How a business manages its inventory can have a tremendous impact on the financial health of the company. Managed properly, inventory can be a great source of increased margins, higher revenue or a combination of the two. In a previous article, we looked at how to understand and optimize inventory. Here, we share two more tips to ensure your inventory is working in your favor.
Tip 1: Weigh the pros and cons of holding costly inventory
The shorter the expected usable life of your inventory, the less room for error you have. If you’re selling bananas, it’s a matter of days before they become unusable by anyone not making banana bread, so you have to know how many to keep on hand at any given time. Raw steel, on the other side, will remain usable for years assuming it’s not left outside in the rain, although by then storage costs will likely have eaten away any profits it would have made.
While this concept is obvious to most business owners, what isn’t as obvious is knowing when discounting the price of your products is less expensive than continuing to hold costly inventory. It may be painful to sell your product at a discount, but if it frees up capital to be better utilized then it may be a good idea. This is another reason why understanding your all-in cost of inventory matters; it can help you calculate how much profit you’re losing every day you hold out for a higher price.
Beginning to think of your balance sheet in terms of sources and uses of cash might transform how you approach your business.
Here are a few quick examples of what thinking in terms of sources and uses looks like:
- Turning inventory (use) into revenue (source).
- Turning outstanding accounts receivable (use) into received payments (source).
- Buying a building (use) with a loan from Elevations Credit Union (source), thereby increasing net income (source) by paying less in interest (use) than you were paying in rent (use).
- Using your Elevations business line of credit (source) to give you the cash you need to pay your inventory suppliers faster (use) and take advantage of payment discounts that you otherwise couldn’t. As long as the money saved with the payment discount is more than the interest paid (use) on the borrowed funds (source), the increased net income becomes, you guessed it, a source.
Elevations Credit Union is a member-owned not-for-profit financial institution serving Colorado’s Front Range. With a consultative approach to solving your business banking needs, Elevations local business bankers can help you