Counts, dollar variances, turnover rates drive this best practice

• What is the right dollar amount for a particular inventory?

• What are the benchmarks for inventory turnover?

• What is acceptable inventory accuracy?

The first two questions are pretty easy to answer. Regarding the first – there is no right dollar amount for an inventory. It depends on too many different factors. An operating room in a 300-bed hospital with $2 million in inventory might not have enough, while another OR in a 400-bed hospital with $1.5 million might have too much.

The only good measure of inventory management is turnover rate. Regarding the second – there are benchmarks that are pretty well accepted in the industry. These were presented in the November 2006 "Back Talk" column of Healthcare Purchasing News as well as the idea of optimizing turnover. The third question is the subject of this month’s best practice.

Maintaining an accurate inventory is critical for customer satisfaction as well as finance’s peace of mind. If an inventory is not accurate stockouts occur on some items, while other items become overstocked. Both situations are costly and stockouts, in particular, can lead to customer issues and even patient safety problems.

But maintaining an accurate inventory is not an easy task. It takes effort, attention to detail and constant vigilance. Inventory managers know that the only way to assure an accurate inventory is to perform periodic inventories. Best practice organizations conduct a cycle count program that provides regular data on inventory accuracy (see the January 2009 "Back Talk"). But what is the best way to measure inventory accuracy?

There are three different ways to view inventory accuracy. The first is by count. If your records show that you should have 100 of an item and you have 50 or 99 or 101 or 200 the count is wrong. Using the count method the number of lines correct (exactly the right amount) divided by the number of lines counted will give you the accuracy. Neither the amount you are off nor the value of the item has any bearing on the accuracy. No one wants to be off – even if only by one. However, particularly with low- unit-of-measure operations, minor picking errors are almost inevitable, and count accuracy is likely to be low.

The second method is based on gross dollar variance. For each line counted, the dollar value of the actual count is compared to the dollar value of the expected quantity. The difference – positive or negative – is the variance. The accuracy of the line is one minus the variance dollar amount divided by the expected dollar amount. If you expected to have 100 of an item valued at $1 each and only found 99, the accuracy would be 99 percent. Your total accuracy would be computed based on the total amount of variances without regard to positive or negative and the total expected amount. In other words, if you had a positive variance of $5 on one line and a negative variance of $4 on another the gross variance would be $9.

The third method is based on net dollar variance. The accuracy of each line is computed the same, but the total accuracy is based on the difference between positive and negative variances. In the above example the net variance would be $1. (If anyone is interested in a spreadsheet to track inventory accuracy, please e-mail me and I will provide one.)

Best practice inventory managers compute and track all three of the measures: Count accuracy, gross dollar accuracy and net dollar accuracy. Each measure gives a different and complementary picture of how well the inventory is being kept. The count accuracy will provide some sense of general picking accuracy.

The gross dollar accuracy is probably the most important from an internal perspective. It is more important to be totally accurate on high cost items than very low ones. But from an inventory management view it is just as bad to be overstocked as under. The net dollar accuracy is the most important from a financial perspective. Finance is most concerned with reporting the value of total assets. If the inventory asset is supposed to be $1 million and it is $999,000 it doesn’t matter to them how much the gross differences were.

Tracking and trending variances is important, but that is only half of the best practice. The data must be used to demonstrate success, point out weaknesses in practices, and ultimately influence improved performance. Best practice inventory managers present the data to the staff on a regular basis. Trend graphs are a great visual way to show employees how the department is performing. Net variance data should be provided to finance on a monthly basis and included graphically on the supply chain quarterly report.

To my knowledge there is no universally recognized acceptable inventory variance. From my experience if the net variance remains below 5 percent finance is usually satisfied. But there is no question that inventory accuracy will improve if inventories are done on a regular schedule and the results are trended and published.

David S. Kaczmarek, FAHRMM, CMRP, is a Derry, NH-based director at Wellspring Partners, a Huron Consulting Group Practice, Chicago. Kaczmarek has more that 25 years experience in healthcare administration and materials management, including director positions at several hospitals and systems. He can be reached via e-mail at dkaczmarek@huronconsultinggroup.com.