The importance of inventory
The importance of inventory (stock help in the business)
Inventory is defined as the stock or store of goods and raw materials in your business.
These goods are typically kept on hand at or near the business location, so that you are able meet demand and fulfil your reason for existence.
- If your firm is a retail establishment, for example, a customer may look elsewhere to have his or her needs satisfied if you do not have the required item in stock when the customer arrives.
- In contrast, if your firm is a manufacturer, it must maintain some inventory of raw materials and work-in-progress to keep the factory running. In addition, it must maintain some supply of finished goods in order to meet demand.
When looking at inventory, there’s a fine line between under-stocking and over-stocking.
The risk of under-stocking
If you decide to under-stock and just buy the raw materials or finished goods that you need right now, it is likely to improve cash flow, as you are only paying out for what you need right now.
This means that the business has more cash available to cover operating costs and to respond to change or uncertainty.
However, this runs the risk that stock will not be available to meet customer demand and makes the business less adaptable to shifts in demand.
Challenges related to over-stocking
On the other hand, it is important not to over-stock. Preparing too much, filling warehouses with raw materials or stock that may not be required, can tie up a lot of cash.
The risks here are significant:
- Tying up too much cash (working capital) that is needed to cover operational costs
- A lack of cash can make the business inflexible – without quickly available funds, you may be unable to respond quickly to opportunities, which may be vital for growth, especially in a competitive or fast-moving sector
- Storing products that may go out-of-date or become obsolescent (think of food items, chemicals, fashion items or fads such as fidget spinners)
- Gambling on the price of raw materials, import duty or interest rate changes: imagine buying a warehouse full of sugar, only to discover that the price has halved in subsequent weeks
Top tip: use cash forecasting tools to model different scenarios, consider the risks, and develop a plan that’s right for your business
Philip King, Small Business Commissioner