IQR

Inventory Quality Ratio

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IQR Overview..............................................................................................................................................3

IQR Metric...................................................................................................................................................3

IQR Methodology........................................................................................................................................5

Plan Your Inventory Reduction...............................................................................................................5

Do Take the Steps to Reduce Inventory..................................................................................................7
Check Your Inventory Reduction Progress.............................................................................................8
Act to Make the Reductions Permanent ..................................................................................................9
Summary of the IQR Tool.........................................................................................................................11

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 Inventory Quality Ratio
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IQR Overview
IQR is an inventory management system that helps prevent the formation of excess and obsolete
inventory. That means less money in inventory, lower carrying costs, and increased capital to operate
your business.

IQR is an abbreviation for Inventory Quality Ratio. The ratio is a calculated value that indicates the
percentage of your inventory that is “good”. An IQR of 30% indicates that 30% of your inventory is
“good” (active inventory) and 70% of your inventory is “bad” (excess, slow moving, or no moving).
This is useful in evaluating inventory performance and in focusing attention on areas in which inventory
reductions net you the greatest financial gain. Furthermore, with IQR you can stop “good” inventory
and “not so good” inventory from becoming “bad” inventory.

The IQR system does much more than calculate this ratio. It provides a complete framework to use and
improve this statistic. IQR provides unique analytical tools to effectively reduce your inventory levels
and improve the quality of that inventory. Said another way, IQR is an inventory management system
that includes a metric, a method and a tool that helps you reduce inventory and keep it down.

IQR uses key information generated by your manufacturing and purchasing systems, including
inventory balances on hand, past usage, and future material requirements. This data is then processed,
synthesized, sorted, and presented in a manner that materials planners and management can easily and
effectively work with.

IQR Metric
IQR uses a proprietary logic scheme that stratifies your inventory into categories then calculates the
Inventory Quality Ratio (IQR) as the ratio of Active Inventory to Total Inventory. The higher the ratio
(expressed as a percentage) the better the quality of the inventory and the less inventory required to
support the operations of the company.

Active Inventory Dollars

IQR =
Total Inventory Dollars
The perfect IQR is 100, meaning 100% of your inventory is likely to be used in the short term based on
future requirements and/or past usage. I’ve never seen anyone with an IQR of 100. Of the hundreds of
companies using the IQR metric world wide, the average ratio when they start out is 30-40. Again that
means that 30-40 percent of their inventory is good, or active inventory and 60-70 percent of their
inventory is excess or obsolete. (To see how the IQR tool displays the metric, go to
www.InventoryPerformance.com)

To calculate the metric, you set a target for the amount of inventory you need. The target can vary based
on the ABC code of the item and targets are set in weeks worth of inventory. For example, you might set
a target of 4 weeks for A items, 13 weeks for B items, and 26 weeks for C items.

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IQR analyzes each individual part against that target and assigns it to an IQR category. The categories
are:
Active 1
- There are no known requirements
- There has been some usage in the past six months
- The Balance On Hand is not greater than the target quantity
Active 2
- There are some known requirements
- At least one piece is scheduled to be used inside the requirements horizon
- The Balance On Hand is not greater than the target quantity
Excess 1
- There are no known requirements
- There has been some usage within the past six months
- The Balance On Hand is greater than the target quantity
Excess 2
- There are some known requirements
- At least one piece is scheduled to be used inside the requirements horizon
- The Balance On Hand is greater than the target quantity
Excess 3
- There are future requirements, but none exist within the requirements horizon
Slow Moving
- There are no known requirements
- There has been no usage within the past 6 months
- There has been some usage within the past 12 months
No Moving
- There are no known requirements
- There has been no usage in the past 12 months

With this more detailed understanding of the IQR categories, we can restate the definition of the IQR
metric as follows.

A1 + A2
IQR =
A1 + A2 + E1 + E2 + E3 + SM + NM

IQR calculates the categories using key data extracted from your manufacturing and purchasing systems.
As most manufacturers have a unique set of computer systems and programs, a program must be created
that will extract and format this data into a standard IQR download file. Once written, this extraction
program can be used on a continuing basis, and will accommodate changes in your business operations,
such as additional planners or storerooms. Resident utilities and/or report writer programs in your MRP
or DRP systems will usually suffice for writing the data extraction routine.

