This is part 6 of Ravit Insights series on the 7 Cash Flow Drivers essential for SMEs.
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In the lead up to summer, Tom, the owner of a beach side gelato store, knows he needs to increase his supplies of cones, cups and gelato to cover the seasonal rush.
The inventory is an upfront cost but will easily be covered by his forecast sales over the warmer period. Tom just needs to ensure he can afford the upfront costs.
For a business like Tom’s knowing when and how to purchase inventory, particularly if he gets a discount for a bulk purchase, can make a huge difference to his margins.
When to buy inventory, how long you hold it, and when it is sold is another critical cash flow driver for a business – your cash is tied up in that inventory.
Cash flow negative: The longer you hold inventory, the worse your cash flow.
What is inventory?
For a product driven business, like Tom’s, inventory is how much stock you have on hand or ready to be converted to sell.
For a service business, this is your work in progress. Also applicable to companies who sell stock, as some component is the manufacturing.
For both businesses, as sales change, so too does the required investment in stock or work.
You may need to look at things like seasonality in terms of keeping your inventory up to date, and hiring staff to cover peak times without losing capital in the slower periods.
There are several ways to manage inventory to improve cash flow.
Knowing how to manage your inventory is important. Inventory will generate cash flow, but purchasing it requires cash outlay.
Your balance sheet will show negative amount in the cash flow statement for the stock you have on hand or positive if that inventory is sold.
The key will be holding the right amount of inventory on hand for your sales projections to meet demand. Holding more inventory than you need may unnecessarily tie up cash flow, while not enough will reduce your revenue.
High turnover of inventory is a key sign a business is doing well.
Challenges of poor inventory control
Hit to sales
If a company doesn’t have enough inventory in stock, or enough staff to take on new work, they will suffer reduced sales. This could push potential customers to competitors.
If customers are finding items or services they want are consistently out of stock or booked out, they’ll likely stop coming to your business, and worse, could leave a negative review or bad word of mouth.
The other end of potential poor inventory control is if there is excess stock not being turned over. This means your cash flow is tied up sitting on a shelf. This is such a big issue. Wine distributor VinoMofo started a high growth company based on helping wineries turn over stock at a discounted rate.
Check out the other cash flow drivers all business owners should understand.