Many businesses need to have some inventory available. But having too much inventory is expensive — not just to purchase but to store, safeguard and insure. So, keeping your inventory as lean as possible is critical. One rule of thumb says the expense of maintaining stock in inventory averages about 2% of the cost of goods sold, for each month items aren’t sold. That means if your business carries an item for a year, you may be down 24%. That’s hard to overcome, especially in tough times.
Lohman Company Partner Craig Lohman gives his point of view on keeping control over your business inventory below:
“Efficient inventory management can lead to better financial ratios and improvements can positively influence a company’s financial statements, making the business more attractive to lenders. Companies with a solid grasp on inventory and working capital management can present themselves as more financially disciplined, which may strengthen their negotiating power with banks when seeking favorable loan terms or credit lines.”
Here are some ways to trim the fat from your inventory without compromising revenue and customer service.
Where to Begin
Effective inventory management requires starting with an accurate physical inventory count. That allows you to determine your true cost of goods sold — and to identify and remedy discrepancies between your physical count and perpetual inventory records. A CPA can introduce an element of objectivity to the counting process and help minimize errors.
Next, compare your inventory costs to those of other companies in your industry. Trade associations often publish benchmarks for:
- Gross margin ([revenue – cost of sales] / revenue),
- Net profit margin (net income / revenue), and
- Days in inventory (annual revenue / average inventory × 365 days).
Your company should try to meet — or beat — industry standards. For a retailer or wholesaler, inventory is simply purchased from the manufacturer. But the inventory account is more complicated for manufacturers and construction firms. It’s a function of raw materials, labor and overhead costs.
The composition of your company’s cost of goods will guide you on where to cut. In a tight labor market, it’s hard to reduce labor costs. But it may be possible to renegotiate prices with suppliers.
Don’t forget the carrying costs of inventory, such as storage, insurance, obsolescence and pilferage. You can also improve margins by negotiating a net lease for your warehouse, installing antitheft devices and opting for less expensive insurance coverage.