10 Ways Inventory Management Can Make or Break You
Inventory Management: 10 Areas that can Make or Break Your Business
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Inventory generally represents a large portion of your assets, if not the largest. If your business handles any inventory or is largely made up of purchasing and selling items, then the abilities within your Inventory Management system can effectively make or break your business. In a retail environment a business must purchase, store, and then sell items to customers. In a distribution or wholesale situation it is possible most of your inventory never even crosses your hands because it is drop shipped or managed in such a way that it doesn’t require housing. In a manufacturing environment your inventory may only consist of the items you purchase as raw materials.
In a competitive industry such as retail, the goal is to maximize profit while minimizing the amount invested in inventory. Therefore if your bottom line is based on calculated inventory valuations, then sound inventory management could dramatically impact where your business really is financially versus the numbers you might be estimating for your inventory levels. Below are 10 strategies to good inventory management that would help your business become or remain profitable.
Strategy #1: What is the Value of Your Inventory -- Right Now?
To have access to the value of your inventory at any point gives your business the ability to effectively plan and assess your financial position. In some cases a business’ setup has the ability to reconcile the value of inventory on a regular basis, otherwise a physical count is required for complete accuracy. Regardless the cost of your inventory is the foundation to profitability for your company.
Obviously there are dozens of business-operating expenses, but knowing the value of your inventory is critical for determining your pricing and profitability. Without an Inventory Management System your best guess would be to review your inventory account balance. However the problem with this option is it may not accurately reflect items that are in inventory but not yet recorded in the books. For example, you may have received or sold items that have not been invoiced and therefore not yet recorded. What is needed is an Inventory Management system that provides you with inventory costing method options, such as LIFO, FIFO, weighted cost and standard cost. Depending on which cost method you use will directly impact your balance sheet, income statement and cash flow in different ways and it is important to understand what they are.
* From General Ledger, Income Statement Report
#2: What Valuation Method are You Using?
It is important to understand your valuation method because it can impact profit margins and your income statement based on which method you are using. The valuation methods available, for example, are First in First Out (FIFO), Last in First Out (LIFO), Weighted Average and Standard Cost.
FIFO is an approach in which the tracking of inventory and costs assumes the first items purchased are the first items sold. This matches inventory flow similar to what you would expect in a retail establishment in which new items would be placed behind the existing items on a shelf so, in theory, the oldest items would be the next sold. Of course even if the actual flow of inventory does not match this, the cost and valuation will follow this pattern and, as a result, costs recorded on sales will be based on the oldest and most likely lowest items, and the current valuation will always be based on the value of the most recent costs. In this case the result is that the costs of the items will be lower and the result is higher recorded profit and taxes.
LIFO is an approach in which the tracking of inventory and costs assumes that the last items purchased are the first items sold. This flow would be less common in practice because it would be as if a business always purchased the newest items on the front of a shelf and the items on the back of the shelf could be much older. Regardless, costs of items sold will be based on the most recent items purchased and the value of inventory will be based on the oldest items. In this case the outcome is that the cost of items will be higher and result in lower recorded profit and lower taxes.
Average cost creates an average based on the cost of all inventory items and takes the approach that the current cost most accurately reflects the cost of all items by 3 using an average cost. This method is most effective with a computer system that can track and update costs as soon as items are received. This method will impact the resulting profitability and inventory valuation, but the results will vary depending on whether items increased in cost over time, by how much, how frequent the items were purchased and so forth.
Standard cost uses a static cost entered manually for an item and any variation with the actual cost is recorded in a variance account. The advantage to this method is that the user has more control over the costing being used and can prevent valuation changes that are not wanted or don’t match the business environment. However, in many businesses the inability to effectively update the cost for items could easily make this method useless.
Overall any business may have good reason to use any of the valuation methods described above to meet the needs and objectives or requirements of their business. The main point to remember is that the method used can impact what your profits and inventory value may look like. Having a good management system can be central to effectively understanding how these methods impact your accounting so that you can make intelligent business decisions based on reality, not based on variance resulting from valuation methods.
#3: Where is Your Cash?
