Excessive Inventory Can Be a Burden

This continues a series of posts focusing on how to manage cash and how managing assets, expenses, and liabilities impact it. Along with accounts receivable which I discussed in All Those Accounts Receivable are not Impressive, inventory is I believe one of the two biggest areas where cash gets wasted. I discussed the inventory impact on cash in an earlier blog 3 Low Cost Sources of Cash – Part 1 but want to take the time to reemphasize this critical cash management issue.

Inventory Filling All the Space

Inventory can easily get out of hand and fill up just about every available space in a warehouse. Like accounts receivable there is a tendency to be impressed with a large amount of inventory on your balance sheet. Don’t be? In fact, excessive inventory can be a burden. While it may make you feel secure knowing that you have ample inventory to meet customer demands and it may also be used to secure a loan, there are some major things to consider when deciding just how much inventory to carry.

Take a Look at the Inventory Turnover

There are at least a couple of ways to evaluate inventory on-hand. First, you can calculate how many days it takes to turn-over your inventory. Second, you can calculate how many months of inventory you have in stock. Here is something to think about. If you have 4, 5, 6, or months on hand and can reorder or produce something in a month or two, then you have a lot of cash tied up in excess inventory. For example, if you have $6 million in inventory that represents a 6 month supply and can replenish it in a month, you have an opportunity to free-up some cash by reducing your inventory. Even if you carry a two month supply of $2 million dollars, then that means you have $4 million in inventory that will not be needed any time soon. In the meantime, you have to pay for that inventory and perhaps borrow to do that. You may have to forego an expansion you want to make simply because the cash is not available. That is what I mean by the expression excessive inventory can be a burden.

It Takes Time to Adjust

If you find yourself in the mess described above, don’t get discouraged. By being diligent and deliberate about reducing your inventory levels you can see a dramatic improvement in your cash position. Here are some steps to help you:

  1. Analyze inventory to determine how much supply you have by item
  2. See what your reorder times are
  3. Gradually target those items that have the biggest impact

In regards to number 3 I suggest you use the 80/20 rule as an aid. You will likely find that only around 20% of your inventory items represent approximately 80% of your inventory value. Yes, those percentages will vary but as a rule a fairly small number of items will be costing you the most cash.

Now that you understand that excessive inventory can be a burden, perhaps you will be encouraged to take a long hard look at how you manage inventory. Remember though, this is not a one-time event but an ongoing effort.

If you want to know more, contact AimCFO – Contact

As always, your comments are welcomed.

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