If you have read some of my other posts, you will know that I often caution against confusing profits with cash. Too often, business managers assume that, because they have earned profits, they will be able to pay for operational expenses. However, you cannot pay for anything with profits—you need cash, which means you need a good system for ensuring that you can collect your receivables in a timely manner. You can read more on this topic by reading the articles in the credit management and cash flow sections of this blog.
The basic mantra is: profits are not cash. In my post about getting more cash from your receivables I amended the mantra so it is now: Profits are not cash. But receivables are cash. I now need to make one more amendment so the mantra is now as follows:
Are you short of funds for paying salaries, vendors, operational expenses or other items? Have you taken a look at your inventory to see where you squeeze out a bit more money? You might be surprised just how much money you have laying around in stock that is obsolete, damaged, out of season, etc. Here are some things to consider:
- Do you know exactly how much inventory you have? How often do you do a physical count of your inventory? What systems and controls do you have in place to minimize overages or shortages when you do take a physical inventory? It doesn’t do you much good to view your inventory stock as a possible cash resource if you can’t be confident that your inventory on your books matches the inventory in your warehouse.
- How much of your inventory is obsolete? This doesn’t only include items that no one will buy; it also includes items that no one will ever buy at your current sales price. You are only fooling yourself if you do not regularly take an honest look at your inventory and mark the value down to market.
- Is it better to hold or sell some of your current inventory? Obviously, it is better to get rid of obsolete inventory because it is very likely that your cost of carrying the inventory is greater than the value of the inventory. But what about inventory that is not obsolete, but just old? Does it really make sense to hold on to the inventory, even at reduced prices, until it sells, or does it make sense to find someone who will take the whole lot off your hands for a reasonable sum? Keep in mind that having cash in hand puts you in a better position to gain supplier discounts on newer inventory that you can sell at higher margins.
- Do you have the correct amount of inventory? If you have too much inventory, then you have cash tied up in an asset that is semi-liquid. In bad times, it will be difficult to convert the inventory to cash; in good times, you are losing money because you can probably get a better return on your money if it is invested elsewhere. If you have too little inventory, you are probably losing sales because you cannot meet customers’ demands.
- When do you pay your vendors? Do you pay as soon as you receive the invoice from your vendor? Do you have credit terms with your vendors? If you can obtain payment terms from your vendors, you should take advantage of this. Vendor financing is often unsecured, and can be one of the least expensive methods of financing your business. If your terms are favorable enough, you may find yourself in a position where you do not have to pay the vendor until after you have been paid by your customer. There is the added benefit that, in bad times, your vendor, who would probably prefer to avoid having to take back his product, will work with you until you are able to sell the product.
- How effective is your pricing policy? Are you using pricing effectively as a strategy to move your goods? Do you know if yours is a seasonal business and, if so, when is your peak season and your low season? Are you aware of what your competitors charge and how you compare to your competition in terms of price?
- What is your inventory mix? Do you have too many individual inventory items? Or too few? If you have a large quantity of individual items, perhaps you would be better off reducing the total number of items you carry. Fewer items means less mistakes when it comes to counting inventory. You also gain a cost advantage when you buy product because you will buy larger quantities of each item. If you have too few items, you are missing an opportunity to increase sales by not offering a variety of choices to your customer. Keep in mind that one way to increase inventory is to have more accessory items, which can increase the value of a sales invoice, and enable you to sell more product without cutting into sales of your best selling items.
So take a walk through your warehouse and look at every inventory item as a pile of cash. Ask yourself: “What can I do to get this pile of cash out of my warehouse and into my bank account as soon as possible?” You might be surprised at just how creative you can be.