Inventory is a liquid asset that heavily influences cash balances. Most businesses are careful about monitoring their cash, and keeping track of how much they have. However businesses that simply rely on their balance statements from the bank to assess their cash flow put themselves at risk if they carry large amounts of inventory. For example, you may know the value of your assets in inventory but do you know how much of it you have paid in full? Do you know how many customers have been sold items from inventory that have not yet paid you? The answers to these questions can dramatically impact your cash situation and your bank statements.
A bank statement might show that you are selling and from all appearances your business is healthy, however the reality is you might find that all your available cash may be tied up in inventory when bills come due or you’re waiting for customers to pay. A large number of businesses that appear profitable end up going out of business because this is often the root of their problem. With a good Inventory Management System you can institute the necessary tracking and controls you need to avoid this from happening.
One solution is to integrate a purchase order process that tracks any inventory purchase order as soon as it is authorized. Then use this information to evaluate how much cash you’ll need to pay for the purchases when they come due. In addition you can better track when items are received and placed in inventory. Although you may not get an invoice until all items are received, you can record their value based on the order as they come in.
A good inventory tracking system can immediately and accurately reflect sales to see what revenue you are generating along with the items sold. In addition, this information can be reviewed to estimate when you can expect to receive payment.
Similarly if a business has a greater amount of cash on-hand they could cover bills and remain in business, even if the revenue didn’t come in on time. Regardless having the ability to track your inventory sales revenue as it relates to what is still owed to you as payment for the inventory or what you may pay out in inventory is critical in determining your business’ actual cash balance.
GL - Cash Flow Report
#4: What is Your Profit Margin?
You may know the profit of your business but at what level of detail can you breakdown where this profit comes from? If your company bases profit largely against the cost of inventory, the ability to track and know the cost of your inventory becomes critical. In addition, it’s difficult for any business with more than a handful of inventory items flowing through their business or being used for raw materials to see where your profit margin comes from.
An effective sales profit report makes it possible to study your business from virtually any angle to see exactly where your profit is coming from and evaluate how profit margin percent translates to actual profit. For example, how much actual cash does an item with 40% profit margin bring in compared to another item currently making 20%.
In addition a report that allows you to break down profit by department, customer, customer type, product type, vendor, location, salesperson, and many other options, in whatever way you need to see it, is important. Having the ability to drill down to where your profit margin is coming from helps you to evaluate what areas to focus on and look for ways to improve profit or track how changes in your business are resulting in net profits.
#5: Do You Know How Turnover Can Change Your Profit Margin?
Imagine you have two existing products, product A and product B, and you need to drop one of them to make room for new product C. Clearly the decision would be based on which current product was generating the most revenue. However, what if product A was generating a gross margin of 40% but product B only 20%, which product would you drop? Product B, right?
If you made the decision just based on the gross profit alone you may be dropping the more profitable product. The rate of turnover can change the scenario. Even at a lower profit margin product B may be a much more profitable product if the turnover is higher than product A. For example, if both products retail at $100 then each time product A is sold you have made $40 of gross profit and each time product B is sold you make $20 of gross profit. In a single month if 2 of product B are sold and only one of product A then they each have generated $40. However, if three or more of product B are sold for every one of product A, then product B actually generates more money and greater profit or revenue for your business and it should be kept despite product A’s higher profit margin.
The size and space a product takes up is also a factor. If you have limited space, you may determine to keep product B simply because it takes up less floor space. However product A may be a more profitable product but it takes more room. In retail this is often evaluated by looking at the gross margin per square foot of retail space.
To help provide more useful and accurate information that allows you to make the best business decisions, expansive reports can provide the information you need to evaluate the true profit and cost of your items. Profit-margin reports that can cross reference the gross margin with the actual dollars generated help avoid overlooking those low margin products that may actually generate a high dollar amount because of turnover.
#6: Do Changing Costs Go Unnoticed?
The details of how costing changes affect your business may vary widely, but if inventory is a large part of your business these changes will have an impact. When items are sold the simplified bottom line is that the profit for the company is based on the sell price being high enough to cover all costs and produce a profit. As a result, any changes to the cost structure can impact profit. In the case of inventory this profit will change whenever the cost of an inventory item changes. In many cases the sale price may be set up to absorb any changes in cost but if costs change and sale pricing isn’t updated soon enough you may be missing out on potential profits or even losing money.
