7 Ways Better Inventory Management Will Improve Your Cash Flow


What does inventory turnover have to do with cash flow? A lot, actually.

You need to spend money to get inventory, which requires a cash outlay that affects your cash balance. So, if you have an increase in inventory, that will be reflected as a negative amount in your cash flow statement. In essence, you’ve bought more inventory than you’ve sold.

So, what you don’t want to happen is poor inventory management negatively affecting your cash flow. It’ll damage your business on multiple levels. 

For starters, how you manage inventory firmly impacts how much revenue you generate. You’ll want to be careful about holding more stock than what’s needed according to your sales forecast and customer demand. If you don’t, you’ll end up spending your available cash to pay for surplus goods. But then you could find you don’t have enough cash available to pay for ongoing expenses like wages, infrastructure costs and suppliers.

On top of impacting your business growth, poor inventory control creates friction with your customers. Imagine you have loyal customers who have been buying certain items from you for years. But then because you’ve put a hold on suppliers, those items are now out of stock. You’ve now frustrated your loyal customers, which could push them into the arms of your competitors. That’s a loss of loyalty and repeat sales.

Want a cautionary tale of poor inventory management? Just look at Revlon. The cosmetic giant filed for Chapter 11 bankruptcy because of supply chain issues, an inability to get the right materials and bad payment practices. We talked about this in our State of Credit Risk: 2022 report. In particular,

Revlon had a Days Beyond Terms (DBT) score of 18 in an industry where the average DBT is 13. This further highlights the cash flow problems that led to the organization’s downfall. 

It's also a wake-up call for getting serious about the suppliers you’re working with and looking beyond credit scores and credit limits. We’re assuming you want to avoid Revlon’s fate, which means you need to do two things. First, you need to have great inventory management. Second, you need to use the right tools and data to understand how strong your finances are and how certain risks can deplete your cash flow.

To help you out, we’ll outline seven ways better inventory management can help you improve your cash flow.

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1: Inventory forecasting can help project revenue growth

As sales volume and customer demand are two key metrics for projecting revenue growth, it makes sense to adapt your inventory in a profitable way. You can dig into these figures and more as part of a full inventory forecast that considers historical sales data, seasonal trends, customer demand for specific products and outstanding purchase orders.

In other words, inventory forecasting is an ongoing process of calculating the inventory required to fill future customer orders. And there are several methods you can use to make sense of your data.

Inventory control software

Trend forecasting

This involves predicting changes in future demand over a certain period of time by analyzing past sales and growth information. Bear in mind. it doesn’t look at seasonal and external effects.

There’s a combination of trend forecasting techniques you can use. For example, use top-down forecasting to look at your most profitable goods and work your way to the bottom. Or try bottom-up forecasting to do the opposite. You can also be selective with customer demographics and gain insight into buying behavior over time.

Graphical forecasting 

If you’re more visual with your data, graphical forecasting is the way to go. You’re able to take the figures from your trend analysis and put them into graphs and pie charts. The advantage here is that it becomes easier to spot patterns in sales and customer demand data that might have been missed otherwise.

Qualitative forecasting 

To gather qualitative data, you need to go directly to the source (i.e. your customers).

Ask them questions like:

  • Why have you bought certain products?
  • What items do you buy the most and is that affected by time of year?
  • What features have you liked about this item and what benefits have come from using it?
  • How was the delivery experience for you?
  • What’s the maximum time you’re willing to wait to receive our products?

To gather this feedback, experiment with online feedback platforms (Typeform, Google Forms, GetFeedback), host in-person focus groups and look at product reviews from your customers. Once you’ve spent enough time getting qualitative insight, you can turn those answers into raw data to improve your inventory control.

Quantitative forecasting 

While qualitative research is useful for understanding the ‘why’ behind sales and customer experiences, quantitative research looks at the when, how, what and who. For example, seasonality falls under the quantitative category.

With this approach, you can analyze behavior around:

  • Festivals (Easter, Christmas, Labor Day, Thanksgiving)
  • Seasonal offers (summer sales, Black Friday, Cyber Monday)
  • Timed events (anniversaries, birthdays, weddings) 
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2: Stocking up on high-demand items is key to generating income

Odds are a lot of your cash flow is coming from your highest-demand products. Make sure they don’t run out. Start by deciding which items have sold the most over a given period (i.e. quarterly) and then compare a similar space of time to see if the sales percentage has gone up or down. 

To work this out, you can use the formula (current period orders) - (previous period orders) / (previous period orders). For example, a manufacturer of consumer electronics might have seen laptop chargers increase from 200 in January to 400 in April, showing a percentage increase of 200%. This demonstrates you have a hot product that you should continue to focus on ordering and supplying. 

Another technique is to do an ABC analysis, which means grouping your products into three categories:

  • A: Big-ticket items that are the smallest part of your inventory and have the largest yearly consumption value
  • B: Products in the middle-ground
  • C: Cheap goods with the lowest yearly consumption value 

As yearly consumption value is annual demand multiplied by an item’s cost, you can be more discerning in how you manage your high-demand items. 

Further analysis should also be done on how you can increase the profitability of your best-selling items. You could:

  • Negotiate with suppliers for a reduced cost.
  • Get your customers involved to see why they like buying the products and give them more incentives to keep buying.
  • Test different marketing strategies to see which campaigns raise the most awareness.
  • Look for new markets that can boost sales during times of the year when customer demand and revenue typically drop. 
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3: Employee theft detection could save you billions of dollars

In recent years, employee theft has become a major challenge for U.S. manufacturers. In 2020, a survey of 5,000 respondents said they lost $42 billion in revenue due to employee fraud. If that wasn’t bad enough, it’s estimated that 30% of businesses go bankrupt because of employee theft. 

