When it comes to inventory, the key is striking a balance between too little and too much.
Your business's basic stock should provide a reasonableassortment of products and should be big enough to cover the normalsales demands of your business. If you're a start-up, youwon't have actual sales and stocking figures from previousyears to guide you, you must project your first year's salesbased on your business plan.
When calculating basic stock, you must also factor in leadtime-the length of time between reordering and receiving a product.For instance, if your lead time is four weeks and a particularproduct line sells 10 units a week, then you must reorder beforethe basic inventory level falls below 40 units. If you do notreorder until you actually need the stock, you'll have to waitfour weeks without the product.
Insufficient inventory means lost sales and costly,time-consuming back orders. Running out of raw materials or partsthat are crucial to your production process means increasedoperating costs, too. Your employees will be getting paid to sitaround because there's no work for them to do; when theinventory does come in, they'll be paid for working overtime tomake up for lost production time. In some situations, you couldeven end up buying emergency inventory at high prices.
One way to protect yourself from such shortfalls is by buildinga safety margin into basic inventory figures. To figure out theright safety margin for your business, try to think of all theoutside factors that could contribute to delays, such as supplierswho tend to be late or goods being shipped in from overseas. Onceyou have been in business a while, you'll have a better"feel" for delivery times and will find it fairly easy tocalculate your safety margin.
Avoiding Excess Inventory
Avoiding excess inventory is especially important for owners ofcompanies with seasonal product lines, such as clothing, homeaccessories or holiday and gift items. These products have a shortshelf life and are hard to sell once they are no longer in fashion.Entrepreneurs who sell more timeless products, such as plumbingequipment, office supplies or auto products, have more leewaybecause it takes longer for these items to become obsolete.
No matter what your business, however, excess inventory issomething to be avoided. It costs you money in extra overhead, debtservice on loans to purchase the excess inventory, additionalpersonal property tax on unsold inventory and increased insurancecosts. In fact, one merchandise consultant estimates that it coststhe average retailer anywhere from 20 percent to 30 percent of theoriginal inventory investment just to maintain it. Buying excessinventory also reduces your liquidity-something to be avoided.Consider the example of an auto supply retailer who finds himselfwith the opportunity to buy 1,000 gallons of antifreeze at a hugediscount. If he buys the antifreeze and it turns out to be a mildwinter, he'll be sitting on 1,000 gallons of antifreeze. Eventhough he knows he can sell the antifreeze during the next coldwinter, it's still taking up space in his warehouse for anentire year-space that could be devoted to more profitableproducts.
When you find yourself with excess inventory, your naturalreaction will probably be to reduce the price and sell it quickly.Although this solves the overstocking problem, it also reduces yourreturn on investment. All your financial projections assume thatyou will receive the full price for your goods. If you slash yourprices by 15 percent to 25 percent just to get rid of the excessinventory, you're losing money you had counted on in yourbusiness plan.
Other novice entrepreneurs will react to excess inventory bybeing overly cautious the next time they order stock. However, thisputs you at risk of having an inventory shortage and continuing acostly cycle of errors. To avoid accumulating excess inventory,establish a realistic safety margin and order only what you'resure you can sell.
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
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