At the risk of spoiling the big ending, if inventory represents a significant portion of your company’s operating costs, the answer is “yes”. If you’re a wholesaler, distributor, or retailer then the answer is almost certainly “yes”.
There are PhD candidates in business schools all over the globe who are studying better ways to manage inventory. Why? Because higher than necessary inventory levels cost you money. Yes, I know you know that already, but let’s dive a little deeper.
The Balancing Act
If your inventory levels are too low, you will miss opportunities for sales. Not just an immediate sale, but future sales. Remember you’ve just sent your customer to your competitor to satisfy their need.
If your inventory levels are too high, your company is financing the purchase and holding of non-productive goods, i.e., goods that are not making money. Cash that could be put toward a productive activity is not available. In other words, excess inventory creates a significant opportunity cost.
Sometimes it means extra costs to store, manage, and insure these non-productive assets. You’re also increasing the risk of loss through damage, theft or obsolescence.
High inventory can also impact your liquidity. If your products cannot be sold quickly without heavy discounting, it can impact your company is several ways:
1. It can actually impact your ability to pay your bills. Your vendors are not going to accept excess inventory as payment – just like you, they want cash for their products or services.
2. If you ever need a loan, banks and other lenders could look at excessive inventory as an indication of weak sales and low liquidity.
3. If you ever decided to sell your company, excessive inventory will reduce the value of entity for the same reasons that the banks will be more hesitant to provide a loan.
Excess inventory is clearly not a good thing. So let’s talk about steps that you can take to deal with that. I’ll get into more detail in future blogs but for now, let’s talk about the need for an inventory system.
It Starts with Tracking
How can you manage something that you can’t measure (or don’t measure)? To state the obvious, you can’t tell if you’re carrying excessive goods, or if you’re running the risk of a stockout if you don’t know how much inventory you actually have.
How can you tell if you’re a victim of theft if you can’t say for sure what you started with?
How do you know when to place an order unless you tell what you have on hand, and how quickly it’s being sold?
Yes, you can go out once a year and count inventory to make the tax man happy, but that doesn’t help you to run your business more effectively.
Make the Connection
As I said previously, if you’re a wholesaler, distributor, or retailer, then you should be tying your Point of Sale system to an inventory management system. You make your money from that inventory. Your inventory should be disappearing because of sales – not for any other reason. If inventory tracking is tied to point of sale, you can make sure that this is the case. If it’s not the case you can take steps to deal with it.
If you’re inventory is consistently too high, you need to fix that. You can adjust the timing and quantity of future purchases if you can tie inventory levels and inventory movement to your sales in real time.
In the next post, we’re going to do a “deep dive” on some inventory management basics. We’ll introduce such ideas as Min, Max, Lead Time, and MOQ. We’ll also look at some of the key performance indicators associated with inventory management such as Average Days to Sell Inventory, Inventory Turnover, Average Inventory, and of course, Inventory Holding Costs.