Inventory and Cash Flow

As one of the staple costs of doing business, finding the right inventory balance is a challenge for both the small sole proprietor and large corporation alike. Invest too little and suffer the consequence of unfilled orders and the wrath of dissatisfied customers. Invest too much and be vulnerable to sluggish inventory turns, cash shortfalls and possibly crippling effects on operations. While no two businesses are the same, the factors that influence a balanced inventory are common regardless of industry and sector. To effectively manage inventory the appropriate forecasting, purchasing, control, and reporting mechanisms should be in place.

Inventory is a business’ response to the anticipated needs of its customers. Market demand, new product releases and competition are examples of what to consider when determining the appropriate inventory level. Seasonality is another concern, as you need to ensure you are carrying sufficient stock to meet demand in response to a sale or other seasonal issues.

Bulk Purchasing / Overbuying
Buying on volume to secure a better price makes good business sense as long as the inventory is sold off. Be cautious of discounts, bundling and other offers that suppliers use to offload their excess inventory. You may receive a discount on the core material you set out to purchase, but take on marginal product that may end up idling in your warehouse instead of your supplier’s.

Bidding and Estimating
Often an inventory build-up is not the result of over-forecasting demand or bulk purchasing, but is due to overestimating the material requirements for a project. This type of inventory is a double whammy, as it is tying up cash and has most likely already been expensed and so is not being recognized as an asset on the balance sheet.

This situation is symptomatic of another problem: overbidding. Overestimating project materials, drives up costs, inflating the bid price of projects, and ultimately may result in poor award rates. If you suspect an inventory build-up due to overbidding, conduct a variance analysis comparing budgeted volumes to actuals on all projects over the past 18 months, to determine if there is consistently excess material remaining at project completion. If there is, educate your pricing staff on how to better estimate material consumption i.e. learn from their mistakes, and implement a standard budget vs. actual report at the appropriate interval (daily/weekly/monthly) to highlight excessive purchasing during and after each project.

Control, Control, Control
Yes, excess inventory is no friend to your bottom line, but what exacerbates the situation is a lack of control. No controls means there is no internal deterrent in place to ward off theft and other rogue activity e.g. doctoring numbers to improve performance. As well, a control mechanism ensures staff knows what is available for use on other projects, as the inventory list is available for review.

One EA client was experiencing overbidding and excess inventory. When asked to see their inventory list to determine the balance sheet impact, there was none to provide. In an environment where the inventory could have been partially if not completely used up on other projects, there was no mechanism for others in the business to use up the inventory. With no costing system in place the fully expensed inventory could have been assigned to other projects at zero cost, thereby lowering the bid prices and potentially winning more business with minimal impact to margin. Excellerated Analysis is currently working with the client to implement an ERP system that will support inventory tracking, forecasting, purchasing and reporting, as well as ensure that the right processes are in place to properly leverage the new system.