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How Does Inventory Management Affect Cash Flow?

Michelle Calkins
Posted by Michelle Calkins on Dec 5, 2023 10:51:06 AM

It takes having enough liquid cash flow to pay all expenses such as employee salaries and equipment maintenance to run a successful business. But how does a business owner ensure that they have the necessary cash flow?

Several factors impact positive or negative cash flow, including accounts payable and receivable, investments, and even market activity. One of the major factors when it comes to cash flow is that of inventory management. Inventory management and cash flow are very closely linked; you simply can’t have bad inventory management and good cash flow.

Let’s explore what exactly is meant by terms like “inventory management” and “cash flow” and the role that inventory management plays in profitable business operations.

Cash flow and Inventory Management Defined

Basically, the meaning of “cash flow” is the same whether it applies to personal or business finances; it simply refers to the amount of money made and how much is paid out. In the case of businesses, payments often reflect those made to creditors, vendors, payroll, and other expenses. If the difference between income and payments is positive, you’re successful; if there’s less cash than is needed to make all necessary payments, things are not good. 

In simplest terms, “inventory management” refers to the way in which product is ordered, stored, and tracked. Product needs to be accounted for whether it is stored in a warehouse or sitting on a retailer’s shelf. By keeping close tabs on product sales and storage, a business will know how much needs to be manufactured to meet sales demands. Should this tracking be off, more product might be produced and stored than is needed. This results in a surplus and thus extra expenses and not enough sales to make up for the production costs.

Components of Good Inventory Management

As you see, strong inventory management directly impacts cash flow. When you know exactly how much product you need to manufacture to meet customer demands, you’re not overspending in production and warehousing costs and are generally assured in selling what product you do make, thus avoiding excess product.

Since there are costs involved with storing product in a warehouse, having too much product that exceeds customer demands means that money is spent on holding on to that extra product. These costs are avoided when good inventory management maintains the right amount of product for sales purposes. Also, tying up too much cash in making product that will not sell will also eat into your cash flow.

Poor inventory management can also lead to the opposite problem: not enough product. Demand exceeds available product, so a company can lose money to competitors. Missed sales = loss of customers = decrease in cash flow.

Thus, the objectives of inventory management that will positively impact cash flow include: 

  • Having the ability to fill orders
  • Reducing losses
  • Understanding when to increase or decrease production based on demand
  • Maintaining minimum storage costs
  • Controlling investment in inventory
  • Analyzing sales patterns 

Good inventory management practices include maintaining a count of inventory; this can be achieved by audits of inventory to ensure that records of product sold and stored are accurate. Focus on those products that sell most consistently. The rule is that 80% of a company’s profits come from 20% of its inventory. So, develop an understanding of the sales lifecycle of bestselling products and track the sales of these items more closely.

Stick with a consistent method for receiving inventory. It is effective to implement a standardized process for accuracy and verification.

What Constitutes Poor Inventory Management?

Perhaps the biggest factor of poor inventory management is a failure to plan. Building a plan helps to create a solid vision and recognize and avoid possible pitfalls or failures that will harm a business’s success.

When it comes to inventory management, it’s of utmost importance to plan, plan, and plan. Study market trends and prepare for proper production windows (for instance, if you manufacture holiday items, be sure to plan to have that merchandise produced and in stores in advance of the holiday).  

Failing to consistently evaluate your product and keep it up to date to meet ongoing consumer demands and expectations is also indicative of poor inventory management that will lead to negative cash flow. If your product has yesterday’s technology or style, chances are good your warehouse will be loaded with that product while any competition that has kept up with the most recent advances will be selling hand over fist.

In short: keep up on marketplace trends to produce the right product for the right times.

If you’re using a vendor to stock and move your product, it’s crucial to monitor these vendors. Are they rotating product? Keeping proper sales records? Maintaining accurate inventory records?  

Inventory Turnover Ratio

Product that’s sitting unsold on warehouse or store shelves is not “turning over” and it is not increasing the company’s profits or attributing to cash flow.

Businesses want a high inventory turnover ratio: product is selling quickly, and demand is high. Low turnover reflects slow or weak sales and decreased demand.

To figure out inventory turnover ratio, simply divide net sales by the average inventory over a given period of time (typically one year). This ratio reflects how many times per year a company sells and replaces its stock. The higher the number, the better the sales, the bigger the profit margin and thus, increased cash flow.

It’s important to calculate inventory turnover for several reasons, one being that a business owner can determine operational efficiency as compared to similar businesses in the field.  

A main reason for using the inventory turnover ratio is to measure a business’s liquidity. A higher inventory turnover ratio equals higher liquidity: more cash on hand to pay expenses.

Investing in Inventory Software

When it comes to solid inventory management: there’s an app for that!

Automating your inventory management system is a practical, effective, and quick way to keep track of inventory levels, sales patterns, production costs, fulfillment processes, and product data—all in real-time!

Is anything perfect? Certainly not, and you might have misgivings about adopting the use of inventory management software for various reasons, such as the expense or maybe your possible lack of technical skills. However, the many benefits of inventory management software far outweigh any possible disadvantages, which might include the cost of such software, software crashes, or hacking risks.

From improving sales to saving in costs, there is a list of reasons why implementing inventory management software is a good idea when it comes to inventory control. For one, you will automate repetitive and boring manual tasks and allow staff to take on more challenging and engaging activities that could lead to better morale, higher productivity, and increased job satisfaction. 

Here’s some other major benefits of using this type of software: 

Avoidance of over-stocking and over-producing 

Assurance that the amount of available stock is sufficient to meet customer demand 

Increase of product visibility 

Use data to make better business decisions 

Expand sales and market trend forecasting capabilities 

Centralise stock information from multiple locations 

Decrease possible shortages in production time 

Check out this guide to the nine best inventory management software solutions to learn more about IMS.  

Topics: Inventory


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