Key takeaways:
- Consider inventory as cash in a different form. Strong inventory management keeps cash free for expenses such as payroll and rent.
- Overbuying, stockpiling deals, and setting your orders on autopilot can all have a detrimental effect on the balance between stock levels and cash flow.
- Using a 4-step system, you can learn what inventory you need to order and when. This allows you to have what you need when you need it.
If you find yourself stuck in an endless battle of having too much stock and too little cash, you need a strategy that will ensure you have the right amount of inventory while freeing up as much cash as possible for other expenses.
Think of it this way: your inventory is your cash, it’s just in a different form. When money is stuck in products that aren’t selling, it can’t be put to work in your business for things like payroll, rent, or supplier payments. The goal for inventory management is to have exactly what will sell, when you’ll sell it. While that sounds like a lofty goal, it’s possible with the right inventory management strategy that balances stock levels with cash flow needs.
The 3 inventory mistakes draining your cash
If you’re struggling to manage inventory, you likely fit into one of these categories. Let’s take a look at common mistakes that could be draining your cash and a quick fix to get things back on track.
The “just in case” overbuyer
If you find yourself over-ordering because you’re worried about running out, you might be a just-in-case overbuyer. When you tie up your cash in stock that you might need down the road, you might also watch it sit on the shelves for months.
The fix: Look at your actual sales data and order based on your needs, not fear.
The “deal hunter” stockpiler
“But it’s a great deal!” If you’ve said that, you might be a deal hunter. Buying inventory because the price is right can be a good inventory management strategy, but when it gets out of hand and you end up with full shelves of “good deals,” it can hurt your cash flow.
The fix: Only stock up on deals when you know the inventory will move. Even a steep discount isn’t worth it if you can’t make payroll.
The “set it and forget it” orderer
It might seem like a great strategy to automate your ordering process. Ordering the same amount on autopilot, however, can lead to inventory that you no longer need. As your business changes, your inventory strategy should too.
The fix: Review what’s actually selling each month and tailor your orders to your current needs.
Your 4-step system to get inventory management right
Let’s walk through the four steps you should follow to get your orders right and proactively manage your inventory.
1. Calculate your inventory turnover rate
Use the following formula to determine how many times per year you sell through your entire inventory:
Cost of goods sold (COGS) ÷ Average inventory value
Where:
- COGS = the total cost you paid for your merchandise in a year
- Average inventory value = (Cost of beginning inventory + Cost of ending inventory for that same year)/2
This will give you a big-picture look at your inventory’s movement throughout the year. This is also important if your inventory flow varies seasonally. Some businesses, like retail stores, see their highest inventory turnover in the fourth quarter, while others, like a swimming pool company, will see most of their inventory move in the second and third quarters.
2. Find your reorder point for top products
The reorder point is the moment you need to reorder before running out. Calculate this using the following formula:
(Average daily sales × lead time in days) + Safety stock
Here’s an example: If you sell 10 units per day, reordering takes 7 days, and you need a safety stock of 20 units, don’t let your inventory drop below 90 units.
3. Rank your inventory by cash value
Pull your sales report and categorize every product you sell as an A, B, or C item.
- A-items: The top 20% of products that generate 80% of revenue
- B-items: Middle performers
- C-Items: Low-sellers
Watch your A-items very carefully and reorder according to the formula in step 2. B-items can be reordered monthly. Consider dropping or minimizing items that fall under C-items. Using this ABC analysis will keep your orders on track.
4. Set a monthly inventory review date
Pick one day per month to review what’s moving, what isn’t, and what’s about to run out and order accordingly. The first few times you do this, it may seem overwhelming, especially if you’re not used to it. The more you do it, the easier it will get and the faster you’ll be able to identify what you need to order and when.
Warning signs you’re getting off track
If any of the following are happening, it’s time to do a review to reassess how you’re managing your inventory.
- You’re constantly running out of best-sellers
- You have inventory sitting longer than 90 days
- You’re delaying bill payments to buy more stock
- Your storage space is overflowing
- You can’t remember the last time you reviewed what’s selling
Your next move
Inventory management isn’t just about having products. It’s about keeping your cash flowing. Your challenge today is to choose one step from the 4-step plan and complete it this week. It may seem daunting at first, but even small changes in how you manage inventory can free up thousands of dollars in cash flow. We’re cheering you on!