit reaches the floor of the store, it is assigned to a line of credit from the bank restricted to this particular brand of lawnmowers. Each month, the interest on the line of credit is allocated to each unit based on the initial purchase price. After three months, this particular unit has accumulated $1,593 of costs. The unit was sold for $1,889 after some tuff negotiations between the buyer and the salesman.
In this example, the gross margin from this particular unit was $296.
The value of this method allows management to compare one model or line of products against others to determine the more profitable model. Traditional inventory methods do not accumulate these additional costs and make it difficult to determine the true gross margin and still more importantly, traditional methods of inventory do not allow for brand or model comparison therefore making it more of guessing game as to the source of low profitability.
Item Tracking and Follow-Up
All of us experience this function with the car we purchase. The dealership desires additional revenues via the service department or parts department. So we are bombarded with direct advertising related to our purchase. This occurs because the dealership uses the specific identification method of inventory management. Not only did they track the car throughout the inventory process, but they continue to track the vehicle after the sale to follow-up and provide additional services. They can tie the respective model and the customer together and based on traditional driving habits send reminders for inspections and maintenance. Furthermore, the auto industry has figured out the approximate cycle of consumer purchases. Just before the usual time to get a newer car, the dealership reminds you through letters and other methods to come back and get your next new car from them.
Well, this form of business operation can occur with any small business by utilizing the specific identification method. Let’s stick with the lawn mower retailer from above. Every month or so, the store reminds the buyer via direct advertising or texts that certain maintenance parts or service requirements are available via the retail outlet. In addition, just towards the end of the expected life cycle of the lawn mower, the store can send out specific discounts for an upgraded model and so on. The specific identification method can act as a salesman, no, more like a sales program!
As you can see, the specific identification method works well with inventory items worth more than $200 each and if the item has a serial number. The benefits include reduce losses in inventory, i.e. greater inventory control, ability to track costs to the specific item and it can allow for additional sales via follow-ups with the buyers. But to make this all work, the process of tracking the inventory has to be properly designed and implemented in your business.
The Process of Managing Inventory Using Specific Identification
The key to a successful inventory control system is tracking the items from start to finish. Every step of the process the item is monitored. Upon receipt, the item is loaded into the inventory software, every detail and as many details should be loaded into the system. From there, where it is stored in the warehouse is loaded too. Most large ticket storage systems utilized a space locator to identify the geographical spot. If and when the model is moved to the floor, this is noted in the software too. ANY change is inserted as a data point in the software so that the item is tracked.
At the point of sale, the item is noted with the customer’s name, address and other pertinent information. In addition, the inventory item is released from the database and should be moved into another database for future marketing and advertising purposes.
The whole system is keyed to the model number and the serial number of the unit. I can’t stress enough the importance of educating the staff on the value associated with any changes to the unit. If the unit is moved, it is noted in the database. When a unit incurs additional costs associated with service or interest payments, this information is added into the database. The end result is a wealth of information that can be used to ascertain the following:
- Value of the inventory and break-outs into distinct groups or types of units and of course their respective inventory value
- Location of every model and the specific unit
- The value of the accumulated costs to each respective unit
- Identification of process issues or lack of attention to certain types of units etc.
The point is that inventory management is a process. The specific identification method provides a lot more value due to the specificity involved. This accuracy is a benefit and well worth the cost involved in time and additional dollars due to the above mentioned benefits with minimum inventory losses, cost accumulation and follow-up ability. But you can’t manage the inventory unless you implement the process properly.
Proper Process Implementation
Alright, I’m only going to emphasize this at the very beginning – DOCUMENT, DOCUMENT, DOCUMENT!
Somebody needs to sit down and create the plan. The first step is to create a flow chart in managing the inventory. All inventory items go through four distinct stages. The first is receiving. Secondly the item is stored in the warehouse as it is prepared for customer interaction. The third step involves moving the item to the showroom or into the store for display. Sometimes, the second step is skipped and the items are taken to the floor immediately. But even the perfunctory process of removing the protective wrap is involved in the second step. Finally the product is sold and delivered to the customer.
For each stage, generate a list of actions that personnel will take in completing that step. For example, in receiving, the receiver confirms the unit exists, it isn’t damage; and the model and serial number match the receiving order or delivery ticket. Next, the receiving clerk identifies the next step in the process. Maybe the unit has to be inspected or unpacked or assembled. Finally the receiving clerk inserts the core information into the inventory software. The paperwork is sent to administration for proper review and insertion of the financial information.
