How to Master the Secret Inventory Formula

It's not always easy to make inventory management a priority, but if you let it slip it can take down your whole operation.

Knowing how to find the just-right balance between sales and inventory is the key to turning a profit. Think of inventory as cash. Everyday your inventory is not sold, your profit margin will contract. Small businesses have to analyze what the true cost of carrying a certain amount of inventory will be before investing in it.

“Don’t build up inventory because your people don’t have anything to do,” said Bill Weddle, a risk management specialist at the North Texas Small Business Development Center. “Cash flow is key, and building up inventory will tie up your cash flow.”

Best practices for inventory-management techniques vary from business to business, according to Steven Martin of Profit Professionals of Business Solutions. He said awareness is the first step toward effectively managing your stockpiles.

“Initially, the best way for a smaller business to manage their inventory is to look at their cash flow and recognize that inventory, although it is carried as an asset on the balance sheet, really is a liability when it comes to cash flow,” he said.

Assessing your current inventory before purchasing more will help eliminate the carrying cost – which, Martin said, can eat into 20%-30% of your profits per year. Remember to review inventory levels monthly, liquidate unused items and cut back on products not being sold. If customers don’t want the items, don’t waste your money holding onto them.

Inventory management is a variation of risk management, Martin said. Business owners must weigh the risk of missing a sale against the risk of unnecessary inventory costs, and find the area in between.

And the balance of the scales can and often does change from month to month, said Weddle. He said the only secret to managing inventory is figuring out what is right for you at a particular time.

“Analyze how much money you can afford to have tied up at [that] certain time,” he said.

Martin said some entrepreneurs error on the side of optimism, building inventory based on their own glass half-full view. On the other hand, others will build inventory based on fears. Both methods, he said, don’t work.

“These two factors alone tend to increase a company’s inventory beyond what [it] should be,” Martin said.

So, he said, don’t forget to question yourself often when planning inventory. Make sure you are being economically sensible, and not reacting to emotion.

Weddle seconded that emotion.

He said too many businesses buy into products they “hoped” would sell. But hoping isn’t enough – base your inventory buys on facts and trends.