Inventory Basics

Operations: Deliver and run the business

Stock on the shelf is money you cannot spend.

A lot of you reading this will say inventory does not apply to you. You sell your time, or your skill, and there is no warehouse. I would push back a little. A cleaner has supplies. A landscaper has mulch, fuel and fittings. A restaurant has walk-in coolers full of food that will not wait. A contractor has a truck full of materials, some bought for a job and some bought because they were on sale. If you buy something before you use or sell it, you have inventory, and this lesson is for you.

Where you truly hold nothing, skip ahead to the questions at the end and ask yourself what you are prepaying for anyway. Everyone else, keep reading.

Stock is cash you have already spent

Buying stock feels like progress, but no sale has happened yet. The cash left your account the day you bought it, and it only comes back when the item is used or sold. Until then it is money you cannot use for payroll, rent or ads.

Say you order $6,000 of stock to get a bulk discount, and you sell about $1,500 of it a month. That is four months of your cash sitting on shelves. The discount looked smart on the invoice. Was it smart if you then struggled to cover a Friday payroll? This is the same timing problem I described in Working Capital and the Cash Conversion Cycle: you spend first and collect later, and inventory stretches the gap between the two.

There are costs beyond the purchase price, too. Stock can spoil, go out of date, get damaged, get stolen or simply stop being what customers want. A shelf of last season’s product is cash sitting in a slow loss that nobody has written down yet. Ask your accountant how to treat it on your books.

Know what you have, and know what you use

You cannot manage what you have never counted. Start with a simple list of everything you buy repeatedly. For each item write down three things: how much you keep on hand, how much you use in a typical week or month, and how long the supplier takes to deliver after you order.

Those three numbers give you a reorder point. If you use ten of something a week and the supplier needs two weeks to deliver, you must reorder when you are down to about twenty, plus a small cushion for a slow delivery. Reorder earlier and you tie up cash. Reorder later and you stall a job or turn away a customer. Which mistake costs you more in your business? Your answer tells you how big the cushion should be.

Count physically on a schedule. Once a week for fast-moving or perishable items, once a month for the rest. Do not trust your memory, and do not trust the number in your head from three weeks ago. When the count and your records disagree, find out why. It might be waste, theft, a job that used more than you quoted, or a delivery that arrived short. Each of those is a different fix.

Sort it, then shrink the slow stuff

Once you have counted, sort everything into three piles. Items you use constantly, items you use now and then, and items that have not moved in a long time. The first pile deserves a firm reorder point and a good relationship with your supplier. The second pile you might buy only when a job calls for it. The third pile is where your cash is trapped.

For the third pile, decide instead of ignoring it. Can it be used on a job, bundled into an offer, discounted, returned, or donated? Selling slow stock for less than you hoped still turns it back into cash, and the shelf space it frees is worth something too. Then ask what you did to end up with it, so you do not buy the same pile again.

Also look at your suppliers. Ask whether they will deliver smaller quantities more often, or hold stock for you against a scheduled order. A slightly higher unit price can be worth it if it frees up thousands of dollars of cash. Do the arithmetic before you decide either way, and ask your accountant how unsold stock is treated at year end.

This week

Pick the one place where you buy the most stock, whether that is a supply closet, the truck, the walk-in or a storeroom. Count it. Write down what it cost you, and circle anything you have not used in the last two months. Add up the circled items. That number is cash you have parked.

A first count and a simple list in a spreadsheet takes an afternoon, two to four hours for most small businesses. After that, plan on thirty minutes a week to recount and reorder. It costs nothing if you use a spreadsheet. Dedicated inventory software runs from free tiers to a modest monthly fee, and it only makes sense once you have enough items that a spreadsheet gets painful.