If your inventory levels are limiting cash flow, focus on economic reorder points

It’s common for company owners to ask us, “My receivables are OK and I’m making money. Why don’t I have cash?” In the industries of distribution, manufacturing and construction, the most common reason is that cash is tied up in overstocked inventory that’s not moving out the door.

The many costs of inventory

Inventory takes more of your cash than just the amount you pay to purchase it. It has a carrying cost too. The inventory increases your cost of insurance, additional storage space, and property tax. Your damaged inventory cost rises the longer you own items and move them around.  

Depreciation is another cost for slow-moving inventory. Obsolescence too—if your engineer says, “Hey I have a better way to do it if we switch to 3/4” bolts,” but you just bought a 5-year supply of 3/8” bolts, you’re less able to move to the better option. Shrinkage costs can go up over time too.

How can you stop buying too much inventory?

The first priority is to use economic reorder points for each item.

  1. Set minimum and maximum levels. You want to meet demand with the lowest amount of inventory that won’t create a risk of being out of stock—while optimizing for bulk discounts to reduce purchase cost.
  2. Take buying cycles into account for items that don’t sell at the same rate year-round.
  3. Monitor your inventory levels against your reorder points; and routinely look for changing trends to adjust your set levels.

 What if you need to scale that up?

For companies that have thousands of items or a more complex business that makes it impossible to manage these calculations in Excel, we set up accounting and ERP systems to automate it with a great ROI, making it super-easy to manage.

For example, we helped a rack jobber who was regularly losing profit by discounting extra stock to move it out, when consumer product trends and product popularity changed. We put in place a demand forecasting system that factors in past sales trends and seasonality, and compares sell-through rates at their retail stores individually and combined—allowing them to keep close track of flow rates and avoid over stocking so their profits aren’t negatively impacted. If you’d like to be in control of your inventory levels, we’d welcome a conversation about your unique situation.