Now that IQR has calculated the metric, you are ready to use the methodology and the tool to improve
your ratio.

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IQR Methodology
The IQR inventory reduction methodology follows the Plan-Do-Check-Act cycle made famous by Dr.
Deming. This cycle has become the standard for any process improvement. The IQR tool supports the
cycle perfectly. Here is what you do for each stage of the Cycle:
• Plan to improve your operations first by finding out what things are going wrong (that is identify
the problems you face), and come up with ideas for solving these problems.
• Do take steps designed to solve the problems. Keep track of your efforts and the results.
Document what you do.
• Check whether the steps you are taking are achieving the desired result or not. Track trends over
time and Check key results to identify any new problems when they crop up.
• Act to implement changes on a permanent basis. Look for root causes of the problem and Act to
eliminate those. This means making the changes a routine part of your activity.
When you have completed the cycle, go back to the Plan stage to identify the next issue.
Now let’s look at how that cycle is used in inventory management and how it’s supported in the IQR
methodology and tool.

Plan Your Inventory Reduction

Plan - Find out what things are going wrong, and come up with ideas for solving these problems
In inventory management the obvious thing that is going wrong is that you have too much money tied up
in inventory. What is not obvious is the right amount of inventory you should be carrying. There is no
standard answer to how much you should have. Your specific situation will determine how much
inventory is right. Variables that go into your thought process should include your ability to generate
working capital.

It takes cash to buy or build inventory. Money that is used to fund operations and inventory is called
“working capital. Working capital that is tied up in inventory is not available for other parts of the
business. Since many companies barrow to support their short-term working capital needs, this has a real
cost to the business, usually called the cost of capital. This cost of capital reduces profits. So every
dollar in inventory reduction, leads to a dollar reduction in working capital requirements and therefore,
to an increase in profits.

With the impact to working capital in mind, you can set a rule about how much inventory you should
have. Ideally this rule will vary by the A B C classification of your parts. A good starting rule is;
A items = 2 weeks worth of your requirements or recent usage history
B items = 6 weeks worth of your requirements or recent usage history
C items = 12 weeks worth of your requirements or recent usage history
Remember these are just guidelines. You have to set your own rules based on the cost of capital.

In IQR you start by entering the rules. The rules you use will greatly affect inventory quality as
measured by IQR. IQR has a set of default values at the time of your installation based on the normal
use of IQR. You can, and should, establish your own rules, based on your specific business needs.
In IQR a Rule is the number of weeks supply based on requirements or usage. The Rule is used to
calculate the maximum inventory quantity that a part may have and still be assigned to an active
category. Rules are calculated for most items that have either known Requirements, or Usage within the
past six months.

