How your inventory affects your cash flow
Want to know a crucial problem that small business owners often make? Mismanaging inventory! When stock management is done poorly, cash flow takes a knock. This can make a massive difference to turnover ratio and cashflow. So how can you ensure that your inventory doesn’t negatively affect your cash flow?
First, calculate your inventory turnover ratio
In a nutshell, inventory turnover refers to how often you sell and replace your stock over a certain time period. This differs between industries and merchandise. To calculate your businesses inventory turnover ratio, you need to look at Cost Of Good (COGS). COGS is divided by the average inventory for the same period. In other words: Cost of goods sold ÷ average inventory or sales ÷ inventory. COGS refers to a business’s cost to produce the service or goods. It can include various factors like materials, labour, factory overheads or any fixed costs used in the production of the goods. Average inventory is used in the ratio because a company may have lower or higher inventory levels depending on the time of the year. For example, over the Black Friday period, businesses will carry more inventory to cater to high demand whereas mid-year around sale time they may be looking to off load inventory.
Something important to hold in mind is that when you control your stock on hand effectively you will boost your cash flow. While holding inventory may not be negotiable, on the flip side if you have too much stock on hand your free cash will then be sitting in goods. This now means that this cash you can’t be invested elsewhere in your business. The other side of the coin is that if you don’t have enough stock on hand you will risk losing sales or create customer dissatisfaction. This in term will lead to more loss of cash flow. So what are some ways to increase turnover ratio?
Diversify your business to assist with turnover
Customers like having many options. By offering new services or products you can actually increase your turnover ratio. Think about when you walk into a store and constantly see the same product on the shelves. On a subliminal level you will understand that there is no rush to buy. Alternatively, by mixing up stock, services and merchandising, you will entice your customer to buy before someone else does.
Be clever with your basics range
Make sure you don’t over-spend, even on your bread and butter items. This may seem like a good idea at the time but in reality it is not a necessity and you will land up tying your cash up in places it doesn’t need to be.
The bottom line
If cash flow is air for business, inventory are the lungs. With proper stock management your inventory can really become your business’ greatest asset. This is not only a strategic consideration but a skill you need to acquire. By getting a handle on your inventory turnover ratio, you will be able to hold just enough stock to build your business, satisfy your customers and increase cash flow. Now who wouldn’t want to breathe that easy?