CFOs Need to Regain the Initiative in Inventory Management
Facing multiple economic pressures, inventory management has become a focus for CFOs. EY expert Peter Kingma advises CFOs to optimize inventory by challenging assumptions, clarifying decision rights, and becoming proactive investors, while leveraging AI for scenario planning to navigate an uncertain environment.
Against the backdrop of inflationary pressures, supply chain instability, rising capital costs, banking turmoil, and geopolitical tensions, corporate management faces severe challenges. And no one is more aware of this than CFOs who are accounting for the costs of ever-rising inventory levels.
Inventory buildup is partly due to supply shortages, but conflicting management priorities have also exacerbated the problem. Sales teams may offer the same service levels to all customers to close deals; engineering departments may constantly adjust product designs; plant managers may favor long production runs to reduce absorption costs. These decisions are often made in siloed departments without considering the impact on inventory.
The finance function can play a critical role. CFOs can now take three actions to help their organizations better navigate headwinds and make smarter trade-offs among seemingly conflicting priorities:
- Challenge assumptions
- Clarify decision rights
- Be an active investor
Challenge assumptions
Let's start with service levels. Are all transactions (or customers) equally important? Do we need to offer the same service levels and commercial terms to every customer? We incentivize sales teams to chase revenue, but at what cost? This is just one of many daily drivers affecting inventory.
As mentioned earlier, other stakeholders such as marketing, engineering, procurement, manufacturing, and distribution also have significant influence. Fortunately, machine learning and artificial intelligence have made tremendous progress and can assist with scenario planning, which is very useful for challenging long-held assumptions about 'why we must operate in a certain way.'
Clarify decision rights
Once you use data to challenge assumptions and quantify impacts, it is crucial to clarify who owns the decision rights. Your organization may have well-established approval processes for capital expenditures involving senior leadership. However, every day, people across the organization make decisions that can affect the balance sheet and drive up inventory levels.
For example, a procurement manager sourcing from Asia to reduce costs may increase inventory due to longer lead times. Please provide frontline teams with trade-off models so they can make the most informed decisions. A common misconception is that the responsibility for resolving inventory buildup lies only in the factory or warehouse, but in reality, many people across various parts of the business have an impact.
Be an active investor
Every dollar of inventory in the warehouse is of equal value. A dollar tied up in slow-moving or obsolete inventory has the same value as a dollar in fast-moving inventory—not to mention funds allocated to other priorities such as R&D, debt repayment, and new equipment.
The finance function should proactively point this out. Conduct regular inventory reviews, use data to challenge assumptions such as build-to-order or fulfillment requirements. Train finance personnel to take a more active role in the planning process. Evaluate metrics and KPIs: for example, a procurement manager responsible for cost reduction may increase lead times; or a salesperson who agrees to service level commitments to meet quotas—are they achieving the best outcomes?
The finance function should actively help other functions make the most informed decisions, acting as an investment advisor for inventory.
Even in the best of times, inventory growth can quickly spiral out of control. But in the current environment, challenges are increasing, and the financial impact is expanding. As capital costs rise and inflation intensifies, trapped inventory consumes more precious cash at a time when other sources of cash, such as debt, are more expensive.
CFOs can play a critical role in addressing these issues. The operational norms of five years ago may no longer apply today, indicating that new data mining approaches should be used to challenge old assumptions. Step back, first identify who is truly on the front lines, and then provide them with the tools they need. Finally, integrate finance into the planning process and treat inventory investments like any other investment.