Your business's basic stock should provide a reasonable range of products for customers and should be big enough to cover the normal sales of your business.
This guide to inventory management will help you track your inventory more effectively and improve your cash flow and financial management practices.
If you’re starting a products business, inventory control will be an essential part of your effective financial management system. If you are going to be manufacturing, you will have to track raw materials, work-in-process and finished goods. Separate sub-ledgers should be established for each of these inventory categories.
Even if you are a wholesaler or retailer, you will be selling many different types of inventory and will need an effective system to track each inventory item you sell.
From a management standpoint, tracking inventory is also important. An effective and up-to-date inventory-control system will provide you with the following critical information:
- Which items sell well, and which items are slow moving
- When to order more raw materials or more items
- Where in the warehouse the inventory is stored when it comes time to ship it
- Number of days in the production process for each item
- The typical order of key customers
- Minimum inventory level needed to meet daily orders
Too little or too much?
Insufficient inventory leaves your business unable to meet customer demands. It means lost sales and costly, time-consuming back orders. If you run out of raw materials for your production process, it leads to increased operating costs too. Your staff will have no work to do, and they’ll have to be paid overtime to make up for lost production time.
Avoiding excess inventory is especially important for owners of businesses with seasonal product lines, such as clothing, shoes, home accessories or holiday gifts. These products have a short shelf life and are hard to sell once they are no longer in fashion. If you sell products such as hardware, office supplies or auto products, you’ll have more flexibility because it takes longer for these items to become outdated.
It’s important to ensure that your physical inventory tells the same story as the number on the business’s balance sheet. Proper inventory controls will highlight what sells well and what doesn’t, and will help put an end to poor purchasing too.
It will also help to monitor and address customer pilferage and employee theft. Using electronic data interchange (EDI) and barcode scanning can help eliminate data entry errors. It’s a good idea to choose a few items a day and compare the inventory record to the actual count. Top sellers should get counted more often.
Tracking material costs
Another key reason to track inventory very closely is the direct relationship to cost of goods sold. Since nearly all businesses that stock inventory are required to use the accrual method for accounting, good inventory records are essential for accurately tracking the material cost associated with each item sold.
Inventory and cash flow management
Tying money up in inventory can severely damage a small company's cash flow. To control inventory effectively, you need to prioritise your inventory needs.
You may think that the most expensive items in your inventory should receive the most attention. In reality, however, cheaper items with higher turnover ratios have a greater effect on your business than more expensive items. Don’t run the risk of running out of the lower-priced products that actually contribute more to your bottom line by focusing high-cost items.
Often, as much as 80% of a business’s revenues come from only 20% of the products, so do not try to manage all products the same way. Spend most of your effort on those "A" items, forecasting, reviewing in-stock position and reordering more frequently. The next highest-selling 30% of items, the "B" items, will typically generate about 10% of sales. The slowest selling "C" items account for half the items you stock, but only generate 10% of your sales.
Once you understand which items are most important, you'll be able to balance needs with costs, carrying only as much as you need of certain items. It's also a good idea to lower your inventory holding levels, keeping smaller quantities of an item in inventory for a short time rather than keeping large amounts for a long time. That can be achieved by ordering fewer items, but doing so more often.
Reducing cycle times
Cycle time reduction is one of the most important elements of successful manufacturing. More and more customers are demanding that manufacturers quickly respond to their wants and needs, and companies are therefore focusing more attention on their order-to-delivery cycle time.
Order-to-delivery cycle time reduction is often a good place to improve operations because long cycle times cause high inventories, higher cost, and poor customer service. Streamlining internal and external supply operations can reduce your overall order-to-cash cycle time and balance your inventory needs.