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written by | September 20, 2022

What is Lead Time? How is it Significant in Inventory Management?

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Lead time can be defined as the time required from the initiation of a process till its gist. Lead time is used by companies to gain insight into operation and production processes like inventory procurement, supply chain management, etc.

In this blog, we have discussed in detail what is lead time in inventory management as well as how we define lead time

Did you know? The concept of lead time is used by managers to analyse the bottleneck, idle or unproductive time in the business process.

What is the Lead Time Definition?

As per PMBOK (Project Management Body of Knowledge) by Project Management Institute (PMI), Lead time is the amount of time whereby a successor activity can be advanced with respect to a predecessor activity. When a process is still going on and at the same time, another process initiates indicating an overlapping of activities between the two. For example - A restaurant is planning to install a tabletop menu in its prominent location, while the test of the system is still going on, employees who will be in charge of using the system begin the training of using it.

Also read: Accounting Information System Explained With Ais Full Form, Types & Examples

Lead Time in Inventory Management

Under Inventory Management, Lead time is defined as the time between placing the order for inventory with suppliers and the time the inventory is delivered. The concept of lead time is used to understand the following business processes:

  • Operating Cycle 

Operating cycle refers to the period of time from the procurement of inventory till the cash realisation from the debtors. The shorter the operating cycle, the better it is for the company to increase sales. The operating cycle includes the lead time of the inventory procurement. Thus, the company should choose a vendor with the shortest lead time.

  • Manufacturing

Under the manufacturing process, Lead time refers to the total time required to source the raw material, and process it until the finished product is manufactured and made available to the customers.

Under just-in-time inventory management, once the customer places the order to purchase a product, only then the inventory procurement begins and the manufacturing starts as a response. Businesses follow just-in-time inventory management to reduce the stress of financing the inventory all the time and managing it and focusing on improving distribution channels. 

Lead time becomes more important when the business is following just-in-time inventory management. The higher the lead time, the higher the waiting time for customers and the less satisfied the customer will be with the product offerings.

  • Supply Chain Management

Supply chain management is the process of managing the movement of goods and services between the business and the point of consumption. It could include the movement, storage, WIP (Work in Progress), raw material inventory, finished goods, and end-to-end order fulfillment from the point of origin to the point of consumption. 

Supply chain management is crucial for the success of a business and its ultimate survival. A sound supply chain management in a company places the company at a competitive edge over its competitors. It also improves business processes like inventory procurement, product design, testing, Research and Development, etc.

Also read: What Is Accounting Rate of Return (ARR)? Explained With ARR Formula & Example

A shorter lead time is always the desired outcome for a business. It improves the cash inflow and prepares the company to fulfill sudden spikes in demand and overall supply management.

With an ongoing pandemic, global supply management has gone through a huge plunge. Many businesses struggle to get the product ready on time and fulfill the demand. A spike in inflation could be observed in India and the rest of the world. As a result, experts suggest that managing supply chain costs and shorter lead times could help the business to deal with uncertainty.

What Are the Benefits of Lead Time Reduction?

A business with a shorter lead time always manages to offer better utility to the customers than that of competitors in the same Industry. The benefits of reducing lead time include:

  • Businesses with shorter lead times have the potential to move to just-in-time supply chain models and better inventory management.
  • Businesses with short lead time manage to improve their operating cash inflow by buying the raw material, processing it for finished goods and selling products, and reduced inventory by caring for cost at disposal.
  • With a shorter lead time, you will be in a position to fulfil the recent spike in demand and will have immunity to react to the changing circumstances in the market.
  • Business usually suffers huge losses from sudden stockouts in terms of idle labour hours, under-absorbed overheads, etc. With improved lead time, businesses could minimise the impact of stockouts and will be in a position to accurately predict when the product will be available for customers.
  • With an improved lead time, your business could reduce the carrying cost of inventory like warehousing overhead, and the cost of holding a lower level of safety stock.

