How to: Manage Inventory

This story appears in the August 1998 issue of Startups. Subscribe »

Ruth Kelsey's method of tracking inventory for her gift basket business, Brittany's Balloons and Gifts, used to be informal--to say the least. "I was going by sight," recalls the Lithonia, Georgia, entrepreneur. "Basically, I stored everything in my den and garage, and every so often I would count it all."

As Kelsey's business grew and expanded to include party decorations, her inventory system became inadequate. "I would think I had 20 baskets left, then I'd go to fill several orders and find I had only 14," she says. "That would put me in a pinch, especially in my busy seasons." Kelsey is in the process of computerizing her inventory, which she expects to give her a more accurate method of tracking.

Inventory can make up 50 percent or more of a business's current assets, and poor inventory tracking is a major factor in business failure. "You want to make the best use of your capital," says Bruce Cohen, managing partner of the Albany, New York, office of accounting firm Coopers & Lybrand LLP.

"How can you manage your business unless you know how much inventory you have, what it cost and where it is? You're guessing," Cohen says. "I've seen a number of companies that guessed wrong over the years--and they're out of business."

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Jan Norman is a freelance writer who specializes in small-business issues. She can be reached at jnsmallbiz@aol.com

Buying Guide

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."

Know It All

The potential for getting stuck with unreturnable inventory is one reason business owners need to monitor what is and isn't selling. Schreibfeder recommends tracking each item separately. You need to know not just that you're selling 20 blouses per week, but how many blue ones and how many red ones.

Inventory management is his company's biggest problem, says Julius Howell Sr., owner of Deep Reflection Products Inc., a Goldsboro, North Carolina, company that makes and sells specialty cleaning products for the automotive, marine, recreational vehicle and janitorial industries. Deep Reflection must track ingredients and production supplies as well as the finished products it sells.

Howell used to do inventory by hand. "It didn't work well," he says. Now he uses a commercial software package that recalculates costs and markups in four different customer categories every time he reorders supplies. The software won't allow him to write an invoice for an order if that order will deplete his finished inventory below a specified amount.

Although Deep Reflections uses a sophisticated software program to accommodate different types of customers, many small companies can manage their inventory effectively with inexpensive software programs such as Peachtree Accounting (Peachtree Software Inc., $69 to $249, http://www.peachtree.com) and QuickBooks (Intuit Inc., $99.95 to $199.95, < ahref=http://www.intuit.com/quickbooks/>http://www.intuit.com/quickbooks/).

Fire & Spice Inc., a Destin, Florida, seller of hot sauces and gourmet condiments, uses QuickBooks, says Ann Reaves, co-owner with her husband, Bill. The company sells its own products, made by a contract manufacturer in Louisiana, as well as products from other food manufacturers. QuickBooks lets the entrepreneurs keep track of each item by company. The Reaveses are able to set the reorder point for each item separately, which is helpful because some items sell faster than others.

Even the smallest companies can use technology to help manage inventory, says Cohen at Coopers & Lybrand. Most products now come with computer bar codes, so distributors and retailers can scan in each item and track them all with a personal computer. "There are many software products on the market now for small companies," Cohen says. "Look for general accounting packages with integrated modules for inventory. They tell you sales information, who your customers are and what they're buying, and they tie in to invoicing."

All Systems Go

Computers alone don't solve inventory problems, Schreibfeder cautions. "Computers are merely tools. They must be used in the proper business environment in order to work effectively," he says. To create that proper environment:

• First, establish a complete list of every product or component your company buys.

• Assign a specific location in your warehouse or storage area for each item.

• Process paperwork quickly--daily, if possible.

Make sure stock balances are always accurate. Schreibfeder says "cycle counting" is better than a once-a-year physical inventory. Cycle counting is an ongoing inventory. You can start at one end of the warehouse and count all the items on one shelf or in one bin each day until you reach the other end. Or you can count all of a specific product, then work your way through your entire inventory. Either method usually adds up to a full inventory several times a year.

• Set up procedures for reordering to help inventory turn over faster and prevent running out of any item.

• Establish inventory goals and compare them each month with actual results.

• Determine how to handle unsold products, whether by returning them to the vendor, discounting the price, donating them to charity or throwing them away and writing them off the financial sheet.

"Many business owners load up with inventory without understanding what is and isn't going to sell," Schreibfeder says. "They let their vendors tell them what to buy." You need to recognize that vendors, while not dishonest, have different objectives than you do.

As a new business owner, Schreibfeder says, you must rely on careful research to determine how much inventory to buy initially. Once your business is up and running, let a well-thought-out inventory management program guide your purchases.

Contact Sources

Brittany's Balloons and Gifts, 4992 Herrenhut Ct., Lithonia, GA 30038-2783, (770) 593-3458

Coopers & Lybrand LLP, http://www.colybrand.com

Deep Reflection Products Inc., (800) 766-3856

Effective Inventory Management Inc., (972) 304-3325, http://www.effectiveinventory.com

Fire & Spice Inc., 757 Hwy. 98 E., #14-246, Destin, FL 32541, http://www.fire-spice.com