Inventory isn’t an asset until it stops being inventory
Inventory management is the single most involved part of managing a successful Profit and Loss. It touches absolutely everything from direct sales to customer service to marketing to the all-important cash flow. To get a handle on how to manage inventory, start by framing inventory as a liability rather than an asset. As the vice president of sales for a manufacturer who is in the business of selling you inventory, this probably seems pretty counterintuitive. The reality of the situation is that your manufacturing partners won’t have a retailer to sell to for very long if that retailer cannot get out from under their inventory liability.
In accounting terms, inventory is always positioned as an asset since it is convertible to cash contingent upon your ability to sell it. That is a really easy sentence to write, however, actually executing the task of “selling it” kind of encompasses the entire purpose of your business and incorporates every facet of your Profit and Loss. That’s why accountants, well, account, and business operators handle the revenue generation. It is this simple position taken on the income statement that leads retailers down the dangerous path of viewing their inventory as money in their pockets rather than maybe someday money. I don’t know about you, but I don’t pay my mortgage in money I might make someday. Buying like inventory is cash leads to squeezes on cash flow that will not fix themselves until you fix one of two things: how you buy and/or how you sell.
Changing how you buy is a real process, and in the corporate world many of us came from, we use the word “process” as corporate speak for enormous pain in the ass. The easiest way to identify your strengths and weaknesses where buying is concerned is by asking yourself some pointed questions:
- When do I buy?
- How much do I buy?
- Why do I buy?
These three questions, while simple, allow you to conceptualize a basic framework surrounding your buying process. For example, in response to the question “When do I buy?” a retailer may say, “Well, when a box is empty or about to be empty.” This is an obvious time to buy for just about everyone. The assumption made here in placing an order based on this information is that an empty box is a box that sold through—always a good thing in both accounting and real world terms.
Determining whether that box you sold was an asset, however, is where the asset/liability conversation comes into play. Now that the box has sold, we can identify whether that box paid its rent in a timely manner. Did that box turn in a week? A month? Did it take a year? How much is that front mark worth to you and your business? The answer you come up with shouldn’t just guide your inventory decisions, it should be gospel.
The next question we should ask ourselves is “How much do I buy?” to which a retailer may say, “One to show and one to go.” This is a good, kitschy saying that relies on the assumption you know how that SKU turns. What I mean by this is that you know, before placing that order, the answer to the above question about how quickly a given front mark has turned. If it took a week to turn, buying the old “one to show and one to go” adage is probably a bad decision from an inventory standpoint. Between the time it has taken for the SKU to run out, you to notice it ran out, you to have time to call the rep or wait for them to show up, and then the order to ship and get tagged and restocked, we could have missed an entire inventory turn if the SKU moves in a week. That extra turn pays a month’s rent if we fix it for the year and, in doing so, frees up cash. Alternatively, if the SKU turns once every six months, your “one to show, one to go” motto just turned that box order into a yearlong liability. Missing this process once or twice is no big deal; however, multiply it by, let’s say 50 bad buys in a year, and we have a serious space issue in the humidor and unnecessarily constricted cash flow.
The last question we should ask, after figuring out when and how much we should be buying, is “Why are we really buying?” A retailer may respond with, “Well, my blah blah rep came in with a 5-1 and the margin was too good to pass up.” Managing inventory to margin is great if you have the cash to stomach it, but sometimes a deal just isn’t a deal. Take, for example, the SKU referenced in the last paragraph that turns twice a year. That 5-1 you just bought tied up that cash for three years. Do that enough times in a year and you might not get the chance to see that extra margin without a friendly landlord and a part-time job. Similarly, if you’re waiting on buys to pay a credit card off or get some bills paid, you’ve entered into a self-fulfilling cash flow prophecy that ends in staying just as broke and the store looking just as empty.
These three questions, coupled with having and actually using a system to measure inventory and how it turns can change your cash flow position and affect your bottom line in a truly meaningful way. The results may not be instant, but they manifest themselves quickly enough to keep you motivated. Track your turns, buy smarter, buy for the right reasons and remember that what gets measured, gets done. Soon enough you may actually believe your accountant when he tells you that inventory is an asset.