So, it’s crucial you have policies to protect yourself against lost revenue and stop employees from stealing goods that contribute to your bottom line. When hiring new staff, always run a background check for criminal history and get references from previous companies. Educate every team member on having a zero-tolerance theft policy and the consequences if an employee steals.

For physical measures, make sure you have a strong security system (CCTV cameras) installed in your warehouses. Place them strategically around the facility and train security staff on what types of behaviors could be suspicious and should be investigated. This could include stock going missing at certain times, missing invoices, certain team members not taking annual leave and goods constantly being found near exits. 

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4: Replenishing your inventory makes good business sense

You can’t have a good inventory management system without regular inventory replenishment. This process means you always have the right quantity of items at the right time. It also solves challenges like minimizing carrying costs, controlling how much stock is bought, managing varied supply chain leads and the proper maintenance of categories, such as safety stock. 

Start by choosing the right inventory replenishment method for you:

  1. Periodic ordering: This involves checking whether inventory needs to be topped up at certain times (i.e. every quarter).
  2. Reorder point: This is based on specific stock levels. For example, you may have a standard 2,000 units of products and choose the reorder point to be when that number drops to 500. So, you’d then reorder 1,500 units to get you back to good inventory health.
  3. Top-off replenishment: This involves restocking inventory when demand slows or spikes in fast-paced industries (i.e. medical supplies).
  4. Demand replenishment: This is used to restock inventory based on forecast demands. It typically means that the amount of stock ordered will meet expectations because it’s been backed up by accurate figures. 

All four methods help with streamlining inventory management and can be further complemented with these tips:

  • Create replenishment categories: All your inventory will have different levels of importance and will need to be replenished differently. That’s why it helps to create specific categories like obsolete stock, safety stock and replenish stock so you can effectively manage your time.
  • Pick the right suppliers: Have a detailed review strategy for existing and new suppliers. Track lead times, fulfillment data and use vetting policies to ensure you work with the right people.  
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5: Creating a policy for obsolete stock will increase your profits

Obsolete stock are essentially goods with little to no customer demand over a sustained period. This type of stock can hurt your cash flow for several reasons. It increases inventory carrying costs, absorbs working capital that could be spent elsewhere and is typically sold at a lower net resalable value or taken as a loss. Either way, your profit margin is affected. 

If you have obsolete stock taking up space in your warehouse, that’s likely happening because of poor demand forecasting and buying practices. So, you’ll want to have a robust company policy in place to prevent this from happening. To make sure the policy is effective, you should:

  • Go back to basics with the inventory forecasting techniques we’ve mentioned and be as detailed as possible with your data. 
  • Track every inventory item through its product lifecycle and analyze customer demand data. By doing this, you can see the items that are in constant decline and becoming excess inventory (having more inventory than your demand forecast suggests is needed).
  • Take action before this excess inventory becomes obsolete stock by doubling down on marketing and selling. Or adapt how you reorder to match demand and lower stock levels. 
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6: Don’t be fooled into buying in bulk

It might sound tempting to order goods in bulk because you can get more goods at a better rate. But before you do that, you should consider what you’re planning to do with that inventory.

Are you planning on selling it immediately or will it be gathering dust in a warehouse somewhere? If it’s the latter, you’re going to be spending a considerable amount of money on storage and that could eat into your cash flow.

Instead, do a sense check on the purchases and deliveries you’ve already set up so you have full visibility into your inventory. By seeing the quantity and flow of goods in real-time, you’ll be in a stronger position to see how and where you’re spending your cash. It’s often helpful to incorporate technology that makes this process easier.

For example, advanced inventory management software includes a mixture of predictive analytics and integrations across sales channels. Imagine using a platform that integrates sales and inventory data together. You’ll know exactly how many units of every item are in stock, how many need to be shipped and where they’re stored. You could also use automated reordering to improve an existing buying process and be more productive with your inventory management strategy.

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7: Inventory financing is a good way to purchase more inventory with less risk

There may be times when you need to rely on inventory financing to buy more goods. Seeing more demand than you planned for, higher inventory costs, covering short-term cash flow problems and expanding product lines are all legitimate reasons to explore this option. There are two paths to consider.

The first is inventory loans, which are short-term loans that can be paid back monthly. But unlike other loans, you don’t need to provide personal assets like your house as collateral. The products you’re planning on buying or existing inventory act as collateral. This choice is good for small manufacturers because inventory loans tend to be easier to manage. 

The second choice is an inventory line of credit, which allows for ongoing funding to restock. It’s useful for big manufacturers who may need refinancing again in the future. This is because larger companies can usually cover the costs associated with the credit through their sales.

Regardless of what type of financing makes sense for your business, you’ll want to do everything possible to increase your chances of getting approved for financing. To do that, there are few things we recommend you do. These include:

  • Decide how much money you’ll need and what you’re going to spend it on. Look at your sales data, customer demand and current inventory and be clear on how much you can pay back on the loan. If you can’t repay your loan on time (or default on it), that will do considerable damage to your credit score and lower your credit limit.
  • Strengthen your current inventory management system. Lenders will do their due diligence and want to see you have good inventory control. They’ll expect evidence of shipping reports, sales order receipts, etc.
  • Check your business credit report before applying for financing. You can be sure lenders will do their due diligence to determine how strong your cash flow is, how reliable you are, how quickly you pay your invoices and if you’re entangled in legal troubles. All this information will show up on your business credit report, which is what financing companies look at when reviewing financing applications. 

Considering applying for inventory financing? Do your due diligence first.