Defining how much inventory you should have is step one in creating your plan. You’ve set the
requirements that your current inventory will be measured against. The second step in the Plan activities
is comparing what you currently have to how much you want to have.
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You probably know how much inventory you have in aggregate The Problems with Inventory
terms. Good inventory managers know the total value of their Turns
inventory. They know their inventory turns (see side bar) and may Two popular measures of
know their days supply of inventory or some other time based inventory are inventory turns
measurement. What may not be known is which parts you have too and Days Inventory
many of and which parts do you have too few of. What may not be Outstanding, DIO. Neither of
obvious is which product lines are affected by too much inventory, these gross measures provides
which plants have too much of a part and which have too few of any actionable information.
the same part. The second Plan step then involves looking closely The first problem is that they
at your current inventory position by all the segments that are are just numbers with no base to
meaningful to your situation. To help you create your inventory compare them to. What is the
reduction plan, you need visibility of the details of the current perfect number of turns? What
situation so you can take action. is the right number of days
outstanding? If your inventory
IQR provides several ways to view summarized inventory data turns was calculated as 10, so
quickly, and the ability to drill down to look at the detailed records what? Is that good or bad?
comprising the summary totals. The summary views in IQR are There is a perfect IQR; it’s
called Quick Looks, and they are just that, quick ways to look at 100%. If all your inventory is
summary data. With a single click of your mouse you can see your active, that is you have no
inventory value by product line, plant, warehouse, account excess, no slow moving and no
number, buyer/planner or vendor. Each Quick Look displays the obsolete inventory, then your
inventory value for each inventory segment (each product line, IQR is 100%. If you calculate
each plant, etc.) in each of the IQR categories (Active 1, Excess 1, your IQR as 40%, then you
Active 2, etc.). Quick Looks give you the detailed visibility you know exactly how far you have
need to understand your current situation perfectly. (To see to go to improve inventory
examples of Quick Looks, go to www.InventoryPerformance.com) performance.
The second problem is both
When you have that kind of visibility, you can take the next step in traditional measures are
the Plan phase, setting your targets. A target is a meaningful typically calculated for the
objective to improve the business. Your targets should include a entire population of inventory,
reduced overall inventory level, a reduced level of excess and but all inventory is not created
obsolete inventory and an increased profit from lowering the level equal. Inventory managers
of working capital. When you’ve set your targets, you have typically stratify inventory into
completed you Plan. A, B and C categories Both
inventory turns and Days
IQR Targets functions help you develop meaningful objectives, for Inventory Outstanding ignore
both inventory levels and increased profits. Each Target function the difference between A, B and
requests user input to create specific “What if….” scenarios. The C items.
output is valuable information that can be used to focus the entire IQR is calculated for various
organization on a single goal. IQR’s Target functions include: segments of inventory. You can
Profit Contribution from Improved IQR - This Targets tool measure the IQR for your A
displays the Inventory Reduction and the Contribution to Gross items separate from your B
Profit resulting from a change in the Inventory Quality Ratio. You items. You can calculate your
can see the inventory reduction and increased profits that you can IQR by warehouse, by plant, by
expect from increasing the IQR percentage. buyer or many other ways. IQR
Inventory Reduction Estimate – This Targets tool displays the is both a measure of your entire
dollar value of inventory that you can reduce. You enter the inventory’s performance and it
percent of reduction you think you can achieve for each IQR Class can also be used to measure any
and the tool will calculate the total dollar value of that reduction. discrete segment of your
Profit Contribution from Improved Turns - This function calculates inventory down to individual
the Inventory Reduction and the Contribution to Gross Profit part numbers.
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resulting from an increase in Inventory Turns. This item is particularly useful in setting realistic
improvement objectives and programs if your company is accustomed to working with inventory turns.
(It should be noted that Inventory Quality Ratio is a more meaningful indication of your inventory
performance. See side bar).

Combined these and the other Target functions of IQR allow inventory managers to set realistic
inventory reduction and increased profit plans based on facts and data.

Do Take the Steps to Reduce Inventory

Do take the steps designed to solve the problems
Your Plan is to reduce inventory levels, to Do that you need to know which parts have excess, slow
move or no move inventory. In the Plan phase you were looking at gross inventory metrics. In the Do
phase you need to know about individual part numbers. You need a list of parts identifying which
individual parts are in which condition and to what degree. To be efficient, you need to get that list
sorted by value of excess. You are likely to have hundreds, even thousands of parts that need to be
addressed. You want to work the ones that will have the biggest impact on your reduction targets first.

Here’s an example of a list. The inventory balance on hand is expressed as a value, as thousands of
dollars, not quantity of pieces. The excess is also expressed in thousands of dollars. This is critical. You
want to focus on the biggest bang for your buck so you need to know the value. You really don’t care if
that value is one piece or a million pieces.

Part $1000 On $1000

Number Part Description Hand Excess
7900-0041 P-3,CVR,BCKREST,06 207.9 191.3
DASHBOARD,INJ-
17100026 MLD,W/HTCH 152.4 138.9
3600001 SHAFT,AL,1.088,BLK,160CM 116.8 116.5
8024528 CLEARW,TTD,SKRT,XL,GY/BK 111.5 109.1
8024135 CLRWTR SPRAYSKIRT 5622 U 68.7 65.3
8024527 CLEARW,TTD,SKRT,LG,GY/BK 62.7 58.4
7900-0042 P-3,CVR,LEGLFTR,06 175.4 54.3
17040124 PAD,STBCK,CSS,BLK,SBP2 56.7 50.9
8025116 SEAT,SOT,FSHNG 50.7 47.4
17040128 PAD,SEAT,BLK,SP4,REV,B 44.2 41
17080064 CVR,HTCH,OVL,KJS,42/30CM 243.1 37.9

