Businesses often have a considerable part of their investment tied up in inventory. At the end of the year, only the cost of those goods that are sold can be deducted as a business expense on your taxes; the unsold portion is considered part of the company’s assets. You might want to think of your inventory as your cash flow!
In order to make a reasonable profit, your inventory must be managed in the most effective way to provide enough products for good customer service, but not so much as to cause financial difficulties. There are different ways of accomplishing this balance. All require good management skills and decision-making.
First of all, precise recordkeeping is vital. Inventory records can be kept manually or by using more sophisticated computer programs. While the type of system and kinds of records may vary from business to business, all require accuracy and timeliness to be effective. At the end of the year, you will need to physically take inventory.
Successful inventory management requires a balance between the costs and benefits of inventory. Costs include not only the money tied up in the inventory, but also storage, insurance, taxes, etc. The benefits of inventory include having adequate stock on hand, a wide assortment, low-cost volume purchases, etc. It is difficult to maintain the correct balance, but the following considerations should be kept in mind:
- High inventories increase financial risk.
- Maintain a wide assortment, but keep an adequate supply of those items with quick turnover.
- Increase turnover, but don’t sacrifice service level.
- Make volume purchases for lower prices, but don’t end up with slow-moving inventory.
- Have plenty of inventories on hand, but don’t get stuck with obsolete items.
Many industries rely on a ratio that measures inventory turnover rate. Inventory turnover rate can be calculated in various ways, providing a rough guideline by which managers can set goals and measure performance.