In the event the sale price is a margin of the cost of your items a good Inventory Management system will automatically adjust the sale price and you can always be assured that when an item is sold you are getting the profit you want. However, in many situations it is not practical to have the sale price fluctuate freely with the cost of an item, especially when cost fluctuations are common but don’t indicate an overall increase in costs that require an increase in price. Or, alternatively, in a cost sensitive market or business a change in the sale price may have a dramatic impact on sales and so management may need to carefully consider any pricing changes.
In this case it would be possible for a cost to increase and to have items sold at a loss before the change is noticed or before management has the opportunity to review the pricing and adjust it accordingly. Do you know if your costs have increased? Or how the inventory costs might be impacting sales prices and profit margin? If not, you may want to consider investing in a more robust Inventory Management system.
If that’s the case then you would want a purchase order module that compares the cost of items received with the items already in inventory. If the price changes, a report that not only shows the change but shows the impact to your sale price and profit margin based on the method of valuation and pricing you have set up in the software is invaluable. This helps make sure inventory costs are addressed immediately, if needed, to avoid any loss in profit.
#7: How Sophisticated is Your Pricing?
Having the ability to set up and automate pricing can be priceless and may only be possible if Inventory Management is used. In fact without a good Inventory Management system integrated to your point of sale or order entry, it is likely that the sheer logistics of communicating and managing complex pricing limit your options.
A good Inventory Management system can accurately track the cost of the items you are selling or using as raw materials and make it possible to set promotional prices temporarily for a sale or some other campaign. You can also have the system identify your customers and automatically adjust pricing accordingly. This is useful for businesses that have wholesale and retail pricing or for contracts in which a certain customer is allowed set pricing based on a contract.
What you should look for is software that provides numerous pricing structures and methods with the ability to maximize your profit without involving salespeople or clerks. This saves you time, labor and errors because all pricing changes are made behind the scenes without mistakes. All the clerks need do is enter the item in the register.
In the end a good integrated system makes it possible to see the impact of your pricing methods, evaluate their success and make it possible to further refine pricing to maximize profit.
What pricing structure do you have in place? Are you leaving profit on the table? Are you limited by your ability to effectively incorporate more complex pricing?
#8: Can You Identify Trends?
No matter what business you are in there will be some fluctuation in sales and, as a result the movement of items in your inventory. In some businesses these changes can be fast and furious, and in some it may be a slow process that takes place over years. Regardless, how do you identify trends and differentiate them from long term changes in sale patterns?
In some situations a failure to effectively track trends can end up in overstocking items that never move or require heavy discounting. In another scenario you may lose business to competitors or spend exorbitant costs to get the items needed to meet demand. Any company that can spot these trends early can take advantage of them by providing what customers want and getting rid of items customers are losing interest in—all faster than your competitor. With the “big box” stores it is often critical that a smaller store do a better job managing customer tastes and needs to stay competitive when pricing is not an option.
So how do you accomplish this? How do you identify sales trends in a timely and useful manner? A tightly-integrated software with purchase order, sales and inventory modules can track details about the movement of inventory from receiving to the sale in detail, without additional work, and produce a report that provides detailed information about movement of your inventory items over 12 months.
#9: Can You Automate Ordering?
If your business has a lot of inventory, then regularly ordering and purchasing those items is something that needs to be addressed. To do this effectively requires a purchaser who can spend time analyzing sales, monitoring inventory levels, and make orders as needed to keep items in stock for customers (or for projects in the case that the items are used for raw materials). While the specific needs of any business vary widely, it is likely that management of inventory can be dramatically improved with computer-assisted ordering.
Overall the key to this is the ability to take advantage of an integrated system that makes it possible to streamline purchasing by automating it. This not only frees up time to focus on other aspects of your business, but it prevents errors and the potential for overlooking needs since it automatically generates orders based on the actual Inventory levels.
So how much time could you save by automating your orders? How many times have customer’s needs gone unfilled because stock on some items was low? Look for a good integrated Inventory Management system that can make all these problems go away and give you a competitive advantage by streamlining your order process.
There are systems where purchase order, sales and inventory are integrated and work seamlessly together -- systems that have the ability to set up minimum and maximum quantities for an item. When that item runs low, the system can then automatically generate an order based on those numbers and current inventory levels. There are even good systems that can generate orders based on ‘the least expensive vendor” or other criteria that you can establish so that you can get the best deal possible for your needs and business.
