How Much Inventory Do I Need?

Inventory is one of the biggest investments you will make in your business.  Your inventory turnover ratio tracks the number of times or cycles new inventory hits your shelves each year.  In addition, it measures the liquidity of your product and your ability to effectively manage your stock.  You can calculate your turnover ratio as follows:

Cost of Goods Sold                                        
(Beginning inventory + Ending Inventory)/2

What Does Inventory Turnover Mean? – Inventory turnover measures how well you manage your cash and product purchases.  Turnover ratios vary by industry.  A higher inventory number than your industry means that your product is in demand and that you have a better cash flow than your competitors. This gives you an edge over other businesses.  A lower than average inventory number can indicate a problem  This could mean that you have too much product on your shelves.  Slow inventory turnover can mean increased carrying costs for warehousing, insurance, and other holding costs.  Overstocking inventory can also have an adverse effect on your cash flow and create obsolete inventory.

How to Improve Your Inventory Turnover – Some strategies to improve your inventory turnover include the following:

  1. Increase Your Sales – Although this strategy sounds simple it can be more difficult than you think.  It assumes that you have customers already for the product in stock.  A good sales plan with clear set objectives, marketing plans, financial objectives and customer acquisition strategy will help you achieve this goal.
  2. Have a Sale – Sales can be a good way to generate cash and move inventory.  This can be a great strategy for low priced retail items and may make sense. For high priced items or luxury purchases be careful, you could be devaluing your brand.  Make sure to understand what types of sales would work best for your business.  Have a pricing strategy that is based on your marketing strategy.
  3. Just in Time Inventory System – A just in time inventory system is an inventory approach were you wait to order inventory until right before it is needed.  This method is effective, but requires a lot of knowledge and coordination with manufacturers and suppliers.  You must co-ordinate manufacturer and supplier lead times and transportation time to your facilities.  It requires a detailed inventory stocking and purchasing planning.
  4. Review Pricing from Your Suppliers – Negotiate discounts with your suppliers based on the amount you order.  These could be price discounts earned based on bulk orders or your ordering statistics for the year.  Sometimes it is possible to join associations for bulk discounts.  You can also take advantage of prepaid freight, early payment cash discounts, or negotiate extended payment terms.
  5. Check What Stock is Selling – Review your sales numbers and determine what inventory is selling and what is moving slowly.  Consider if you should order slow moving inventory at all.  Remember,  inventory on your shelves is only cash in the bank if you sell it. Why re-invest in a low producer.
  6. Get Rid of Obsolete Inventory – This strategy allows you to use your warehouse for products that are selling.
  7. Order Less – I have to admit that I like to watch “Shark Tank” on ABC.  The “Sharks” consistently ask entrepreneurs the same question “How many purchase orders do you have for your product?”  It is definitely a question you should be asking yourself.  Be a good steward of your cash and buy what makes sense for the sales you have or reasonably can anticipate.

Need more help determining what your inventory turnover should be?  Want to learn more about the key indicators for your industry? Contact me for more information on how a B2B CFO® can help.


photo credit: SurfaceWarriors 170726-N-BY095-0006 via photopin (license)

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