How much inventory should I hold?
Inventory is the stock you have on hand and available to sell or the raw materials you are holding that will produce goods or a service.
Inventory is a main source of revenue generation. On the balance sheet it’s listed as a current asset.
Work-in-progress inventory is partially completed goods that will be sold when they’re finished, such as a partially made car in an automobile factory.
Cameron Edwards is a director of InfraNomics, a company that provides infrastructure advice and financial services. He says there’s a cost associated with holding inventory and you need to make sure you turn it over as quickly as possible.
“Ultimately, anything that’s greater than one day is a cost to the business. So, the lower the number (of days you keep inventory) the better,” he says.
“It’s always the 80-20 rule where 20 per cent of your stock makes 80 per cent of your profit. So, the other 80 per cent you need to continue to whittle down or really look at why you’re holding it in the first place. Then look at whether you can increase the 20 per cent that makes all the money?
“People forget the costs of holding inventory. They usually hold some line stock too long and this comes down to analysing it again and looking at the 80-20 rule.”
When servicing regional areas there’s usually higher transportation costs as well as less people and lower turnover so businesses tend to hold inventory for longer.
Edwards advises it is up to each individual business owner to decide what the balance is between the cost of holding inventory and having it available to sell.
“They have to make that balance, what turns over and what doesn’t. How long will it take to turn over? What will it return? That really depends upon the individual business.”
There are also management strategies for inventory. Just In Time (JIT) is where you have a supply chain that gives you inventory just before you need it.
Just In Case (JIC) is where you hold large inventory to cover you with supply and demand uncertainties. It is worth researching these to see what works for your business.
To help you measure how quickly things are selling and how long to keep inventory, Edwards suggests breaking your inventory down along the product lines.
He also suggests looking at the revenue of your competitor or inventory sales and seeing how it turns over. Look at what is turning over fast and what is not.
Any accounting software these days will have a variety of tools with a whole lot of ratios available as well, and this is all automated. So rather than trying to write it down, just use the tools that are available in the accounting systems to analyse your stock and how it’s moving.
Because of the software and automation, stock-taking should now be an everyday thing that is done in real time.
How often you do a full stock-take depends on your business, for example a food business also needs to consider perishables and loss rates.