How Your Inventory Affects Your Cash Flow

One crucial mistake small business owners often make is mismanaging inventory. Poor inventory management can significantly impact cash flow, affecting both turnover and profitability. So, how can you ensure that your inventory doesn’t negatively affect your cash flow?

Calculate Your Inventory Turnover Ratio

Inventory turnover refers to how often you sell and replace stock over a specific period. This varies by industry and product type. To calculate your business's inventory turnover ratio, you need to consider the Cost of Goods Sold (COGS). The formula is:
COGS ÷ Average Inventory or Sales ÷ Inventory.

COGS refers to the cost a business incurs to produce its goods or services. It includes materials, labor, overhead, and fixed production costs. Average inventory is used because stock levels fluctuate throughout the year. For example, during high-demand periods like Black Friday, businesses carry more inventory, while mid-year, they may look to reduce stock during sales.

Controlling Inventory

Effective stock control boosts cash flow. While holding inventory is often necessary, having too much means tying up cash that could be invested elsewhere in the business. On the other hand, not having enough stock risks losing sales and disappointing customers, both of which can also harm cash flow. So how can you improve your turnover ratio?

Strategies to Increase Turnover

Diversify Your Offerings
Customers enjoy variety. By offering new products or services, you can increase your turnover ratio. If a store continually stocks the same items, customers may feel no urgency to purchase. Rotating inventory and offering new options can create excitement and prompt quicker sales.

Be Smart with Basic Stock
Avoid overstocking, even on your best-selling items. While it may seem like a safe bet, tying up cash in excess stock isn’t always necessary and could limit your flexibility.

The Bottom Line

If cash flow is the lifeblood of a business, inventory is its lungs. Proper stock management ensures that inventory becomes one of your greatest assets. Managing your inventory turnover ratio allows you to hold just enough stock to grow your business, satisfy customers, and improve cash flow. Now, who wouldn’t want to breathe that easy?

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