How to Reduce Lead Time in Inventory Management?

  • Consider Sourcing Inventory Nearshore

For a business, Nearshoring refers to the approach of inventory procurement from a third party relatively close to the company’s manufacturing location. It ensures that the company does not face stockout by backing up supplies when the other supplies are affected by natural calamities.

Sourcing inventory from near the business operations centre could shorten the lead time. However, the company could face difficulty to explore the best opportunity, globally. Due to the COVID-19 pandemic it is crucial for businesses to predict the future with precision. 

  • Avoid Bulk Orders 

Suppliers usually offer discounts when the companies place orders in bulk and also reduce their ordering costs. However, if you maintain your inventory in bulk, the carrying cost for inventory could spike up to cover the benefits you get. Before placing an order in bulk, a deep analysis of cost and benefits should be carried out to understand the impact on the profit.

Thus, if you have a shorter lead time, you could be in a position to order as little as required and maintain a good state of operational cash inflows.

  • Agree on a Lead Time With Your Supplier

Agree on a lead time that best suits your business needs with your supplier. If required, prepare a formal contract with them. This way they will be under contractual obligation to fulfill the order in the agreed-upon lead time. The following terms could be included in your contract:

  • Forecast the demand for the product's delivery and include a clause of lead time for specific orders or types of stock that have the most demand as a response.
  • Penalties for delayed shipments.
  • The advance notice period for foreseeable shortages of inventory and clauses for price changes.
  • Automation

Automation and use of IT are unavoidable in current business processes. Automation reduces the chances of human error and helps your business to be a better contribution to the customers. Here are a few processes where automation can be applied.

  • Automate the order processing system in response to inventory below the safety level.
  • Track your lead time from software and measure the supplier's performance.
  • Checks for quality of inventory received.
  • Identify the delayed order and respond to corrective actions.
  • Share the recorded delays and performance with the suppliers to improve the processes.
  • Maintain Good Terms With Suppliers

Maintain a culture of honesty and integrity with the suppliers. After all, they are important pillars of your value chain system. Good and healthy communications with suppliers help your business to strive in difficulties. Communicate with your suppliers about the ongoing good things and talk to them about the areas of improvement. When you talk to them only in times of difficulties, it does not create a sound and strong relationship.

Also read: Indian Accounting Standards (Ind AS) - Factors, Benefits & Adoption

Conclusion

It is important that your business runs on a shorter lead time. The shorter the period of placing the order and making it available to the customers, the more the customers will be satisfied. A robust lead time also ensures that your business maintains sound liquidity. Alright, we have been through a lot on lead time and its usage in inventory management. At last, we talked about how to improve lead time followed by a conclusion here. Hope this article helped you understand lead time definition, what is lead time in inventory management and the lead time meaning.
Follow Khatabook for the latest updates, news blogs, and articles related to micro, small and medium businesses (MSMEs), business tips, income tax, GST, salary, and accounting.

FAQs

Q: What are the various ways to reduce the lead time in inventory management?

Ans:

Lead time is very crucial for businesses, especially those operating in a competitive environment. Your business could shorten the lead time by maintaining a sound and healthy relationship with suppliers, applying automation in the processes, avoiding bulk orders, sourcing inventory from a nearby place to the manufacturing units, etc.

Q: What is the formula for lead time management?

Ans:

It might vary depending on the circumstances. Manufacturing lead time, has to factor pre-processing (plan), processing (procurement and manufacturing) and post-processing (dispatch) lead times into account.

Q: How is lead time used in inventory management?

Ans:

Under inventory management, the concept of lead time is used by managers to improve the processes in inventory procurement, operating cycles of the business, and Supply Chain Management (SCM).

Q: What is lead time?

Ans:

Lead time can be defined as the time required from the initiation of a process till its conclusion. Lead time is used by companies to gain insight into operation and production processes like inventory procurement, supply chain management, etc.

Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.
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Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.