How To Turn Your Stock Into Precious Working Capital
Most businesses have stock or inventory of goods for sale, unless they are in a purely service based business. Obviously stock is required to be available for sale when your customer is ready to buy. The aim of the game is to have the stock on the shelf ready for sale for the shortest possible time.
This is because it costs money to have the stock sitting around waiting to be sold. Stock sucks up precious working capital that could be used for other things like advertising, salaries and expansion costs. Stock can cost you interest if you have borrowings in your business.
If you can get into the habit of thinking of stock as fifty dollar bills piled up in your stock room, this gives a really good incentive to manage every stage of the process where stock is concerned.
Vital to this objective is to know the sales cycle of your products i.e. how long does it take from when the goods arrive into stock until they are sold. You may have historical data upon which to calculate the sales cycle.
If not, you need a way to calculate how long goods are sitting in stock so that you can minimise the length of time and maximize your available working capital. This is called ‘Stock Days' and is an average of all stock lines. One way to calculate ‘Stock Days' is by using your financial reports as follows:
Stock on hand ÷ cost of goods x time period = stock days
A business with $150,000 in stock at 30th June and cost of goods for the year of $400,000 has ‘stock days' of 137.
i.e. $150,000 ÷ $400,000 x 365 = 137
This means that, on average, stock in this business takes 137 days from when it arrives into stock until it is sold. Once you know this number, you are then in a position to manage the situation and work on shortening the cycle.
You may think this is a ‘no-brainer' and that all you have to do is sell stock quicker. We all know how hard it is to sell anything; otherwise everyone would be doing it. The real trick to shortening the ‘stock days' number, is to carefully manage when the stock is coming in, as well as focusing attention on when it is going out.
You need a system for purchasing stock i.e. not just buying when the sales representative of your supplier calls in. If you have a ‘model supplier' who knows your sales cycle and only supplies when you need it great, but if not, you need to create your own methodology.
This first thing you need is a good record keeping system that tells you the following:
- what is selling
- what isn't selling
- what are slow moving items
- what has become obsolete
- what are the trends/seasons
- what are your margins on items
- what is it costing to store stock
All of the above needs to be known for individual items as well as item groups.
Once you know the above, you are well on the way to being able to manage stock at optimum levels. You can determine your minimum and maximum stock level requirement for various item lines. This makes it much easier for staff to know what, how much and when to order.
Many businesses buy when the sales representative calls in or if they get offered a discount. You should buy stock when it suits you and your needs, not those of your supplier. Discounts can also be a big trap.
Ask yourself "Why are they discounting?". Do they know something you don't? Is there a new product coming up that will supersede the existing one? You need to measure the cost of having that stock sitting around sucking up your precious working capital against the discount being offered.
It may be tempting to swap cashflow for potential increased profits, but if it's going to cause you cashflow problems perhaps it's not worth it.
Stocktaking is a necessary evil in any business dealing with stock. You need to regularly check stock levels, not only for tax purposes, but for knowing your business profitability. You can do this by keeping a continuous record, also known as ‘Perpetual Stock Method' or by regularly counting stock levels.
There are literally thousands of stock management systems available which should reduce the need for manual stock-takes. It may seem like a pain and expensive to install one but the dividends far outweigh the cost.
Such systems will report on all aspects of stock management including stock searching, stock receiving, bar-coding, special pricing, sales orders, picking and packing, dispatch register, order fulfillment, product specifications, manifests as well as reporting on stock usage and re-ordering requirements.
Many systems will also assist you to manage sales prices based on cost prices so that your margins are always maintained. They will automatically adjust sales prices without you having to constantly re-calculate them.
Obsolete stock can be a real ‘hiding place' for cash. It can be heartbreaking to have to sell items at a loss, but if they are going to sit there forever, you may as well turn them into working capital to spend on better selling items.
If you have good records, you are also in a position to know just how much you are purchasing from suppliers. This puts you in a better bargaining position when it's time to re-negotiate prices and terms.
A really great tool you can use to manage your ‘stock days' is industry benchmarks. Good benchmarks should include ‘stock days' for the low, average and top performers in your industry. This gives a real clue to why some businesses are in the ‘top performers' category. You will find their ‘stock days' are less than those in lower categories.
In summary, shortening the length of time stock sits in your store room will free up your precious working capital to spend on other things.
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Sue Hirst, Director, CAD Partners (CFO On Call). CAD Partners is a team of Financial Controllers who can review your accounting systems, advise on how you can improve your cash position and profitability. Please feel free to call us on 1300 36 24 36 or visit the website: www.cadpartners.biz. Mention this article to receive a FREE Financial Health Check. There is also a FREE e-book on Cashflow control available to readers of this publication. To see further details of this e-book go to http://www.cadpartners.biz/e-book.htm
First published: 3 July 2007.
Last updated: 3 July 2007.