Some parts managers rely on complex mathematical formulas to compute optimal “economic order quantities” (EOQs). In plain English, the question these formulas try to answer is, “What’s the right quantity of inventory to order to minimize the variable costs of ordering, stocking, and holding inventories?” In applying these formulas, you can develop and graph two separate cost curves. The more you order of a part, the greater the likelihood you’ll achieve higher purchase discounts, less transportation costs, less opportunity cost of lost sales, etc. As such, the parts acquisition cost curve will generally decline as the order quantity increases. However, the more you order, the tendency is that your costs of carrying the ordered parts are going to be greater. This is because that demand can vary greatly from part to part, and you have to factor in the costs of tied up working capital, stocking expenses, insurance, security, obsolescence, shrinkage, etc. As a result, the holding cost curve will generally increase as the order quantity increases. The point where the two cost curves meet is theoretically the optimal economic order quantity.

However, not all parts managers employ these complicated formulas. And that’s okay; I take my hat off to anyone who relies on those formulas to guide their ordering decisions, as they’re tremendously complex. However, for those parts managers that don’t use formulas, it’s important to think about these concepts and use whatever system or manufacturer information you have available to order parts and accessories intelligently.

Optimally, parts and accessories inventories will turn 6 to 4 times per year, which equates to a 60- to 90-day inventory supply. To compute your dealership’s parts and accessories turn rate for the calendar year 2007, first determine your 2007 parts cost of goods sold amount. (This amount does not show up separately on your financial statement.) To determine this amount, take your December 2007 factory statement and subtract the parts department’s gross profit for the year from the parts sales for the year. The result will be the parts department cost of goods sold for 2007. To arrive at the 2007 parts turn rate, divide the parts and accessories inventories reflected on the dealership’s December balance sheet into the parts cost of goods sold amount.

Example:

Parts Sales = $2,900,000
Parts Gross = $1,000,000
Parts & Accessories Inventories = $350,000
Parts Cost of Goods Sold = $2,900,000 – $1,000,000 = $1,900,000
Parts Turn Rate = $1,900,000 ÷ $350,000 = 5.42
Days Supply = $350,000 ÷ ($1,900,000 ÷ 12 = $158,333) = 2.2 × 30 = 66

If you’re looking at some interim period of a year and want to compute your approximate parts turn, then simply annualize the parts department sales and gross amounts from whatever statement you’re looking at and perform the computation above.

It’s important to keep in mind that the optimal turn rate and days’ supply guides mentioned above are for parts and accessories inventories in total. You’d expect to experience a higher turn rate and lower days’ supply for faster moving and lower-profit-margin parts and accessories.

We recommend that the owner or general manager of the dealership receive a frozen capital cost determination based on the excess parts and accessories inventories above a 60- to 90-day supply times a cost of money factor on a monthly basis. In addition, management should be reviewing reports of part numbers that aren’t moving.

In closing, employing the best practices mentioned above will increase your dealership’s profitability. Math may not be fun, but the prosperity associated with doing it correctly certainly is! For more information, or if you’d like assistance working through these matters, please contact Jim Eagan at 800.544.0203, extension 3257, or e-mail jim.eagan@plantemoran.com .

Next Month: Our next Auto Dealer Alert will focus on fixed asset management