BBO Consulting

Improving your Cash Flow: Optimizing Inventory

In my previous blog I briefly outlined ways for businesses to improve cash flow. This article is going to focus more specifically on improving cash flow by optimizing inventory (or stock).

I have to admit that I love inventory – for most wholesale and retail companies it is the physical manifestation of what your business is built upon and is something you can see and touch. I have always enjoyed getting to understand my clients’ business by getting to understand what products they sell.

However, many businesses struggle with managing their inventory efficiently and end up with excess or obsolete inventory that ties up their cash and reduces their margins.

In this article, I will share some tips on how to improve your stock days and cash flow by identifying opportunities for fast-moving or long-lead-time stock, liquidating aged stock, learning from poor buying decisions and marking down slow-moving stock.

Data is your key to unlocking the full value of your inventory.

The first step that is needed is to access your inventory, sales and gross profit data – ideally at a product or SKU (stock keeping unit – the barcode retailers scan) level. Ideally you will need the following data for the last 12 months at a minimum:

  • Sales
  • Cost of sales
  • Gross Profit (Sales less cost of sales)
  • Opening and closing inventory value
  • Aging of each inventory item

In my experience the most useful tool to use in analyzing your inventory is to use a method known as Gross Margin Return on Inventory Investment (GMROII). This takes the gross profit % (also known as gross margin %) and multiplies this by your inventory stock turn rate (cost of sales for a year multiplied by average inventory for the year).

The inventory or stock turn measures how many times you will sell your inventory in a year. The higher this measure, the better – especially from a cash flow perspective – as it means your inventory will not stay on your shelves or warehouse for that long. Conversely, the lower the measure, the longer it will take to sell.

Once this is done you can rank your inventory items to help make more rational, data-based inventory decisions. Obviously, this method does not take into account real-world problems, but it is a useful tool to rank items and for you to then identify what actions need to take place.

I will illustrate the process I take using the example below:

Identify fast-moving or highly profitable inventory and invest in these items.

Using the data above it is clear that Item C is the most profitable item. I would discuss with my sales and product teams whether there is any potential for increased sales (the market might be saturated). If the team believes this product could grow, rather invest more money into purchasing this item.

The fastest moving item is Item D (based on the average inventory it will sell-out 5 times this year). However, the GP% is very low. This item might not be worthwhile trying to grow sales as it is the 4th ranked product.

By investing more in fast-moving or highly profitable inventory you can potentially:

 

Meet the high demand of fast-moving stock and avoid stock-outs, thus increasing sales.

Increase your profitability by selling more highly profitable items.

Negotiating better terms or discounts with your suppliers for fast-moving stock.

Improve your stock turn and therefore generate more cash flow.

 

Liquidate slow-moving, aged or loss-making inventory items.

One of the easiest ways to improve your stock days and cash flow is to get rid of your slow-moving, aged stock or low profitable inventory items.

Aged stock is usually harder to sell, takes up valuable space, and incurs higher storage and handling costs. It can become obsolete or damaged over time, which reduces its value and increases the risk of write-offs. Slow moving stock will end up becoming aged stock, so it is important to be proactive at reducing prices and/or stimulating sales of these products.

It goes without saying that by getting rid of loss-making products your profitability will improve, and the cash lost on these items will also improve.

Going back to the example it is clear that Item E is both unprofitable (Negative 10% GP) and has the worst stock turn (0.4 times per year). It would be better to clear out this inventory item, convert to cash, and stop purchasing it going forward.

Again, this is purely based on an objective basis – there might very well be a reason for stocking this item (such as it being a necessary product to sell Item A for example), but it is worthwhile to ask the necessary questions to interrogate the need to continue stocking it.

To liquidate this stock, you need to be aggressive and proactive in reducing the price and promoting it to your customers. You can use various strategies, such as:

  • Offering discounts or free shipping.
  • Creating bundles or packages that include aged stock and other products.
  • Advertising aged stock on your website, social media, or email newsletters.
  • Selling aged stock to clearance outlets, liquidators, or online platforms.

 

By liquidating your slow-moving, aged or loss-making inventory items, you can free up cash, improve your stock turnover, and make room for new and more profitable products.

Learn from Poor Buying Decisions

Another final way to improve your stock days and cash flow is to learn from any poor buying decisions and to avoid repeating them in the future. Poor buying decisions are the ones that result in excess or unsuitable stock that does not meet the demand or preferences of your customers. Some of the common causes of poor buying decisions are:

  • Overestimating or underestimating the market demand for certain products.

  • Buying too much or too little stock at a time.

  • Buying the wrong types, sizes, colors, or brands of products for your target market.

  • Buying products that are out of season, out of fashion, or out of date.

  • Buying products that have low quality, high defect rates, or short shelf lives.

To learn from your poor buying decisions, you need to keep track of the lessons learnt and apply them to your future buying decisions. You can use various tools, such as:

  • Inventory reports that show the sales, margins, and stock turnover by product.

  • Customer feedback from your customers.

  • Market research providing insights into trends of potential customers.

  • Competitor analysis that benchmarks your products against your rivals.

  • Supplier evaluations assessing performance, reliability, and quality of your suppliers.

  • Seasonal or monthly reviews of products and sales with your sales and product teams.

The key in this process is to learn from mistakes made, and ensure preventable errors are not repeated. It is not necessarily a finger pointing exercise, but rather a learning process that can be inculcated throughout your business.

Conclusion

Improving your stock days and cash flow is a key goal for any business that deals with inventory. By following the tips above, you can liquidate your aged stock, learn from your poor buying decisions, and invest in the more profitable product items. By doing so, you can improve your stock management, increase your sales and margins, and enhance your cash flow and profitability.

Optimizing inventory needs to be an ongoing process, and needs to be driven from the top down. BBO Consulting would love to help you optimize your inventory processes and improve your cash flow.

If you want to improve your cash flow through inventory optimization, please email me at kevin@bboconsulting.co.za.