In IQR you can quickly and easily drill down from summary data to details. The first drill down level is
going from summary data (such as the number of items and total dollar value) to a listing of the
individual records comprising that particular category. This listing shows every part in the category you
selected to drill down on. For every part on the list, you see: Part number, Description, planner code,
balance on hand in thousands of dollars (not the quantity, IQR focuses on inventory value), Weeks of
supply that the balance on hand represents, the excess inventory in thousands of dollars, and the number
of open orders including their value. This view points out clearly which parts need your attention. For
example, you can see at a glance that a part has thousands of dollars of excess material and has more
material on order.

From your list, you select an individual part to work. Of course you select the one on the top of the list
because it has the greatest potential for reduction. To realize that potential, you need to see all the details
about that part. Critical details include information like usage history, future requirements, last used
date, and key planning factors. With that information before you, you can see what must be done to
reduce inventory on that part. The specific action you take depends on what you see. Here are some
general guidelines.
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 If the part has no requirements and no recent usage history, you should get it
off the books. Remember, you are paying carrying cost for every part in your
inventory. Carrying cost typically equals 25% to 30% of the part’s cost and you
pay that every year you hold this useless part. Sell it at a discount. Return it to
the supplier. Donate it to a charity. What the heck, sell it on e-Bay. Many
companies are reluctant to write off inventory but it’s the action of last resort.
When you have no other options, write it off the books and throw it away.
If the part has requirements or recent usage but you have too much of it or
have it too soon, you should attempt to reduce your overage but definitely
prevent any more from coming in until you need them. This usually means
rescheduling purchase orders and production orders.
Once you’ve done that analysis, you take the action required to reduce the inventory.

In IQR when you see a part that has a condition that needs your attention, like the parts described above,
you can drill down on that part to get more details. The second level of drill down is known as a Part
Detail screen, and is used to see all of the information for a particular record (specific part number).
Some of the fields you can see in the detail screen include: Usage history, requirements details, and
panning factors like lead time, safety stock, and order quantities. On this screen you see all the data you
need to take action to resolve the issue. (To see what a Part Detail screen looks like, go to
www.InventoryPerformance.com)

When you’ve looked at the detailed data and determined what action you need to take, you can mark the
part with an Action Code. Action Codes are input by the user based on their analysis of the detailed data
and signal the planned action or current review state of an item. In addition to the action code the user
can add comments to any part to further defining what needs to be done. Action codes and Comments
become the to-do list that will help you reduce inventory to meet you plan.

Check Your Inventory Reduction Progress

Check if the steps you are taking are achieving the desired result
In Dr. Deming’s Plan/Do/Check/Act cycle, the Check step has you look to see if your activities are
getting you closer to your plan. After Doing the steps to reduce your inventory, you need to measure the
progress you are making. There are two basic types of measures: snap shots of a point in time and
trends. You want to use both.

Take a snap shot about weekly and compare it to the previous snap shot. Did you get better or worse?
Most likely it will be a combination of both. Ask yourself, why. What caused the numbers to get better?
Is it something you did or was it caused by factors you did not control? If it was something you did,
repeat it; do it again. What caused the numbers to get worse? Again, was it something you did or was it
an outside factor? If it was something you did, do not do it again; find out how to prevent it.

In addition to a snap shot, you also need trend charts. You need to create charts that show how you are
progressing over the long period. Line graphs or area charts give clear visual display of how you are
doing.

IQR’s Performance programs are designed to point out the differences between prior IQR measurements
and the present, and to highlight the significance of these changes. The first report shows the movement
of inventory between IQR Categories, the second report computes the financial impact of these
movements, and the third report provides a historical perspective of key IQR measurements.

