Managing Inventory to Improve Cash Flow

Nearly all of us in the finance world understand the importance of maintaining good cash flow to operate our businesses, but many business managers don’t know the importance that maintaining the right levels of the right inventory plays in managing cash flow. Even fewer managers really understand the principals of managing inventory to maximize cash performance.

In the cash flow cycle, you use the cash you have to buy inventory. When that inventory sells, it eventually turns back into cash. Maximizing the performance of your inventory can be help you obtain “best in class” management processes. Some metrics that are used to measure inventory performance are:

• Inventory turnover – This is a measurement of how many times per year your inventory sells. There are several ways to measure this turnover. The method that gives you the truest picture of your entire inventory turnover is calculated by creating a ratio of your cost of goods sold (COGS) to the average inventory value at cost. The higher the ratio, the better your overall inventory performance is. Since inventory turnover varies dramatically by industry, you need to benchmark yours against your own industry data.
• Percentage of order fill – A customer places an order and expects it to be filled 100 percent. The more items ordered that are not filled as ordered, the less satisfied your customer will be. For most industries achieving a 98 percent or greater fill rate is considered “best in class.”
• Percentage of orders arriving on time – Customers not only want their orders filled at the highest possible percentage, they also want them delivered on time. Best in class performance requires a 98 percent or greater on time delivery. Sometimes, missing a deadline by even an hour can have dire consequences. I recently spoke with a business owner who supplied advertising novelty items to an event that was to occur on a specific date. The novelties were plastic sports water bottles printed with the event sponsor’s name, logo, and the date of the event on them. The bottles were being contract printed in China, the event was in Scotland, and the company with the order (and reputation) was in the U.S. Even though the company contracted with to supply the 10,000 water bottles did everything they could to get the order to the event on the correct date, the bottles arrived one day after the event occurred. The customer didn’t pay for them since they didn't arrived as promised; but the contract manufacturer had already been paid, so the distributor was left with the loss and 10,000 water bottles that couldn't be sold for salvage because of the organization’s trademark on them.
• Customer order turnaround time – In most industries, time is a critical factor. When managing inventory, it's important to establish warehouse processes to constantly measure and improve order turnaround time so that you can get the order out the door within the specified time. It is important to balance turnaround time with quality control. If you are a manufacturer, it is more important to make your product right, rather than to make it right now. If you are a distributor, picking the correct parts off shelves and filling the order correctly is very important.

All of us in business today are feeling the pressure to do “more with less.” Managing inventory efficiently means you have to create an end-to-end process that is flexible and focuses on improving efficiency and performance. Other best in class strategies include making greater use of warehouse automation, and making better use of your warehouse space through optimization of existing storage mediums.

If you doubt that small companies can meet or beat the metrics I discuss above, consider this. I have a number of customers who supply products or services to Dell Computer’s custom manufactured desktop assembly lines in Austin Texas. Numerous times every day each Dell supplier (many are SMBs) must have a supply of their parts to the appropriate place on the assembly line within one hour of being ordered. If one supplier misses delivery by 30 minutes, it can mean as many as 2,000 PC assemblies get delayed, which costs Dell tens of thousands of dollars in lost time. Remarkably, because both Dell and each of their suppliers have perfected processes like those I describe above, down time caused by a supplier slip-up doesn’t happen very often.

You don’t have to develop a precision process resembling an intricate ballet for your company, but the more often you get everything right, the more profitable you will be and the happier your customer will be.

Sam Thacker is a partner in Austin, Texas-based Business Finance Solutions.