Inventory Controls
Inventory is key part of small business success but unfortunately, often is not priority for most owners. With most business becoming increasingly more difficult and margins becoming slimmer, owners must be able to successfully manage inventory. Most business owners pay attention to only the income statement expenses and not the balance sheet items like receivables and inventory. That it is unfortunate because most of the time, a business struggles due to a lack of controls on the balance sheet.
Are you in control of your inventory? Can you answer?
- What is your current carrying level of inventory?
- Do you have guidelines for carrying levels with seasonality considerations?
- Which is your top selling products and does your carrying level reflect that?
- Which product line or individual product has your best return on investment?
- What is your average inventory turn?
- What is the most price point product you stock? What is the most price point product you sell? Is there inconsistency here?
- Do you stock what you sell?
- How often do you audit your inventory?
- What inventory gives you the greatest exposure to loss or market condition changes?
Many things can be done to boost profits in inventory. One of the key things to understand is which inventory line (if not exclusive) or individual product is providing the best rate of return on the investment (roi). Gross profit is typically sales minus cost of investment. Return on investment is gross profit divided by the investment. This gives you an annualized percentage rate of return on your investment.
Then you want to get a grasp on how long you keep the product in order to generate the gross. The goal is to turn the product quickly. Many times business owners keep products far too long on the shelves for one product and not nearly enough for the next product. The result is a slower turning inventory lowering the owner return on the investment.
To figure ROI:
1.Calculate the Rate of Return
- Gross profit divide investment cost = rate of return
2. Annualize the Days in Stock
- Days of the year divided Day Actually in Stock = Annualized turn.
3. Calculate the Velocity of your Money
- Rate of Return multiply Annualized Turn = Return on Investment (ROI)
Step One: Rate of Return Gross Profit 40 Investment Cost 70 = 57% rate of return
Step Two: Annualize the days in stock Days in the Year 365 Days in Stock-Actual Day in Stock 45 Annualized Turn = 8.1
Step Three: Calculate the Velocity of Money Rate of Return 57% Annualized turn Multiply 8.1 Return on Investment Equals 461%
Once you have this information, you can correctly stock your inventory and maximize your return on investment. Profitable business owners do not guess on inventory. Rather they a system based on math and very efficient with cash and hence profits.