While there may always be a need for careful ordering and review, an option to automate the ordering and fulfillment of the staple items is beneficial. It frees up your time so that you can focus on the areas in inventory and purchasing that require greater attention.
#10: Do You Know Where Your Vendors Are?
Who are your vendors? How many vendors have you purchased your inventory items from? Are they late delivering orders? If so how often? Do quoted prices differ from prices listed on an invoice? These are all questions you may have about your vendors. Based on your business and business needs—delivery timeliness, availability of items and service—may vary in importance. For example, you may be more interested in timely and quick supply of items, or you may want the cheapest price and you can handle late shipments or poor service, or you may be somewhere in the middle, or you may have some items you need shipped on time and others that you don’t.
Managing your vendors and tracking what they provide and how they meet your needs is critical to your business. In many industries cultivating good relationships with vendors often provides a competitive advantage that can make your business excel. With a good integrated system you can collect and gather the information you need to make good decisions about your vendors. In addition, with a complete, integrated, Inventory Management system you can also provide your Vendors information to help them better serve you.
The Cougar Mountain Software Solution
The bottom line—proper management of your business’ inventory starts and ends with a customizable, robust, fully-integrated software setup that outputs reports outlining the information you need to see on a daily basis.
For over 25 years Cougar Mountain Software has designed and produced solutions to help small- and medium-sized businesses better manage their inventory and improve their bottom line. Unlike software that merely interfaces, our programs are truly integrated and a change made in one aspect of the system (a sold item for example) is automatically reflected in every other facet of the system. You never have to enter the same information twice and always know your business’ numbers are up-to-the-second and accurate.
Not only do we have a myriad of tools and features that comes with each of our packages, it’s the amount of information available in our reports—and the fact that they are customizable—that has been the subject of praise from our customers since the beginning. We provide multiple report options from within the Inventory, Sales, and Purchase Order modules—and since Cougar Mountain Software is tightly integrated, business owners and managers can track details about the movement of Inventory from receiving to the sale. Two other reports, the Monthly Movement report and Snapshot report are just two more we recently created for the release of our most updated software, CMS Professional Version 12.
The Monthly Movement Report in the Inventory module provides detailed information about the movement of your Inventory items over a 12-month period. With this you can track movement in detail and identify trends in your sales, then adjust your strategy and purchasing based on this information.
We also added a Snapshot Report in each module. Where, for example, in Inventory the Snapshot report shows outlines information such as the top 10 best and top 10 worse selling items, along with other information that helps highlight big movers and identify any dramatic changes in sales. This report helps you make good business decisions that take advantage of opportunities or avoid pitfalls as patterns change.
Cougar Mountain is dedicated to helping small- and medium-sized businesses improve their bottom line by better managing inventory.
See first hand how Cougar Mountain can help your Inventory Management!
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About Cougar Mountain Software
Cougar Mountain Software has remained a leading developer of truly integrated accounting, point-of-sale, and nonprofit accounting software for 25 years. We’re entirely based in Boise, Idaho, and for the last quarter century we’ve served thousands of small- to mid-sized businesses across the country.
In 1982 Bob Gossett, CEO and founder, established Cougar Mountain Software to meet the demands of growing businesses that required solid accounting and point of sale software. Suddenly managers and business owners were no longer confined to making important financial decisions based on outdated information. He felt it was important to develop a business that acts as an ally to customers and business partners by providing them with the insight and information needed to help their businesses operate more efficiently.
But we’re not all about software development. Cougar Mountain prides itself on the service and support we offer our customers. From first contact we do our best to make sure the software is the right fit for your business. And if a purchase is made we do everything we can to help them with the installation (we have a staff that travels across the U.S. providing on-site installation), training (we offer classes at our Boise headquarters or on-site), and are available if problems arise (our phone-support staff is on location as well).
For 25 years we’ve prided ourselves on our service and product integrity. There’s a lot more to Cougar Mountain’s products, and we invite you to visit our website at www.cougarmtn.com or call one of our Account Executives at (800) 388-3038 for more information. Let us help you set up a truly integrated accounting system that will help your business reach its full potential.
Contact Cougar Mountain Software
Sales: (800) 388-3038
sales@cougarmtn.com
Website: www.cougarmtn.com
