13 tips for effective stock management.
With much of their working capital tied up in stock, it is essential that businesses manage that stock efficiently to support their cash flow.
There are 3 very good reasons to implement effective inventory management systems. Stock …
- Uses up cash.
- Uses up space.
- May lose value.
Many people believe that buying the right stock at the right price is all that is needed for good stock management. However, just as important, is the time factor which can influence both cash flow and profit. The end objective with stock or inventory management is to ensure that when your customer is ready to purchase, you can supply the product at a time suitable to the customer.
You may hear the terms ‘inventory’ and ‘stock’ used interchangeably, and for many businesses they are. Stock is part of inventory and represents any goods that are ready and intended for sale. Inventory includes stock and all those other physical items you buy that will be consumed or used in the business and adding value to the finished product for sale. In this article I will use the term inventory from now on.
So, why is time important when it comes to managing your inventory? There are three main reasons:
i.) It uses up cash.
If I pay $10 cash for inventory, I am out of pocket $10 which I would need to fund from my own resources (equity) or borrow and pay interest on.
If I sell that inventory the same day for cash, I get my $10 back almost immediately hopefully with some profit as well. This goes back into my pocket. I can then pay the $10 back to the owner or lender or use it to buy another $10 worth of inventory to sell tomorrow. This is called just in time inventory management.
However, if there is a time delay before I can sell the inventory, let’s say the delay is 5 days, I need to buy enough inventory to meet 5 days of sales. If daily sales are $10 worth of inventory, I now need to buy $50 worth of inventory to ensure I can meet my sales. I am now out of pocket $50 which I would need to fund from my own resources (equity) or borrow which will potentially cost more in interest.
ii.) It takes up space.
When inventory arrives, I need to put it somewhere. How much space I need will depend on my level of sales and how much time my inventory sits there before I sell it. In the cash example we saw that if I sell my inventory the same day as it arrives, I only need enough space for inventory to cover one days’ worth of sales. However, if there is a time delay, for each extra day I need another day’s worth of sales. In the example above instead of 1 item of inventory I need to find space for 5 items of inventory.
Of course, space is usually not free, I may need to rent the space. The longer it takes from receiving inventory to selling, the more space I will need and the more it will cost me.
Rent is not the only cost. The inventory may also need temperature control, pest control, insurance, security, people to count it and move it and it may reduce efficiency if it gets in the way of other processes in the business. The more inventory that is held the more costs that may be incurred.
iii.) It may lose value.
Depending on the inventory held, it may lose value over time. This may be because it passes its ‘best before’ date; gets damaged or lost over time; goes out of fashion or becomes superseded. This list is not exhaustive but is intended to give you an indication of why inventory may lose value or even become unsaleable.
With the potential of time causing us to require more cash and potentially greater costs, what are some ways to get good inventory control? Below are 13 areas a business could investigate, but recognise that they may or may not suit your business. Again, the list is not exhaustive but it’s a good place to start.
1. Know your inventory turnover ratio.
As a first step it’s important to monitor how fast your inventory turns over. The inventory turnover formula is your Cost of Goods Sold (from your Income Statement) divided by your inventory (from your Balance Sheet). This ratio tells you, on average, how many times you sell all your stock each year. If the ratio goes up it means you are turning your stock over faster, which is generally the desired result.
Another way to look at this ratio is to convert it into days using the inventory days ratio. It is calculated by taking the number of days in the year, 365, and dividing that by your inventory turnover ratio. This ratio will tell you, on average, how many days it takes to sell your inventory. In this case, the aim is to reduce the number of days as this may lead to holding less stock.
2. Understand your whole inventory journey.
It may be helpful to be aware of the timing and other variables that may impact your stock holdings from the time you order the inventory, to when it arrives on your doorstep, how long it takes to get through your value adding processes to make it saleable and how long it takes to get on the shelf and into your customers hands.
This will enable you to understand the minimum length of your inventory’s journey and hopefully help you identify where that journey may be slowing down.
3. Sales budget / pipeline.
The objective of a good inventory management system is to have only enough inventory to meet your expected sales. A good sales budget or sales pipeline should inform your inventory management system when inventory will be needed for sale.
4. Inventory management system.
An effective inventory management system is one that shows you how much inventory you have, how long you have had it, where it is, at what point you should reorder it, how fast it is turning over and be integrated with your sales budget.
It is important to periodically check your physical stock against your system records to ensure it matches or to highlight any anomalies.
5. Buy less not more.
While a discount on a bulk purchase may seem attractive, is it enough to outweigh the cost of storing that bulk inventory and having your cash tied up until you can sell it?
6. Stop buying.
A temporary solution to quickly reduce stock is to simply stop buying for a short period of time.
7. Look at your product mix.
If you sell multiple products, some might turnover faster than others. Look at slower moving items and consider whether it is worth the cost of holding it. If it is a product that brings customers to your business, who then buy other products, or if it has a high profit margin, then it may be worth continuing to hold it.
8. Limit variations.
Every variation in size, colour and attributes can multiply the amount of inventory to be held. Too much choice may confuse customers and reduce sales.
9. Standardise inputs.
Where possible, design products with as many interchangeable components as possible. For example, use screw sizes that could be used on multiple products or the same ingredients that could be used in several meals.
10. Increase sales.
Increasing sales may be a solution to managing inventory, however if you are already using all your skills in this area, some of the other ideas may help more if inventory is an issue.
11. Get cash for old, slow moving, or obsolete inventory.
If you have inventory that is not selling in normal channels, consider selling it for scrap, at a market or online. Even if you need to sell below cost, it gets cash in the door and the inventory out.
12. Donate or gift it.
If you cannot get cash for your inventory, consider donating it to a charity or gifting it to a local school or club. This not only frees up space for new inventory that may sell, but it may also make customers more inclined to buy other products from you because of your community support.
13. Dispose of it.
At the end of the day you may need to dispose of inventory that is not selling. Do it sooner, rather than later. This inventory is taking up space, costing you money and may be demoralising for you and staff as it sits there gathering dust.
Efficient inventory management may improve a business’s cash flow, reduce the amount of funding needed to operate and could potentially reduce costs and increase profitability.
This information is general in nature and has been prepared without taking your objectives, needs and overall financial situation into account. For this reason, you should consider the appropriateness for the information to your own circumstances and, if necessary, seek appropriate professional advice. ©Westpac Banking Corporation ABN 33 007 457 141 AFSL and Australian credit licence 233714.