A Stock Pile equals a Money Pile

In order to maximise the working capital in your business, it often helps to minimise the length of time stock sits on your shelves.

A good start to managing the length of time that stock sits on the shelves is to measure it.  This measurement is known as ‘Inventory Days’

Inventory or Stock Days is calculated as follows:

Stock turn or Inventory Days is a calculation of the amount of time, on average, stock sits in your store i.e. from the day it arrives from your supplier to the day it leaves for your customer.

Calculation of Inventory Days = Inventory ÷COGS x Time Period
(COGS means Cost of Goods Sold)
(e.g. Inventory  = $150,000
COGS    = $400,000
Time Period   = 365 days
150,000/400,000x365 = 102

This example indicates that a business with COGS of $400,000 and Inventory of $150,000 is taking on average,  102 days to turnover it’s stock.  This means on average stock is sitting in store for 102 days.

To put it really simply if you think of stock sitting on the store room floor at your business premises as piles of $50 notes you can see the need to manage the situation and get it moving in and out of stock as quickly as possible.  Depending on the terms from your supplier and the sales cycle of your stock you may have to pay for the stock long before it moves out of your store- room.  So it’s important to ensure it sits there as little time as possible. 

We can show an example where a business with turnover of $3,500,000 and a stock level of $1,033,696, could put $237,000 back into the bank account just by reducing the Inventory days by 34.  This is a fairly big incentive to invest in managing stock at optimum levels i.e. enough to fulfill customer needs but not too much to cost unnecessary amounts of working capital.  Just by knowing this one number and managing it you could be putting thousands of dollars back into the bank and working capital for your business.

The more stock you hold the more inventory storage costs escalate and this doesn’t include the cost of the actual stock you’ve had to pay for, before you sell it.  Inventory storage costs include - handling costs, store-room rental, insurance, obsolescence/spoilage, fraud/stealing.

If a business is growing rapidly, it’s easy to get carried away and buy in lots of stock to meet the needs of customers, and that’s an important aspect of any stock management system, but it must be managed and systemised.  If stock purchasing is run by ‘gut feel’, it could be very costly to hold too much stock that’s not moving quickly enough.  One of the most important things to understand in any business dealing with stock is the supplier lead times and sales cycle.  If you can get this aspect right you are well on the way to healthy profits and cash-flow. 

Inventory Days is one of the most sensitive drivers affecting Working Capital.
Inventory Days is a number lenders look at when assessing a business loan.  If a business is holding more stock than necessary the bank would be asking “Why?”  Similarly they may look at the Benchmark on this number for the industry.  Benchmarks are a great basis upon which to manage stock.  Look at the top performers in your industry, find out what their Inventory Days number is and work towards it.  They may be turning over more than you now, but if you hope to compete and grow you need to emulate them and find out how they manage their stock levels. By knowing the Inventory Days, which is a relative number, they have given you a clue as to part of the strategy for profitability.

Inventory Management

The crux of good inventory management is to ensure you have enough stock to meet customer needs and buy stock in at just the right time from suppliers (bearing in mind supplier lead times) so as to not hold stock for too long.  This is known as ‘Just in Time’ stock management.

How does one predict the sales cycle of stock?  A good place to start is with historical information.  The more information you can accumulate on product sales the better armed you will be with knowledge to predict the future.  You need to know dollar sales value of not just stock in total, but a breakdown by product types and individual products.  Some may move quicker than others and you need to take this into account.  Seasonality also has a bearing obviously and you will be able to gauge this from historical information if you’ve had the benefit of some time in the business.

Once you have determined the above you can set a reorder point or minimum stock level.  This gives those in charge of stock something to work with and most good stock management systems can handle this and report when it’s time to reorder products.

Stocktaking

If you enjoy this you’re a masochist!  Unfortunately though, if you sell products it’s a necessary evil.  You need to regularly check stock levels, not only for tax purposes, but for knowing your business profitability.  You can do this by keeping a continuous record, also known as ‘Perpetual Stock Method’ or by regularly counting stock levels. 

There are literally thousands of Inventory Management systems available which should reduce the need for manual stock-takes.  It may seem like a pain and expensive to install one but the dividends far outweigh the cost.  Such systems will report on all aspects of stock management including stock searching, stock receiving, bar-coding, special pricing, sales orders, picking and packing, dispatch register, order fulfillment, product specs, manifests as well as reporting on stock usage and reordering requirements.

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