Solomon Bruce Consulting Blog

Sunday, January 31, 2010

Need working capital? Look at the inventory!

         One of the challenges that many businesses have at this time of year, February/March, is the lack of cash flow.  No matter how good or bad the sales were last year, many businesses seem to short of cash in February and March.
         Last week, we worked with a client who was in this exact situation.  The firm had a successful year in 2008, however, did not break even in 2009.  Alas, the client needed some help and engaged our firm to ascertain what might not be working.
         As we reviewed the firm's financial data, it became very apparent that a substantial amount of money was tied up in inventory.  Now, this is NOT a bad thing, if the inventory is moving in and out at a rapid rate.  However, it is a bad thing if the inventory is sitting on the shelves and not moving.  Alas, that was the case with this client.  The firm had purchased excess inventory "expecting" to rapidly sell it as the year progressed.  However, the economic conditions turned in such a way that the inventory did not sell, became stale and consumed much needed and precious working capital.
          One of our first questions to the client was why the excessive inventory?  The answer-- "I know we'll need it and we'll be able to sell it once a demand is placed.  After all, that is good customer service!"
           As we analyzed that response, our next question was what, if any, data was available to substantiate that decision.  Sadly, no hard data was available, just a "gut level" intuition that the inventory would be needed.
           This client is in an industry where once the inventory has been purchased, it is not returnable to the vendor for any reason.  Thus, the firm had inventory that may or may not be sellable.
            The further we explored the financial data, we conducted a physical count of all inventory to verify the data that was contained in the accounting system.  Here, we found a couple of errors which reduced the value of the inventory by approximately $15,000.  Now, finding that error caused us concern on what other data errors may be in the accounting system.  We'll leave that question for another time-- just focusing on inventory today.
            Inventory is one area where business owners have to pay real close attention to dollars.  If you forget to watch the inventory account, you may end up with excessive inventory which may or may not be able to be sold.  Inventory which is perishable, i.e, chemicals, paint, film, solvents must be carefully monitored.  Inventory which is pilferable is another big concern.  Everybody likes a "free" steak from the restaurant when the shift is over.  Food costs in the restaurant can make the difference between profit and loss.
            We explored the "supply chain" system.  In our client's particular case, the lead time for an inventory item is about 4 weeks.  As we dug deeper, we determined that the industry that the client is in accepts 4-6 week lead times for inventory parts.  Thus, there was no reason to put working capital in inventory "Just in Case!"
             What about your business?  Do you have tight control on all of your inventory?  Do you monitor your sales each nite to be sure that the inventory is properly decremented?  When was the last time that a physical inventory was conducted?  Do you reconcile your accounting system with your physical inventory, making any adjustments necessary?  These are all questions that a consultant will explore when addressing inventory issues.
              With technology changing so rapidly, if you fail to pay attention to inventory, you will have excessive capital invested in a commodity that has no value.  Much inventory is very perishable today.  Most supply chains are able to deliver new products to your store in 48-96 hours, negating the need for excessive amounts of product inventory.
               If cash flow is a problem in your firm, investigate inventory quantities and vendor return policies.  Although you may have to pay a restocking charge, it may be worth it if you are able to gain some additional liquidity.


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