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Inventory and Cash Flow

How you handle inventory can have a major effect on your cash flow.
June 16, 2003
URL: http://www.entrepreneur.com/article/21846

Cash flow problems are some of the most common difficulties small businesses encounter, and they are usually the first signs of serious financial trouble ahead. Tying money up in inventory can severely damage a small company's cash flow.

To control inventory effectively, prioritize your inventory needs. It might seem at first glance that the most expensive items in your inventory should receive the most attention. But in reality, less expensive items with higher turnover ratios have a greater effect on your business than more costly items. If you focus only on the high dollar-value items, you run the risk of running out of the lower-priced products that actually contribute more to your bottom line.

Divide materials into groups A, B and C depending on the dollar impact they have on the company (not their actual price). You can then stock more of the vital A items while keeping the B and C items at more manageable levels. This is known as the ABC approach.

Often, as much as 80 percent of a company's revenues come from only 20 percent of the products. Companies that respect this "80-20 rule" concentrate their efforts on that key 20 percent of items. "It's a major mistake to try to manage all products the same way," says Kay Roscoe Davis, a professor of production management.

Once you understand which items are most important, you'll be able to balance needs with costs, carrying only as much as you need of a given item. It's also a good idea to lower your inventory holding levels, keeping smaller quantities of an item in inventory for a short time rather than keeping large amounts for a long time. Consider ordering fewer items, but doing so more often.

Excerpted from Start Your Own Business: The Only Start-Up Book You'll Ever Need, by Rieva Lesonsky and the Staff of Entrepreneur Magazine, © 1998 Entrepreneur Press