Inventory Management for SMEs

Transcipt of an interview with Paul Trudgian for DestinoNegocio, the entrepreneurship website for Latin Amercia.

As a small business owner, what are the main challenges to manage the inventory?

In any small business it is likely that working capital will be very constrained and the business will need to optimise the use of available cash. The temptation is often to over-stock ‘just in case’ or source products in bulk to achieve discounts, but ultimately this usually leads to over-stocking, obsolescence and ultimately wasted cash.

What are the usual mistakes in this area — and how to avoid them?

The usual mistakes are buying too much stock as a consequence of not forecasting demand, not managing the product portfolio and failing to react to the product life-cycle.

To avoid these mistakes there should be a strict inventory policy that determines the ‘optimal’ level of inventory for each product that the business sells. This inventory policy should be driven from historical demand, forecasted demand, product lead times, procurement quantities and customer service targets.

There are many inventory optimisation systems on the market that can facilitate the above, but for a small business I would recommend building simple statistical spreadsheets to make the relevant calculations. This avoids unnecessary expenditure on software.

Bad inventory control can prejudice the business finances. What are the major risks?

Bad inventory control leads to over-stocking which consequently means a business has invested more cash than it needed to. Also over-stocking increases operating costs through storage, insurance, damage, loss and obsolescence.

Ultimately all businesses want to maximise returns with the lowest level of investment. To put this into context a small business could sell $1m worth of a product each year, providing total revenues of $2m. If the business buys all $1m worth of the product at the start of the year, by the end of the year it would have made a $1m gross profit on an investment of $1m. However, if the business buys 50% of the product at the start of the year, sells it and then buys the next 50% with the sales revenue, then the profit will remain the same, but only $500k is required as a total investment.

This is the essence of good inventory management – try to buy only what you need, when you need it.

What else do you think our reader (latin american small business owner) should know about it?

The key points I would make on inventory management are:

  • Forecast your demand, and aim to purchase stock in line with that demand
  • Don’t spread your cash investment in inventory equally across all products. It’s better to never run out of stock for the high earning products in exchange for occasionally running out of stock for low earning products
  • Beware of bulk purchase discounts – does the discount compensate for the additional storage, handling, insurance and obsolescence costs that you may incur?
  • Always try to negotiate the lowest purchase quantity and quickest lead time with your suppliers. The less time you own the stock the more money you will make
  • Don’t assume that you need to invest in inventory management software – Microsoft Excel is a very powerful tool that can be applied to great effect

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