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The Inventory Movement Matrix provides a snap shot on the movement of items from one IQR Category
to another. It allows you to easily track the progress as values move between Categories, and to view
those items in detail. You may then investigate and take appropriate action to get those items back into
the active columns. It identifies the source of obsolete inventory and the area in which effort should be
focused to prevent its formation.

The inventory matrix is comprised of two axes: “FROM” Categories comprise the rows, and “TO”
Categories comprise the columns. Each cell of the matrix contains two numbers. The top number is a
count of the number of items (part numbers) that changed IQR Categories since the previous processing
cycle. The bottom number is the value of that inventory in thousands of dollars. You can use this data
for a snap shot of your IQR performance, either in a numerical chart format or in graph.

Financial Impact of Inventory Movement presents the total value of all favorable and unfavorable
inventory movement since the previous processing cycle. It also calculates the incremental changes to
financial reserves and the resultant change to net profits.

These inventory valuations and changes to reserves are calculated using the information contained
within Performance, Inventory Movement Analysis. The first line is the inventory value of all
unfavorable movements. The second line is the cost, or increase in reserves, due to these movements.
Lines three and four reflect the favorable inventory movements contained within the top right triangle.
The Net Profit / Loss line is the net change to financial reserves.
Prior Periods Summary Data - Each time you process new data, IQR adds the new data to your Prior
Periods Summary Data. The new summary information is be added to the existing data, and will be
identified with whatever date you input. IQR will save an infinite number of periods (or iterations) on
line. You can use this data for tracking of your IQR performance, either in a numerical chart format or
in graph. (To see what a trend graph in IQR looks like, go to www.InventoryPerformance.com)

The Performance reports in IQR highlight the progress you are making toward your inventory reduction
goal. They show you if you are on plan or not. When you know that, you can move to the last step in the
cycle, Act.

Act to Make the Reductions Permanent

Act to implement changes on a permanent basis
Following the Plan, Do, Check, Act cycle calls for you to analyze your current condition and create a
Plan to improve toward a goal that you set. Once you have the goal, you Do what it takes to improve the
current condition. A regular intervals you Check your progress. Based on what that check shows, you
take the appropriate Action to make the changes permanent.

Making your inventory reductions permanent means you have understand the root cause and take steps
to eliminate them. Some typical root causes of too much inventory include not adjusting order quantities
and due dates when requirements change, accepting orders early from suppliers, and planning factors
that are either out of data or just plain wrong. Critical planning factors include lot sizes and order
policies, minimum order quantities, order multipliers, lead times and safety stock.

To Act on these root causes, you must have a way to identify the parts that have issues, review the data
and Act to correct the data. For example, you need to compare safety stock to future requirements. A
good rule of thumb is to question the reason for any part having safety stock that is greater than one
month’s requirements. Following that rule of thumb you want to get a list from your planning system of
all parts where safety stock is greater than one month’s requirements. For each part on that list, you

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should Act to verify that you have that much variance in demand. If you do not, reduce the safety stock
level to a more reasonable level.

The same process should be applied to each root cause category. Get a list of all parts that have open
orders that are due within your current weeks supply on hand. Reschedule all the parts on that list. For
example, a part number has 5 weeks worth of inventory on hand right now. You look at the report of
open orders and you see that a PO is scheduled to be received in two weeks. You should reschedule that
PO out to 5 weeks from now.

Look at your excess inventory by supplier to identify if certain suppliers are constantly delivering early.
Let that supplier know that you will no longer be accepting orders before their due dates. Look at your
list of parts with large lot sizes, with order policies that bring large period worth of inventory, with
significant minimum order quantities or order multipliers, and look at list of parts with long lead times.
Verify that all these planning factors are appropriate to current circumstances and correct those that are
not.

IQR has a series of standard Action Item functions that are used to identify existing or potential problem
areas. Each Action Item report includes the necessary information for you to take action in keeping your
inventory exposure to a minimum.

