Monitor Inventory to Keep Cash Flowing
Skillful inventory management is often one of the biggest factors in maintaining positive cash flow. Consider these techniques for controlling your company’s inventory to improve your cash position:
- Track inventory turnover. The inventory turnover ratio measures the number of times inventory is sold and replaced in a given time period (annually, quarterly or monthly). It’s calculated by dividing cost of goods sold by average inventory. Let’s say you’re a retail business that has $5 million in cost of goods sold. At the beginning of the year, your inventory balance is $600,000; at year-end, it’s $400,000. That means your average inventory is $500,000 (the sum divided by two). To get the annual inventory turnover ratio, you divide the cost of goods sold by this average. So in this example, the turnover ratio would be 10 ($5 million divided by $500,000). On average, you’re selling and replacing inventory 10 times each year. Compare historical ratios and industry averages to get a clear picture on the state of your inventory management. Low or deteriorating turnover ratios may indicate that your business is carrying excess inventories. Research to find out why.
- Scrutinize aging inventory. An aged stock or inventory aging report lists items grouped by the length of time they’re being held in inventory. Like an accounts receivable aging report, an inventory aging report enables you to quantify the cost of specific slow-moving inventory items. A way to calculate this is to take the number of units on hand and then determine how many months of sales it will take to sell out of the item. If certain items aren’t selling, they may be obsolete or beyond their shelf life. You may need to write down values in the company records, provide discounted sales, or write off specific items by removing them from inventory.
- Consider just-in-time (JIT) inventory management. JIT is designed to increase efficiency, reduce costs and minimize waste. Companies order goods only as needed. Depending on your business, JIT might be used to lower inventory holding costs, reduce problems with order fulfilment, and improve cash flow. Given the risk of being out of stock, JIT can work for your business if your products can be manufactured or supplied quickly, and your company’s order fulfillment system is efficient.
By skillfully managing inventory, your firm can continue to generate positive cash flow, satisfy customer demand, and invest in new opportunities.
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