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How Much Inventory Does Your Company Need?

How Much Inventory Does Your Company Need?
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Q: What's the right level of inventory for my business?

A: In my book, there's only one right answer to this question: You always want enough stock on hand so that customers can buy whatever they want, whenever they want. If you're sold out, then you're turning away people who are primed to buy--and that's worse than having no customers at all. Compounding this situation is the fact that "sold out" switches your company into crisis mode, in which you're likely to pay a premium to vendors for a quick turnaround of new inventory, on top of vastly more expensive airfreight charges.

Follow the Numbers
Tracking inventory on a regular basis does more than help you zero in on the ideal number of goods, parts and supplies to maintain--it can also uncover theft and fraud. Dishonest bookkeepers have been known to hide embezzlements in rarely audited inventory numbers. And thanks to a count I conducted at an A/V installation shop, I caught an employee who was stealing equipment--including a $75,000 TV--and selling it on his own.

But I suspect the root of your question has to do with having too much inventory. The first step to finding an answer is to count what you have every quarter. As a consultant, it's the first thing I tell my clients to do. Yes, it's a pain. Yes, it sucks up manpower. Yes, there's no revenue behind it. But it must be done.

If you don't, you may end up like the head of an electronics manufacturer who bought his materials in bulk at a discount. For 25 years, he'd never tabulated this stockpile. When I finally got him to go through the counting process, he was horrified to find that he had enough parts on hand to last 365 days, an eternity in the circuit-board industry. Worse, he was paying $50,000 a year in unnecessary warehousing and tax costs. Needless to say, he stopped buying in bulk.

Every industry is going to have different inventory standards. Retailers may want a 30- to 60-day inventory. Food-related businesses will want to turn theirs over in a matter of days, while wine- and spirits-makers may hold inventory for decades. To determine what's right for your category, contact a trade association to find out the industry standard. Then try to do better than that standard by keeping a little less inventory on hand. Don't overdo it, though: Strive for a 3 to 5 percent reduction. Doing so should make you more profitable than the competition, since you're shrinking the time between buying product and moving it out the door, which frees up cash flow.

There's a flip side to the question: when having a lot of inventory can be a competitive advantage. I work with a company that started as a wholesaler of acupuncture needles but expanded to carry 15,000 SKUs related to Eastern medicine. This distributor soon became known as the go-to resource for everything needed to run a practice. The inventory became a strategic benefit that has helped ensure the company's ongoing success.

Depending on your business, you can track inventory in real time, scanning it into a database as it comes in the door and when it leaves with a customer, or doing so manually. Whichever route you take, just make sure you count what comes in and goes out. You'll have no idea if you're profitable without knowing what you have.

CFO Consultants founder Mike Sowinski has managed financial operations for SMBs and Fortune 500 companies.

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This article was originally published in the May 2013 print edition of Entrepreneur with the headline: Get Down For the Count.

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