Inventory is generally defined as the raw materials a business has available to manufacture finished goods or merchandise available to sell to customers. Too much inventory uses cash ineffectively, while too little inventory holds up production in a manufacturing environment or gives customers a reason to shop with the competition. Additionally, having the wrong inventory uses resources without providing a profit opportunity. Inventory management is the art of knowing what to carry, when to buy it, who to buy from, where to keep it, and how much to spend on it to achieve profits.
Accountants typically recognize inventory control issues because they notice financial trends that concern them. For example:
- The inventory may be increasing with no corresponding increase in revenues, leaving less operating cash.
- Cost of goods sold may be increasing in relation to total sales, squeezing the profits in the business.
- Write offs of obsolete inventory may be increasing, causing both profits and cash to decrease.
- Revenues may be decreasing, showing customers are not interested in purchasing the merchandise your business has for sale.
- Inventories of raw materials, work in process, and finished goods may be out of balance in a manufacturing environment, showing the flow of inventory is not as effective as it could be.
Having the right amount of the right inventory takes planning. First, develop a forecast:
- What inventory is needed for each cycle of business over the next year?
- What is the customer demand for each product you offer?
- How long does it take suppliers to deliver raw materials once they are ordered?
- Are there any discounts available for purchasing in larger quantities of raw materials?
- Do you have storage space available to maintain inventory until it’s used or sold if it’s ordered in larger quantities?
- Do you have the cash flow to purchase inventory in advance?
Research industry trends and talk to customers to forecast future demand. Talk to at least three suppliers to get the best terms on purchasing products. Establish an inventory control system that provides the information needed to make business decisions.
Inventory management is also about tracking the flow of inventory in and out of your business. Many inventory management tools exist to assist with knowing what you have in stock, what each unit cost, how long it was on your shelf, and what each product sold for. Your accountant can be helpful in choosing the tool that will work best for your business needs.
Good inventory management helps improve cash flow, customer loyalty, and business profits.
Have a question about your small business? You can reach Arlene at firstname.lastname@example.org or leave it in the comments here!
[ Down to Business is a weekly small business advice column featured in The World Newspaper, originally published online by the Oregon Small Business Development Center Network, and republished here with permission. ]