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Apr 7, 2015

How a Just-In-Time Can Increase the Profit of Your Business ?

If you are still striving to increase the profit margin of your business, do not overlook your inventory management system. The just-in-time inventory method may be what your business needs to increase its profits. Indeed, the ultimate goal of any business is to generate profit. This is accomplished when revenues exceed all the expenses needed to sustain a business activity. Financial analysts have many ratios at their disposal to measure how well a business is performing. Return on Investment (ROI), defined as the "net income divided by the average of total assets," is by far the most important ratio used to measure the profitability of a business. The ROI ratio basically measures how much profit a business is able to generate with the assets it has available within a certain operating cycle. If this concept seems strange to you, just imagine two companies, A and B, which manufacture the exact same product. If the only difference between the two companies is that company B needs to utilize more assets to generate the same amount of profit (because it operates more plants for the same production output for example) it becomes clear that company A is more efficient and profitable than company B. Inventory is an important portion of any business' assets. In the manufacturing industry, inventory is usually divided into three separate segments: raw materials, work-in-process and finished products. Because inventory is often a company's largest asset, the way it is managed can greatly affect a company's return on investment. Generally speaking, with all other things being equal, a company can increase its ROI by keeping its inventory low. Why? Because inventory is an asset item computed in the denominator of the ROI ratio. Any reduction of the denominator will increase the ratio. The amount of inventory that sits on a company's shelves also affects the company's profitability in other ways. For one, inventory ties up capital that the company can no longer use elsewhere. When raw material is purchased on credit, the company will incur an unnecessary interest expense. Second, excess inventory will also cause an increase in the inventory carrying costs, which are costs associated with holding an inventory. Carrying costs can range between 15% and 25% of the inventory value. It is comprised of storage cost, handling cost, utility costs as well as insurance and taxes to be paid on warehouses. Finally, an inventory can also become obsolete, meaning that the parts held in storage are no longer useful (and salable) if the company decides to manufacture a new line of product in order to keep a competitive edge in the market. Obsolete inventory becomes waste which translates into a loss to the company. The just-in-time inventory management is a strategy that was developed by the Japanese auto manufacturer Toyota in the 1970s, whereby inventory is kept at a minimum. The objective of a just-in-time inventory is for a company to acquire only the exact amount of raw material needed to manufacture the exact amount of finished goods for direct sale. This inventory management has been summed up as "having the right material, at the right time, at the right place, and in the exact amount." This inventory management requires that a company maintains long-term relationships with reliable suppliers and maintains a very accurate production and inventory information system. When correctly implemented, the just-in-time inventory system will effectively increase a company's return on investment and boost profitability by reducing inventory carrying costs and preventing capital and investment from being tied up in unnecessary assets.