7 Ways Better Inventory Management Will Improve Your Cash Flow

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.

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.

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) 

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. 

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. 

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.