The goal of inventory management is to keep you informed about the quantity of each product or component in stock. This information is your guide to what, when and how much to buy.
If you have too much inventory, you tie up cash in products--money that could be better used for running your business. Unsold inventory costs a company in several ways, Cohen says. You pay for space to store your products; large amounts of inventory are more susceptible to theft; and some states tax inventory separately, so companies with large amounts of inventory pay higher taxes.
Too little inventory can be as big a problem as too much. If you don't have enough of an item on hand, you lose sales because you can't fill orders promptly.
How do you know if you have inventory problems? Cohen lists these danger signs:
- Inventories are climbing faster than sales.
- Back orders are piling up.
- Customers complain that products are unavailable.
- Production is interrupted because of lack of materials.
- Inventory turnover rates are slower than you expected.
How quickly you turn over inventory is an important measure of your business success, says Jon Schreibfeder, president of Effective Inventory Management Inc., a Coppell, Texas, consulting and seminar firm. Turnover measures how long it takes to sell a certain amount of product. "Distributors, retailers and manufacturers who have 20-percent to 30-percent gross profit margins should strive to have a turnover rate of five or six times a year," Schreibfeder says.
Your company can increase its turnover by placing smaller orders. If you sell $10,000 worth of a product in one year, you'd make better use of limited capital by ordering $2,500 worth of the product four times a year rather than tying up the entire $10,000 in inventory for the whole year.
"Even if you've budgeted for losing money at first, you need to generate cash to pay bills," Schreibfeder says. "In order to generate cash, you must sell the material you've bought as quickly as possible."
Another tip: "Special-order only the number of items your customer will commit to buying," Schreibfeder says. "If you don't negotiate a good return policy [with the supplier] and you can't sell all the merchandise, that's money down the drain."