The relationship between inventory, sales, and cash
The relationship between inventory management and sales is important because you can only know what inventory you have – if you know what has been purchased and what has been sold – with the net effect being the impact on the cash flow. In order to track the profitability and cash flow, the business owner must make good decisions about key operations in the areas of re-ordering products, how much to purchase, where and when to purchase.
In business terms, inventory management means the right stock, at the right levels, at the right place, at the right time, and at the right cost and selling price.
Although services and physical products are different, the general rule is that 80% of the sales come from 20% of the products.
Controlling inventory is essential, especially during a time when consumer spending is low, as it can help save you a lot of money.
Sometimes business owners are tempted to buy larger quantities to make use of vendor discounts or free delivery offers but having excess stock does not always contribute positively to the bottom line!
Excess stock is problematic for a few reasons. It depletes cash-on-hand; the inventory stands on the shelves; if the sell-by date is reached or it is a seasonal product, you could risk losing money. A good example is the impact of Christmas merchandise not being sold before the 25th day of December!
Other factors to consider are that consumers expect large discounts – you may sell at a loss. The storage costs also need to be considered. Not stocking too many brands and confusing consumers regarding a specific product line (when the decision-making becomes too difficult, they may not buy at all). Balance all this with the impact of insurance and taxes – not an easy task!
A German study found that 63% of shoppers who cannot find what they are looking for, chose to buy the product from a competitor, or did not buy at all.
Another costly problem is losses due to- theft, paperwork errors, supplier fraud, damaged goods – it’s a double hit – you cannot recoup the cost of the inventory and you cannot sell the inventory! In some cases, it is possible to increase the price (and allow the customers to cover the shortfall) but this will depend on price sensitivity. It may be better to put longer term processes in place, for example, additional security measures, however, this will increase your overheads.
What you need to know
What are the effects of your inventory management?
Do you have the right products available when needed?
Did you lose out on business when products were out of stock
Did you present the consumer with too many choices?
Did you lose money due to excess inventory?
Accurate records are essential
You can use manual tools (good old Excel) or inventory management software or systems – helping you know when to re-order, how much to order and where to order. Most important, is the accuracy of your record-keeping!
If you are starting out, here are some key tips on how to have enough inventory, without compromising sales and cash flow.
Forecasting
Planning is crucial! Adjust the forecast based on seasonal trends and economic conditions. Analyse the data of your competitors or the industry, in general, to assist with the forecasts.
Product inventory
Identify the 20% of products that constitute 80% of your income. Analyse the sales of your business.
What are you purchasing and what are you selling?
Are you selling essential or luxury products? Within the analysis, you will have classes and sub-classes, and categories and sub-categories. Classify inventory according to a system, e.g., fresh produce, non-perishables, etc. and within those classes, identify:
What is not selling but just sitting on the shelf?
If you are in a tight corner financially, you could reduce or stop selling the other 80% of goods that do not move as fast. If it is difficult to make this decision do, consider the information you get from the following 4 eye-opening calculations:
1. Economic order quantity – The EOQ is the optimum number of products to be purchased to minimize the total cost of ordering and storage.
2. Day’s sales of inventory – This refers to the number of days it takes to sell the inventory. It differs from industry to industry, but generally, a lower number of days is ideal.
3. Re-order point – Do determine the right time to order more inventory.
4. Safety Inventory – The buffer to ensure that you have enough inventory to meet demand, but not too much to increase storage cost and to impact the cash flow.
In conclusion, you will have realised that balancing the inventory-to-sales ratio is a delicate operation, but it is essential as it has a direct impact on the cash flow (the lifeblood!) of the business.
By Gerty Green