Recently I have been working with a few companies in a variety of industries all of whom have inventory issues. The biggest issue is that most of the business owners didn’t realize how big their issues were until we started measuring the impact on their bottom lines. It’s always an eye opener.
There are two very broad categories of issues when one is talking about inventory. The first is the actual cost of maintaining and managing inventory. The 2nd is the impact that poor inventory control has on customer service and future sales. All kinds of organizations have inventory including, but certainly not limited to; manufacturers & assemblers of hard and soft goods, distributors, dealerships, medical & healthcare organizations, restaurants & food services, retail organizations, customer service providers, non-profit organizations, etc. This article is way too short to go into much detail about either type of cost so let me hit the high points in the next few paragraphs.
Inventory often represents one of the biggest items on a company’s balance sheet. The amount of inventory on hand represents working capital that is tied up and that can’t be used for any other purpose. In that regard it is like accounts receivable. The trick is to have just enough but not too much on hand.
Not only does inventory represent working capital that cannot be readily converted to cash but there is also a significant expense related to it that is over and above the actual cost of the inventory itself. That is the financing cost of inventory. In other words, in order to be able to keep inventory on the books, a company has to borrow the cost of the inventory from somewhere. That “somewhere” could be in the form of a loan from an outside source such as a working capital line of credit or, if a company is cash rich and is able to pay cash for its inventory, then there is an opportunity cost associated with the inventory. That is to say, if the money wasn’t tied up in inventory it could have been invested in something else that would yield a return. That is the opportunity cost; income you might have realized but couldn’t because your cash was tied up in inventory. Of course you need inventory for your business but too much of it is a drag on profits.
There are other significant costs associated with inventory including, but not limited to; loss from spoilage and/or pilferage, the cost of storage / warehousing, the cost of labor to manage it (and the additional cost of labor if it is hard to find items), the cost of overstocking and not knowing what the optimal level of inventory is for each item, the cost of running out of inventory, the cost of not being able to easily track down lot and/or serial numbers when necessary, the cost of not getting the best possible prices from your suppliers because you can’t get your hands on historical purchasing data for specific items with which to negotiate, etc. Often a company doesn’t know what these costs are because it doesn’t have a true inventory control system in place. But, rest assured, these costs are real whether you have the ability to measure them or not.
The second major category of cost associated with inventory control is that of customer service. And, this may be the biggest cost of all. Orders that can’t be fulfilled and invoiced quickly, efficiently and, correctly can result in a bad customer experience and that can adversely affect word of mouth advertising and future sales.
Taken together, all these costs have a definite and adverse impact on the profitability and value of a company. If the cost of; purchasing, storing, retrieving, assembling, packaging and shipping items is higher than it should be and, if customer service is not perceived by your customers as top notch, then the profitability and value of your company will be depressed. So, the point is, the more “in control” your inventory is, the greater your profitability and company valuation.
So, what can be done to help your organization? There are two key things that will give you a fast return on investment and a solid platform for future growth. First, find someone who has expertise with your accounting system and with inventory control programs. S/he will be able to help you identify and configure an optimal solution that will: a) reduce the cost of inventory, b) improve profit margins, c) increase cash flow and, d) maximize valuation. By the way, there are some great solutions available for even very small companies.
The second thing is to work with the consultant to determine which program will best satisfy the unique needs of your company. Then invest in the program, upgrade your IT infrastructure if necessary and, invest in the effort required to get the program up and running in a single effort. Do it all at once. Don’t try to do part of the project today, then some next quarter, etc. Starting and stopping a project in that way is always more expensive because some very time consuming tasks need to be repeated each time the project is re-started in order to catch up with changes in the business.
These two suggestions will improve your profit margins, make your company more competitive and will enable your business to grow profitably. And, wouldn’t that make you happy? A B2B CFO® partner can help you make that change.
About the Author
Mr. Casebere is a partner with the firm B2B CFO®, a national association of highly skilled Chief Financial Officers who provide part-time assistance to small and mid-market companies. Mr. Casebere has over 30 years of experience in corporate finance helping companies of all sizes achieve their goals. He is an expert at helping business owners increase their profit margins while improving cash flow and maximizing company value. He holds an MBA, is a Certified International Credit Professional and Project Management Professional. You can contact him at: firstname.lastname@example.org .