Small businesses often find themselves wedged between the rocks of working capital. You understand that you need to maximise working capital to grow and thrive, but you’re limited on how to do it. You’re aware you need to increase liquidity to facilitate success but you’re understandably wary of increasing debt, external financing, and other external ways of strengthening the balance sheet.
However, it is possible for small businesses to optimise their working capital by looking closely at their inventory management and making some key changes.
What is Working Capital?
Working capital is effectively the money you have to ‘play with’ as a business. It’s the number of your current assets minus the number of your current liabilities. Therefore, even if you have many valuable assets, you may only have a very small working capital if your liabilities are proportionally high. Conversely, if both assets and liabilities are small, you may, in fact, have greater working capital.
There is a whole range of factors which affect working capital – both how much you have, and how much you need. Factors such as the industry you are in, your supplier relationships, and customer relationships all affect your working capital.
Working capital is also greatly affected by the nature of your current assets and how quickly they can be liquidised or turned in to cash. If the majority of your assets are either actual cash or highly liquid assets (such as investments), then you may be able to function with a smaller amount of working capital. On the other hand, slow-moving inventory items may require you to have more liquid working capital or simply more working capital overall. Therefore, you can see the importance of optimising working capital through inventory management.
Optimising Inventory Management Optimises Working Capital
By focusing on optimising your inventory management you can, in turn, optimise your working capital. Given a healthy amount of working capital is imperative to the success of your business, you cannot ignore this. In short, if you cannot meet the needs of your liabilities then not only is growth stifled and impossible, your very business’s survival is at risk.
On a day to day basis, business leaders tend to think of working capital as their cash flow. The natural tendency, of course, is to chase growth and success and increase your working capital, or cash flow, by increasing profits through sales. They will also look to limit expenses wherever possible, and minimise wastage. Both are good practice. However, anyone who has run their own business will know that growing profits don’t necessarily equate to improved cash flow, for a myriad of reasons.
However, there are some ways you can improve things:
Think Minimum: Holding inventory costs. It utilises money you could be using elsewhere, you have to store it and insure it, and it poses all sorts of logistical headaches. That’s before you factor in the risk associated with holding more than the bare minimum amount of inventory. By holding too much inventory you are risking loss should the market, demand, or price change, and you also risk deterioration or damage to the inventory over time. Therefore, your goal should be to minimise the amount of inventory you hold to the lowest possible amount without jeopardising your sales. It’s a careful balance.
Read ‘Inventory Management for Small Business – 5 Helpful Tips‘ for insight on how to minimise your inventory.
Use Analysis to Your Advantage: Insight is powerful in any businesses, and you should never be afraid of analysing the data. A key analysis you should undertake is the Inventory Turnover Rate or Ratio (ITR). This is a calculation of the number of times within a set time period (usually a year) you are able to sell and restock inventory. There are a few different ways of doing this, and which is most appropriate will depend on your business. The ITR you’re looking for will vary according to the nature of your business. However, a good general rule of thumb is an ITR of about 80-20. This means that you should expect around 20% of the items in your inventory to be responsible for generating around 80% of sales. In real terms, this means that for inventory management, you need to be focusing your attention on that all important 20% – always making sure that is in stock, and taking a slightly more compromising approach to the remaining 80%.
Read ‘So Many Products, So Little Margin‘ to find out more about managing your product portfolio.
Refine, Refine, Refine: Inventory Management isn’t a one-off exercise. It is continual and should continually be refined over time. Just bringing inventory management on to the table you’re taking strides to improve your working capital, but you can go further.
For example, you need to be looking both up and down your supply chain to see where refinements can be made. You can look at your order fulfilment process and timescales – is there wastage there? Does your supplier offer free delivery for orders of a certain size, and is it worth it? Can you operate with more just-in-time deliveries rather than bearing the burden of storage and holding on to inventory? How do promotions, sales, and historical trends affect your inventory management? How ‘forgiving’ and loyal are your customers? If you don’t have an item in stock will you lose them rapidly to a competitor? The good news is that this is excellent business practice anyway, regardless of whether or not you want to improve your working capital.
Read ‘10 Questions – How Effective is Your Inventory Management?’ to see how effective your current approach is.
Small Business Decisions
Small businesses have a considerably smaller ‘buffer zone’ when it comes to operating with working capital, and also how they approach their inventory management. This means that it is essential that they are savvier in their approach and use the latter to optimise the first. Optimising your working capital through inventory management gives you the framework in which your business can grow and thrive, and turn profits into real success.
The consulting team at Paul Trudgian are experts in inventory management and inventory optimisation. Contact us today to discuss the improvements we can make to your business through improved inventory control.