So each stage is documented and in addition, inventory procedures related to the specific identification method are created.
Once all this is done, the next step is to identify several inventory software programs that can fulfill the required roles of specific identification method and has the ability to record all the information noted in your inventory process. This software should have the capacity to work with your existing accounting software. Many of the small business accounting software creators have inventory packages that can meet the elements of the process as described above. So you don’t necessary need to go out and purchase some highly customizable software package. I’m highly confident the lower end packages made by Intuit or Sage will fulfill the role. However, it does mean you may need to document the process of field identification and description so that future users understand the terminology and the corresponding software fields to the physical actions of inventory management.
Now that you have the process documented, the software ready, it is time to test the system. My suggestion is to start with a line of products or a particularly valuable inventory group. With the data loaded into the software, run a mock example from start to finish. Identify existing issues and possible potential issues. Create resolutions and do it again! Once you feel comfortable that it works, now create an implementation time line. Maybe each month add one more group of items or model numbers. Choose logical timing dates to successfully implement this new process. If you decide on year end, begin training in October for the staff. Send out reminders to the warehouse folks and the store personnel of when this process will start. Let them know you are aware that there will be issues in the beginning but the benefits far outweigh the snags involved. Remember, people don’t like change and you will have naysayers. If this happens, remind them of their respective position and when they develop a better plan that is acceptable by the ownership, you will be willing to accept and work with the better plan. In the interim, this associate needs to use this plan.
I guarantee that if you think this through and document the process you will have a good system to manage inventory using the specific identification method. Furthermore, this system will augment the Point of Sale System.
Cautions and Issues
There are other forms of inventory management systems out there. These include the following:
- Vendor Managed Inventory – here the vendor controls the process and foots the bill for the inventory, in effect the retail store doesn’t own it in any form
- Just in Time Inventory – this form of inventory management works well with high volume retail and where freshness is critical (produce, raw food, restaurant preparation etc.)
- Traditional Inventory Management – similar or like items are grouped together and inventory is monitored in a daily or weekly review. Orders are made based on experience and customary purchasing patterns. You see this form of inventory management in clothing outlets, beverage industry, sports and entertainment outlets, specialty item stores such as pet supplies and outdoor supplies
In these other types of systems, the cost to detail the items as exercised in specific identification is prohibitive. Therefore the specific identification method is just not a good idea in the lower value retail environment. Furthermore, the staffing levels (education, maturity, compensation) can be lower due to the nature of the above systems. The specific identification method requires a more educated and responsible employee to successfully obtain the required outputs. So, one of my first cautions to you is the following: ‘Make sure your staff has the education and maturity to follow the process when using the specific identification method for inventory management.’ When I mention education, I don’t mean they need to be college graduates, I mean that they are trainable and can understand the reasoning involved.
A key issue is a discrepancy from the documented plan. Let’s say the plan relates to tracking A/C units for hotels. You are a distributor and you have a process implemented. All of sudden the latest version shows up in receiving and it’s a two part system. We got the first part today and the auxiliary part will be here next week. What do you do now? Answer: have the ability to mark the software item as partially received. In addition, somebody needs to be the decision maker for addressing issues like this. Me personally, I would have an indicator in the item section of the inventory that this item is part of a system. You should have the ability to add notes to the item in the software for others to review and understand the situation.
A final word of caution about the specific identification method, it takes some intelligence to fully grasp the why and how of all this. Get the staff onboard with this inventory control tool. At the end of the day, it is essential to improve the overall profits of the company and retain good paying jobs. The last thing you need is some staff person generating drama over a flaw in the process. I’ve seen it way to often that somebody somewhere doesn’t really want to make a change and when something doesn’t work, they act like it’s a terrorist plot to take down the company. You don’t need somebody like this in your business. It wreaks havoc with the rest of the staff. Get everybody onboard and educate them. Remind them that there will be some problems along the way but that the end value far exceeds the few headaches the company will endure. ACT ON KNOWLEDGE.
If you have any comments or questions, e-mail me at dave (insert the usual ‘at’ symbol) businessecon.org. I would love to hear from you.