The more inventory you have, the less cash you will have. It’s as simple as that.
Inventory is the biggest drain on a company’s cash flow. My typical client — depending on their industry — has anywhere from 20 to 40 percent of their working capital tied up in inventory. That’s a lot.
But it’s certainly avoidable. Your working capital ratio (cash, receivables and inventory compared to accounts payable) should be at least 1:1, and really, twice that if you want to be in good shape. Your inventory can have a positive influence on this ratio, but only — and I mean only — if it can be quickly converted to cash. Otherwise, it’s considered a drain.
Inventory is designed to be sold. It needs to turn.
How often should your inventory “turn” to generate cash? That also depends on your industry. In most manufacturing and distribution businesses, inventory turns about two to four times a year. In retail, it can be as much as 10 times. To calculate turn, take the average of your beginning and ending inventory at the beginning and end of a period and divide it by your cost of sales.
All of this impacts cash, and the best way to maximize your cash is to minimize your inventory. Here’s how.
First, count it and count it frequently.
Take a full physical and make sure you know what you have. Update your inventory software so that it’s tracking the ins and outs of inventory every day (it’s called a perpetual inventory system). Then apply the 20/80 rule, which generally means 20 percent of your inventory is generating 80 percent of your sales, and make sure you continue to count that 20 percent of inventory daily or weekly. That’s called cycle counting, and it’s critical to make sure you’re on top of your quantities.
Next, age your inventory and get rid of the old stuff.
I consider something old when it’s been sitting there more than a year, but you may have a different definition depending on your business. Old inventory also drains cash. It takes up too much space. It absorbs overhead. It can be a safety and workflow issue. Remove it, and you can get a tax write-off. Plus, you’ll clear up room to store better inventory that you can sell and generate more cash.
Invest in technology.
You think Amazon, Toyota and all the other corporate manufacturers and distributors invest in new technology for fun? No, they’re doing it for profit, and my smartest clients are imitating them. Thanks to recent developments in RFID (Radio Frequency ID) and GPS technologies (which have also become much more affordable), many smaller companies are learning that by spending a few dollars to tag every item in their location, they can immediately know what they have on hand and where it is with no physical count required. Think about the savings.
They’re also investing in autonomous vehicles to carry materials, drones that can view and even carry items to higher places, IoT (internet of things) sensors to monitor the performance of machines, and robotic arms that are helping with stacking, storing, assembling and packaging materials. They’re also buying augmented reality wearable devices to guide workers and provide real-time views of jobs and materials.
I’m happy to make technology recommendations in the comments section of this article if you’re interested in learning more.
Finally, spend time forecasting.
Just-in-time manufacturing is quickly becoming a relic thanks to the lessons we’re learning from the current supply chain crisis, the biggest being that the supply chain isn’t as reliable as we think.
That’s why my smartest clients are building safety stocks and creating re-order points for their critical supplies inside their inventory management systems, complete with notifications and automatic purchase ordering when amounts are triggered. They’re looking at material resource planning (MRP) technologies that can help forecast inventory needs based on projected sales. They’re digging into backlogs, open orders, prior histories and salespersons’ input to guesstimate sales over three- to four-month periods of time. People who run businesses successfully avoid surprises. They do their best to predict the future and know what their inventory will be. They plan accordingly.
As a result, they have closer-to-optimal (no one’s perfect) levels of inventory. Which means they have less cash wrapped up in their storage. Which means they have more cash in their bank. And isn’t that what it’s all about?
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