All accountants know, one way of improving your profitiability is controlling your inventory. Different profit levels are perceived on your income statement due to different ways your inventory is managed and sourced. Therefore, how much cash your business generates on a daily basis is dependent on a few factors including the way you manage your inventory. Sourcing and managing inventory properly will help you to increase profitability, as it results in a lower cost of goods sold. A decrease in cost of goods sold means an increase in gross profit. A bigger gross profit can translate into higher profits if all other accounts are equal.
Recognizing the signs of poor cashflow and poor inventory management usually go hand in hand, and this is how:
Calculate your inventory cashflow
Something you need to know is if your inventory will be able to meet the demands placed by your client. A simple calculation figures it all out: just examine this year’s inventory balance alongside last year’s inventory balance. If the balance has decreased, year on year, this represents cash inflow – i.e. you have exchanged inventory items for cash. If there is an increase, this indicates unsold items, and a cash outflow, both of which can lead to problems.
Understand your inventory turnover
Talking about simple calculations, it is so important and so easy to calculate your yearly inventory turnover, yet so many businesses forget to implement it! Inventory turnover is basically the time it takes for you to sell your entire inventory. Use the following calculation.
Inventory turnover = Cost of goods sold / (0.5 x Opening inventory + 0.5 x Closing inventory)
If the result is 5, for example, this means you completely sell out and replenish your inventory five times a year. This number will help you to recognise whether your stock levels are too high or too low so you can adjust accordingly.
Well, great, we have figured out how to recognise it, what’s next?
Have better flexibility with suppliers
Engaging in a mutually beneficial agreement with your suppliers creates not only a transparent and positive transaction that is able to be altered as both please. Aim to develop good relationships with your suppliers and to bring about a situation in which they are happy to work with you to provide the terms you need to get cashflow problems under control.
It may be necessary to renegotiate credit terms with your supplier, giving you more time to pay for any outstanding inventory bills you may have. This, in turn, provides you with additional breathing space when it comes to managing inventory cashflow. However, as mentioned, suppliers are business people too, with their own issues and their own bills to pay. As such, all negotiated terms must be mutually beneficial.
Re-evaluate your Inventory valuation method in terms of cost of goods sold
Most of you know that you don’t buy items at the same price, the buy price can inflate with a sudden surge in demand or can deflate with a fall in demand. That is why your inventory cost is recalculated every time you make an inventory purchase. To accomplish this, you would take the total cost of the items purchased divided by the number of items in stock.
Your choice of inventory valuation method determines the cost of goods sold which directly influences your cash flow statement.
There are the various method of inventory valuation FIFO, LIFO and Weighted average method. The choice among these methods can lead to a drastic difference in cost of goods sold, inventory value and net revenue. You should carefully adopt an inventory valuation method that fits the nature of your business, although this seems like an obvious thing most companies fail to adopt a method which fits the nature of their inventory operation.
At BUSINESSNAV, we could go on and on about inventory control for your business. We understand the importance of financial performance management and are expert accountants and financial advisors. We help you find where your cash flow problems are, help you overcome them and subsequently create sustainable growth for your business. Call us on 1300 BIZ NAV (249 628) or email us at firstname.lastname@example.org and talk to us about how we can help grow your business!