Inventory control is essential to the financial success of a business. It is worth noting that inefficient inventory management, like overstocking and failing to forecast demand, leaves immense cash resources strewn across a business’s assets. This scenario stifles the business’s capability to grow and invest simultaneously. In this article, we delve into the effects of inefficient inventory management for different firms along with the common types of stocks held by businesses, and the major ratios that would help in determining inventory productivity.

Regular Problems Faced in Inventory Management

Many businesses, regardless of their sector, deal with an issue known as cash flow blockage that stems from inventory issues. These concerns inhibit a business from making rational financial decisions leading to overall decreased profitability. Here is a list of some common issues.

Failing To Properly Analyze The Demand:

• One common mistake businesses make is overstocking without proper market research. Excessive inventory leads to enormous amounts of cash flow shortage.
• Devaluation of Inventory If stock is not sold in a specific period, it may lead to losses and other useless capital.
• Fulfilling Measures of Inventory Cost When proper measures are not taken, inventory may be lost or severely damaged, rendering the business to lose significant amounts of revenue.

Types of Inventory

Inventory management plays an essential role in decreasing the risk of cash becoming tied up and subsequently ensuring that you are able to manage your stocks appropriately.

Raw Material:

These materials are classified as those that form the next stage of the inventory cycle, commonly referred to as work-in-progress (WIP).

Work in Progress:

These are items undergoing the manufacturing process but are not completed products yet.

Finished goods:

These products are completely produced and are available for sale.

To avoid surplus stock and for a flawless production cycle, all inventory types should be planned for and managed properly.

Fast Inventory Rotation:

Revolving the inventory quickly yields multiple benefits for businesses.

Higher Profits :

With increased sales brought by fast moving inventory, profit margin tends to increase.

Moving Old Stock:

Old inventory items are more likely to be sold hence reducing the chances of items not selling or becoming outdated.

More Cash Businesses can benefit by receiving cash from fast moving stock that can then be used for reinvestments for other departments.

Inventory Management:

Effective inventory management requires input from various departments. They include the production director and the financial manager who play a pivotal role in inventory and cash flow management.

Production head ensures that the production processes runs smoothly and on time, including the procurement of materials and the crafting of finished goods or products.

Finance Director:

Ensures there are sufficient cash flows for an optimal stock purchase so that a company does not excessively overspend.

Important formulas and ratios for managing stock have proven to be useful. Businesses monitor certain critical ratios as an indicator of stock management efficiency and effectiveness, and they include:

 Inventory Turnover Rate

Determines how long it takes an organization to sell and replenish its stock based on a one year period approximation.Upper ratio indicates efficient stock utilization and enables the gains to be reinvested back into stock purchases.

Formula: Inventory Turnover Ratio=SalesAverage Inventory\textInventory Turnover Ratio = \frac\textSales\textAverage InventoryInventory Turnover Ratio=Average InventorySales

Example:

Using the same INR ten average inventories, we can also determine inventory turnover ratio over a period of one month with 100% utilization.

10010=10\frac10010 = 1010100=10

This means that the entire inventory will be sold ten times every year.

Days of Inventory

It displays the organization’s average stocks and the total units sold as per industry classification. It is better to have a lower number of days, since it means quicker rate of sales and hence a higher rate of profit.

Work through the following formula:

Days in Inventory = Inventory Turnover Ratio
365

Example:

For those who prefer visual presentations, this means if we use the example above of a 10 percent inventory turnover, the days of imventory would be as follows:

A business takes approximately 37 days to sell all of its inventory.

D-Mart Example

Inventory Turnover Rate: 12,65 times

D-Mart’s higher turnover rate indicates better cash flow because of the ability of the inventory to be sold quickly.

Maruti vs. Mahindra: Practical Examples

It isn’t so challenging to observe the inventory turnover ratios among well-known brands such as Maruti and Mahindra. Those with higher concentration of inventory such as Mahindra would almost always have lower revenue or profit which is a given because their inventory carrying cost in the long run whittles it away.

Start by determining the current inventory turnover rate.

Take a look at your balance sheet:

A detailed analysis and thorough review of your balance sheet should provide helpful information to your business.

Try to improve your inventory turnover ratio:

Get rid of surplus inventory, optimize other sales processes, and make sure that production cycles are finished on time.

Activate a rapid turnover strategy:

Remove inactive stock, and adjust stock levels to align with demand to ensure cash flow does not become an issue.

Conclusion:

As mentioned before, cash flow management is a crucial element of managing a business. By diminishing the amount of time cash is locked in inventory, companies can have more capital to reinvest into growth opportunities. Concepts such as inventory turnover ratio, days sales of inventory, and inventory days will enable you to make more informed and profitable choices. Remember to achieve optimal liquidity by promptly clearing existing stock and rapidly rotating stock on hand.

Categories: Working Capital Management