Inventory

Inventory

Part of being an effective leader of your small business is to be able to make sense of the numbers and to know that cash is king!  Understanding inventory is important because your business must be able to understand how to properly manage inventory in order for your business to expand and grow.

In the cash flow cycle, you use the cash you have to buy inventory. When that inventory sells, it eventually turns back into cash. As a small business owner, maximizing the performance of your inventory can be help you obtain “best in class” management processes.

The most effective way to manage Products and Inventory is through the effective use of reporting.  Here are some reports that you can benefit from:

• Inventory Valuation Summary – Summarizes key information, such as quantity on hand, value, and average cost, for each inventory item.
• Inventory Valuation Detail – Lists the transactions that each inventory item is linked to and shows how the transactions affected quantity on hand, value, and cost.
• Product/Service List – Lists the products and services you sell along with detailed information about each: sales price, name, description, and (optionally) purchase cost and quantity on hand.
• Sales by Product/Service Summary – Summarizes sales for each item on your Product/Service List. Includes quantity, amount, % of sales, and average price.
• Sales by Product/Service Detail – Lists sales for each item on your Product/Service List. Includes the date, transaction type, quantity, rate, amount, and total.
• Physical Inventory Worksheet – Lists your inventory items with space to enter your physical count to compare to the quantity on hand in QuickBooks.

Understanding inventory metrics is vital if you are to make the best decisions.  Here are some of the key performance metrics (KPI’s) that are used to measure inventory performance:

• Inventory on Hand: The amount of stock physically present in your warehouse/storage location. It’s important to remember with this metric that even if a product is sold, it is not subtracted from inventory on hand until it physically leaves the warehouse, so this number will usually be higher than your available inventory. (This definition is based on industry standards, though some customers do measure it differently).
• Inventory turnover – This is a measurement of how many times per year your inventory sells. There are several ways to measure this turnover. The method that gives you the truest picture of your entire inventory turnover is calculated by creating a ratio of your cost of goods sold (COGS) to the average inventory value at cost. The higher the ratio, the better your overall inventory performance is. Since inventory turnover varies dramatically by industry, you need to benchmark yours against your own industry data.
• Percentage of order fill – A customer places an order and expects it to be filled 100 percent. The more items ordered that are not filled as ordered, the less satisfied your customer will be. For most industries achieving a 98 percent or greater fill rate is considered “best in class.”
• Percentage of orders arriving on time – Customers not only want their orders filled at the highest possible percentage, they also want them delivered on time. Best in class performance requires a 98 percent or greater on time delivery. Sometimes, missing a deadline by even an hour can have dire consequences.
• Customer order turnaround time – In most industries, time is a critical factor. When managing inventory, it’s important to establish warehouse processes to constantly measure and improve order turnaround time so that you can get the order out the door within the specified time. It is important to balance turnaround time with quality control. If you are a manufacturer, it is more important to make your product right, rather than to make it right now. If you are a distributor, picking the correct parts off shelves and filling the order correctly is very important.
• Sales Velocity: How well your product sells when it’s available to consumers on the shelf (sales / distribution). This metric is important to demand planning and preventing out-of-stock situations.
• Days of Supply: The number of days it would take to run out of supply if it was not replenished (inventory on hand / average daily usage). This measurement enables retailers to see how much available inventory they need in order to maintain normal operations for some period of time after a supply chain disruption occurs.
• Sell-Through Rate: Comparison of the amount of inventory a retailer receives from a manufacturer or supplier against what is actually sold to the customer (sales / stock on hand). This metric is useful for comparing products against each other as well as comparing how a specific product does month over month.
• Cost Per Unit: A measure of a company’s cost to build or purchase one unit of product (variable costs + fixed costs incurred by a production process / number of units produced). Knowing cost per unit is imperative to pricing products.
• Revenue Per Unit: The total amount of revenue a product generates, divided by the total number of units of that product sold. This metric is critical when considering where you might improve, expand, or cancel a product.
• Cycle Time: Total time it takes from when an order is first issued until it is completed. Cycle time is a critical metric for setting realistic expectations with customers.
• Gross Profit: A company’s total revenue minus the cost of goods sold. Many small to medium-sized retail businesses operate with a gross margin in the range of 25 to 35 percent.
• Gross Margin: The percent of total sales revenue the company retains after paying the direct costs associated with producing products ((total sales revenue – cost of goods sold)/total sales revenue).
• Average Age of Inventory: The average number of days it takes a retailer to sell a product to consumers ((cost of inventory at its present level / cost of goods sold) x 365). The older your inventory is, the more it’s costing you. If a product’s average age of inventory exceeds 120 days, it’s time to drastically reduce price, consider bundling it, or use whatever means necessary to get it off your shelves.

Many small businesses can benefit from the effective use of accounting software to help manage your inventory.  If you are wanting to learn how to improve and streamline your inventory management solutions, we are happy to help with this.