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SME: Managing Inventory To Improve Cash and Profitability



The opportunities to improve profitability by the efficient handling of inventory for small business are endless. Inventory isn’t gray, like marketing, or in the future, like sales; it is here, today, on your shelves, available to touch and feel and count. As a result, if you improve your efficiency at handling inventory, your business can have a double financial benefit:

  • Profitability: The less inventory you write off, the more profitable you will be.
  • Cash flow: The fewer dollars you have invested in inventory, the more cash you’ll have in your bank account.


Aside from driving with your eyes closed, the accumulation of excess inventory is the quickest and easiest way I know of to get into trouble. Excess inventory and its long list of hidden horrors have turned many a healthy small business into an ailing one.

Unlike getting rid of employees who aren’t performing, you can’t give inventory that isn’t performing a pink slip and send it out the door. Nor can you step up your collection effort with your inventory, as you’d do with slow-moving receivables, and expect it to turn into cash. Nonperforming inventory just sits there, collecting dust, at the same time that you’re paying interest on the money you’ve invested in it.

Yes, sometimes inventory disappears, but not always in the manner intended and not always in exchange for a customer’s money. Inventory can disappear in a number of unsatisfactory ways, including internal theft (by your employees), external theft (by your customers), and at the hands of the most virulent scourge of them all – obsolescence.

If inventory is an integral part of your small business, use the following tips to effectively manage it:

Tip-1. Gather information on past purchasing and sales transactions. Prevention of inventory accumulation starts with the person doing the purchasing. The more information on past purchasing and sales transactions that person has, the better his or her future purchasing decisions can be:

  • Make sure that you buy the best inventory-tracking software you can afford, because inventory’s past performance is usually the best indicator of how it will perform in the future. A good smallbusiness tax advisor should be able to counsel you on which software choice is best for you. (If you aren’t computerized, ask your accountant to help you develop a manual system.)
  • For those considering entering the retailing business, make sure that you include a point-of-sale program (a system that makes adjustments to inventory as a result of cash-register transactions). The system should be sophisticated enough to capture the information needed for you to accurately track your inventory.

Tip-2. Divide your inventory into small, manageable pieces. Pay especially close attention to those pieces where you have the most financial exposure. Remember, inventory is subject to the 80-20 rule: You usually get about 80 percent of your sales from 20 percent of your inventory units. Pay special attention to tracking that 20 percent. And start considering which of the slow-moving 80 percent you may want to stop selling.

Tip-3. Make sure that you have a workable system and qualified employees in place at the inventory-handling corners: shipping and receiving. Most inventory disappearance problems can be identified at one of these two positions. If your inventory system is manual, ask an experienced tax practitioner to help you establish a workable system.

Tip-4. Take frequent physical inventories. To determine whether you’re having inventory-shrinkage problems and, if so, how significant they are, count the items in your inventory and compare your physical count to your financial records. (If you divide your inventory into small, manageable pieces, you can more readily determine where the shrinkage is occurring.) Taking a physical inventory is the only way you can be assured that the gross margin figures on your profit and loss statements are correct. We suggest that most businesses take a thorough physical inventory at least twice a year, and preferably four times.

Tip-5. When selecting suppliers, don’t simply settle on the supplier with the lowest price. Include delivery time and shipping dependability at or near the top of your criteria. After all, the shorter the delivery time and the more dependable the vendor, the less of that vendor’s inventory you’ll have to carry. Some vendors will even take returns on inventory you’ve purchased from them, oftentimes charging a restocking charge of some sort. If so, give such a company a long, hard look as your vendor of choice.

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