Inventory is a critical component of most businesses’ Balance Sheet, but managing inventory effectively is often a challenging balancing act. A business needs to keep enough inventory on hand to meet its customers’ needs – but holding on to too much inventory can be costly. What are some smart ways to manage inventory more efficiently, without compromising revenue and customer service?
Reliable counts
Effective inventory management starts with a physical inventory count. An accurate count of inventory provides a snapshot of how much your company has on hand at any one point in time. This is easier said than done. The value of inventory is always in flux, as work is performed and items are delivered or shipped. To capture a static value as of the reporting day, companies may “freeze” business operations while counting inventory. For larger organizations with multiple locations, it may not be possible to count everything at once; so, they often break down their counts by physical location.
Accuracy is essential to calculating cost of goods sold, and to identify and remedy discrepancies between a physical count and inventory records. And there are always discrepancies. Errors made in data entry, shipping errors, inaccurately labeled products, theft, and sometimes even intentional misstatements are all common factors that can throw off an accurate inventory count.
Benchmarking studies
After a business has calculated its inventory as accurately as possible it can compare its inventory costs to those of other companies in its industry. Benchmarking is the process of measuring key business metrics and comparing them against other companies in the industry to see how the business is faring and how to improve performance. Trade associations often publish benchmarks for gross margin, net profit margin, or days in inventory, and a business should strive to meet — or beat — industry standards.
Efficiency measures
What can you do to improve your inventory metrics? The composition of your company’s cost of goods will guide you as to where to cut and what to modify. Consider the carrying costs of inventory, such as storage, insurance, obsolescence, and pilferage. You may be able to improve margins by negotiating a net lease for your warehouse, installing antitheft devices, or opting for less expensive insurance coverage.
To cut your days-in-inventory ratio, compute product-by-product margins. You might stock more products with high margins and high demand — and less of everything else. Consider returning excessive supplies of slow-moving materials or products to your suppliers, whenever possible. In today’s tight labor market, it may be difficult to reduce labor costs. But it may be possible to renegotiate prices with suppliers.
Inventorying your inventory
Management usually directs its greatest efforts into the growth of its business, which is appropriate; but this focus often puts inventory management on the back burner. This can be a costly mistake. Speak to your accounting professional for help in researching industry benchmarks and calculating inventory ratios to help minimize the guesswork in managing your inventory.
This material has been prepared for informational purposes only, and is not intended to provide or be relied upon for legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.
