For most manufacturers, importers, wholesalers, distributors and retailers, their inventory, or their stock, will probably be their biggest working capital investment.  Not enough stock is a frustration for your sales staff, while too much stock will send you broke!

Each business will have its own methodology for working out a level of stock that it would like to have, to satisfy its target market. 

Which stock items are performing?

A useful hint is to use the functionality within your existing accounting package to ‘group’ your stock lines.  This provides more practical information for decision-making.  Most accounting packages will have an option to group your stock into common categories E.g. a furniture retailer may group stock by usage – dining settings, lounge settings, bedroom settings, etc.

Once part of a group, information on an individual stock line - like margins and stock-turn - is more meaningfully compared to like items.  Individual non-performers can be weeded out from the group, thereby improving the average performance of the group.  

Talk to your bookkeeper or accountant about doing this in your business.

How much stock can you afford?

You can calculate a level of stock the business can afford, within its current cash flow constraints.

Implicit to this system is the financial relationship between sales and stock. 

Imagine a business that held two months worth of stock at any point in time. Its sales were even over the year and it made a 40% gross margin.  At any point in time, the business would be holding (2/12)*60% or about 10% of its sales value in stock.

If that business wanted to grow its sales, it would follow that 10% of that increase in sales would need to go to increased stock.

Perhaps this amount could be supported out of profits?  If the business’s after-tax profit margin were less than 10%, the business would have to turn elsewhere to fund that growth. A source of funds could be its’ suppliers for an increase in Creditors (or Accounts Payable) or maybe borrowings from the bank. Or perhaps more money from the owner is required?

It could be easy to see how growing businesses need to be careful to fund their growth plans.

The important consideration is, if stock is in excess of that needed to meet customers’ expectations - you have an opportunity to unlock cash flow from the business.

If stock is less than needed, use sales growth as a marker for what cash flow structure the business will be faced with - including increased stock.

Forward plan stock levels 

Users of BusinessNAV’s CashflowNAV management system forward-plan stock levels and funding needs, and monitor working capital performance relative to sales growth.  This provides financial indicators of when to act on stock levels and other cash flow drivers in the business.