Want More Cash Flow? Look At Your Inventory

Have you ever been told your business made a nice net profit, but there is hardly any money in the bank account?

Cash flow for a business is more than just making a profit. If you have an inventory of products that you sell to your customers, then the amount of inventory you keep on hand and cycle through to sales will impact your cash flow. It’s one of the four pillars that drive cash flow (check out our articles on the other three: A/R, A/P and EBIDTA).

Maintaining a proper level of inventory is important to help sustain sales growth. However, too much inventory can lead to cash flow issues and restrict a company’s ability to meet its obligations. Customer buying patterns and other economic factors can all help determine how quickly you can cycle through your inventory.

Understanding how many days of inventory may you have on hand is an important measure for your cash flow. Knowing this metric can help you spot trouble where inventory in your warehouse may become obsolete.

How do I measure inventory cycle?

Below is a formula for calculating the number of days inventory on hand.

• Formula
  • Cost of Goods Sold / 365 days= daily cost of goods sold
    • Inventory / daily cost of goods sold= days of inventory on hand
• Example:
  • $500,000 / 365 days= $1,370 daily cost of goods sold
    • $75,000 / $1,370= 55 days of inventory on hand

In the above example, this company has approximately 55 days of inventory on-hand, or in other words, the company turns over inventory a little over 6 times a year.  This metric is dependent on many factors including supply chain constraints and vendor source opportunities.  The important fact is to measure this regularly to understand what it means to cash flow.

For instance, if the company reduces its days of inventory by 5 days down to 50 days, then it would have approximately $7,000 more cash in its bank account.  Managing inventory levels is as much an art as it is a science based on the numbers.  We don’t have a crystal ball to know how our customers might change their buying habits or when an economic event may occur that impacts our industry.  However, knowing how to measure our inventory in relation to how it impacts cash flow is important knowledge to make timely and reasonable decisions.

Do you know your inventory days on-hand?  If not you may find yourself asking the question of why you had such a profitable year, but you don’t have any cash left in the bank. Check out our downloadable template to help you measure this important metric. Let us know if you have any questions.