The ideal scenario is to run out of product the day the new supplies arrive. This “just in time” philosophy has some dangers attached. Sometimes, supplier availability and/or lead time is not as expected. Occasionally, business has unexpected surges and your rate of consumption is faster than expected. There are even times when “Murphy’s Law” takes over and things just go wrong without prior warning. While some of these challenges cannot be anticipated, many can be avoided by building a cushion into your ordering system.
First, determine the normal lead time for supply orders to arrive. Next, using your expected rate of usage, determine the latest you can order for “just in time” needs. Back up from there, about half the lead time, and that’s your reorder point. Each time your supplies reach the level equal to 1-1/2 the amount needed during the normal reorder period, place your order for the next amount.
Remember, your rate of usage will vary with the flow of business. Any seasonal fluctuation in business must be taken into consideration. You don’t want to stockpile supplies in the slow season, and you certainly don’t want to run out in the busy season. Rush shipments from suppliers can be costly.
Not being able to get the job done when promised may be the biggest cost of all in the long run.
Start an equipment account that is tied to production volume. For example, you could put 3% of the gross amount produced by a truckmount into the equipment account each month. A truck producing $10,000 per month would build the account at a rate of $300 per month, or $3,600 per year, or $36,000 in 10 years (plus interest if it is the right kind of account). Money is available for “emergency” repairs, and when the time comes to purchase new equipment or replace old machines, the equipment account is there to help reduce the purchase price and reduce the amount paid in finance charges. The reason it should be on a percentage is that the bigger your business, the more equipment costs you will have. Also, the bigger the business, the greater the account becomes.
If your business plan calls for a sharp growth, don’t forget to budget in the cost of good equipment to accomplish the growth. Arrange the financing with your banker before going to the supplier. You’ll often get better rates from the banker who knows you and your business than from a stranger.
Yes, you need to spend money to make money, but spend it wisely and save money as well.