Subscribe to Entrepreneur for $5
Subscribe

Inventory and Cash Flow

How you handle inventory can have a major effect on your cash flow.

Opinions expressed by Entrepreneur contributors are their own.

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

To control inventory effectively, prioritize your inventoryneeds. It might seem at first glance that the most expensive itemsin your inventory should receive the most attention. But inreality, less expensive items with higher turnover ratios have agreater effect on your business than more costly items. If youfocus only on the high dollar-value items, you run the risk ofrunning out of the lower-priced products that actually contributemore to your bottom line.

Divide materials into groups A, B and C depending on the dollarimpact they have on the company (not their actual price). You canthen stock more of the vital A items while keeping the B and Citems at more manageable levels. This is known as the ABCapproach.

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

Once you understand which items are most important, you'llbe able to balance needs with costs, carrying only as much as youneed of a given item. It's also a good idea to lower yourinventory holding levels, keeping smaller quantities of an item ininventory for a short time rather than keeping large amounts for along time. Consider ordering fewer items, but doing so moreoften.

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

Entrepreneur Editors' Picks