A recent conversation with a business owner of an Online Business, selling through Amazon, made me realise how confusing Stock, Cash and Profit can be. If you have an online business but have no idea how to manage your inventory and how to calculate your profits, you could be heading for a cash flow meltdown!
For a start, don’t confuse what is in your bank account with what your profits are. Particularly in the case where stock is involved.
They are simply not the same thing!
You can be highly profitable but be low on cash. Why? Well, because all your profits may be tied up in unsold inventory!
For this young lady, it certainly seemed like this was the case.
This lady, was an Entrepreneur, who had started her on line business selling new eco products online. A product she felt very excited about and really believed in their health value. Her model to purchase the product from a main supplier and resell it at mark-up looked like a great idea.
She was charged commission on her purchases and just had to cover her own distribution, marketing and selling costs. Her overheads were pretty low as she operated this as a home business and just needed storage for the stock. Her question to me
“When will I ever start to see any profits?” was plaintive and desperate.
You see, she was a stay at home mum and desperately wanted to have some cash of her own, yet the business seemed to be sucking more and more money in despite the sales growing.
It felt like an enigma so we sat down and talked this through and I was able to explain some key points about stock management which I feel are absolutely crucial to understand.
Stock and inventory management can lie as the heart of the problem. The more you buy the more cash you require.
This is fine where you move the goods quickly but inefficient purchasing can result in more products lying on the ‘shelves’ and let’s remember
Here’s my hit list of Key Questions you should be able to answer about your inventory management. If you are confident in your answers you should be feel confident that you are releasing the most cash back into your business.
Question 1: Are you buying the right stock?
The right inventory will be stock that moves quickly. The time between you spending the cash to purchase this item and you receiving the cash for the sale of this item should be minimal.
Question 2: What is the best amount of time to hold inventory for?
So let’s not forget, every item of stock you hold is cash tied up for you. You want to try to turn every item of stock into a sale as quickly as possible.
In order to know what is the most efficient holding time, think about the way you are purchasing. Are you buying on credit so you get delivery and pay 30 days later? If so, you can hold the stock for up to say 25 days.
However, if you pay at the same time as you either place the order or receive the goods, then you want to get your stock moving as quickly or even before the point you purchase the item of stock. With some online stores I know the final customer pays first and the stock could be ordered from the supplier and posted out to the end customer in a fairly quick turnaround time.
The trick is to try to get the cash in for the stock your sell before you have to pay for it.
Question 3: How do I work out which stock is not being managed in the most efficient way?
The ratio called Stock Turn is a great measure to use here.
Stock Turn works out how many times you replenish or order in you stock per year. It gives a great indication of whether it is slow or fast moving. You would be aiming to hold as much fast moving stock.
The insight really comes though, when you compare different stock items against each other. You can then look to try to weed out the slower ones. Or perhaps where you need to discount these products to get them to move faster. Sometimes it is better to have faster moving stock at higher volumes of sales.
Selling at a lower price can give an overall higher profit.
So here is how we calculate this metric
Stock Turn = Sales per year/stock
The higher the ratio the more efficient your stock holding. Efficient meaning you tie up less cash in stock in order to service this level of sales.
Question 4: So what determines the best level of stock to hold?
Firstly, the Lead time. Do you know how long it takes for you to order a unit of stock?
If not, here is how to calculate lead time. This is the number of days it takes from placing an order to delivery of your stock to you.
But of course it isn’t as simple as that, you also need to look at the other variables:
How many do you sell a week or a day?
How often do you place orders?
What batch size do you have to order in. (MOQ)
This last question, can complicate things. Your supplier may have minimum order quantities (MOQ’s) that he will apply to you. Therefore, you will need to bear this in mind when trying to assess your lead time and the most efficient level of stock to hold.
Generally speaking, you should try to push for the lowest batch quantities to order which are right for your business, rather than letting these be dictated by your supplier.
Infact, Suppliers may try to lure you into holding the wrong levels of stock by using minimum order quantities. Try to negotiate the lowest batch size you can, especially if this item of stock is slow moving. Just because the supplier offers a discount on buying larger batch sizes, don’t forget the money’s not yours until you sell it. If that’s one year from now, well that’s a long time to wait!
Question 5: What other metrics can I use to determine if my stock is being held at the most efficient level.
Days inventory is a great measure to use as it literally tells you:
How many days of stock are you holding?
So that’s great isn’t it? You can also compare different lines of stock and see which levels are being held at the higher levels. Try to think about and understand why some stock levels are higher than others. Perhaps this is due to long ordering and delivery lead times or high minimum order quantities are restraining you. In this case you may need to look at alternative options where you can.
If there is no logical reason cut back down.
So let’s see how that might look:
If you have 100 units of stock and you sell 50 units a month;
then you are holding 2 months’ worth of stock.
If the lead time for ordering is 10 days, this tells you that you are over stocking and your much needed cash is being locked up in stock. Reduce your stock levels.
However, if you are holding 100 units of stock,
you sell 200 units a month
and your lead time for stock is 2 months,
you probably need to increase your holding, to prevent running out of stock.
We don’t want that as that will impact on our customer delivery times and service level.
So there we have it. A whistle stop tour of stock management.
The principle though in its most simplistic form is
Of course stock levels will inevitably have to rise the more you sell. So, ensure the cash tied up is minimal given the level of your sales growth. Being able to measure, track and adjust your stock levels can release much needed money back to you, so this is an area that deserves focus
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