Each Action Item report presents your inventory data in a unique way. The Action Items menu in IQR
includes following:
Purchase Orders for Non-Active Inventory & Manufacture Orders for Non-Active Inventory - Identifies
open Purchase or Manufacture Orders for items where some of the material on hand has been
categorized as non-active (E1, E2,E3, slow move or no move). Parts that are in one of these IQR
categories already have more inventory than you need. Open orders must be reviewed to make sure they
are not going to add to the current problem. For each E1, E2,E3, slow move or no move part, the display
shows the current inventory balance in thousands of dollars, the weeks supply represented by that
inventory, the open order quantity and due date. At a glance you can see what orders need to be canceled
or rescheduled.

Potential Shortages - Items listed on this display represent potential shortages by IQR criteria. These
items are A1 and A2 only, for which the Balance On Hand is less than the requirements in the next
month, and for which there are no open orders (either Purchase Orders or Manufacture Orders). The
display shows the balance on hand, the requirements quantity for each of the next three months, the lead
time and the supplier. This is all the information you need to quickly get the parts on order and avoid the
shortage.

IQR has a series of report that help identify potential problems with planning factors.
Questionable Safety Stock - This report will list all parts where the safety stock is greater than on month
worth of requirements or one month’s usage if there are no requirements. Look at every part on this list
and make sure you really need that much safety stock.
Lead Time Longer Than X Days – You enter the number of days of lead time you think is a good
maximum, and the report will list all parts whose lead time excees that number. Verify the lead time of
each of these parts to make sure you are not putting parts on order early and therefore getting them
delivered too soon.
Minimum Order Quantity Greater Than 3 Month’s Requirements or Usage but Lead Time Less Than 30
Days and Order Policy Code Greater than 8 Month’s of Requirements or Usage - These reports
highlight order quantities that don’t make any sense. Review and correct as needed.

The information presented in the Action Item functions helps you close the loop and meet the targets
you set in your Plan back at the beginning of the cycle. All that’s left tot do is to start the cycle again.
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Review your current Inventory Quality Ratio and use the Target functions to create your Plan. Do the
analysis and define what steps you need to take to reduce the inventory levels. Use Action Codes to
mark specific parts and comments to denote what needs to be done. Check the level of improvements
using the IQR Performance functions. And finally Act on specific issues using Action Items functions.

Summary of the IQR Tool

With the IQR Tool you:
Plan
Get complete visibility of your situation
IQR provides a series of Quick Look Reports. Quick Look provides you several ways to view
summarized inventory data by segment quickly, and the ability to look at the detailed records comprising
the summary totals.

Set inventory reduction targets

IQR lets you set realistic inventory reduction targets to help you develop meaningful objectives, for both
inventory levels and increased profits. You create specific “What if….” scenarios to analyze your
opportunities to free up working capital.

Do
Assign actions to drive inventory reduction today
Quickly and easily drill down from summary data to details. The first drill down level is going
from summary data (such as the number of items and total dollar value) to a listing of the
individual records comprising that particular category. Put action codes on parts that need
attention
Check
Track your inventory reduction performance
IQR has built in performance tracking tools designed to point out the differences between prior IQR
measurements and the present.

Act
Use Action Items to identify root cause and make permanent reductions
Action Items are used to identify what course you plan to take to address existing or potential problem
areas. Each Action Item report presents your inventory picture in a unique way and includes the
necessary information for you to take action in keeping your inventory exposure to a minimum.

And if that isn’t enough

IQR includes a custom reports generator. a very powerful and flexible tool to analyze your inventory data.
It allows you to create custom reports to focus on special information or relationships. You choose which
data fields are displayed, the sort sequence, and the selection criteria for displaying only the situations
you wish to view. IQR also provides you with the capability to graph any of the Quick Look
stratifications.

Here are some of the features and information that IQR provides for your company:

IQR...
• Identifies material that may become excess or obsolete.
• Directs your attention and efforts to the areas in which you can best improve the use of your
inventory dollar.
• Gives each planner their own Data Set, A-B-C items and IQR ratio.
• Helps you establish inventory goals and measure your progress.
• Does the detailed analysis for you and gives you more time to work the problems.
• Provides managers with the necessary information needed to make strategic decisions regarding
inventories.
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• Analyzes information from your Material Requirements Planning system and gives you
recommendations to fine tune it, including feedback to your forecasting system.
• Is sensitive to your unique situation. You can adjust the IQR parameters to meet your changing
business environment.

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