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The Cash Impact of Reducing Inventory Levels

4 years ago
Rita K

The object of the game is to reduce inventory relative to sales.

Expressed another way, it is imperative to improve inventory turns. Simply, if a company has $1 million invested in inventory to support $10 million in annual sales, that equates to 10 inventory turns per year. Obviously, that doesn’t account for peak seasons, where inventory levels might go up to anticipate increased seasonal sales, but expressed as an annual average, it means that the company has $1 million tied up in inventory on a regular basis. If that company could support the same level of sales with only $500,000 invested in inventory on an annualized average basis, the company would free up $500,000 in cash to invest in other priorities.

It is trite to recognize that every business could list many initiatives that would improve the future of the business, but which cannot be accomplished because of budget limitations.

As everyone knows, the expression just in time came to dominate corporate planning activities during the 80’s and 90’s to the point that large companies have completely altered their expectations about appropriate inventory levels. They accomplished their objectives by investing in infrastructure. Specifically they invested in warehouse management software systems, warehouse automation, order integration and linking all of that to inventory forecasting.

Unfortunately, the rich got richer and the poor got poorer.

Smaller companies, unable to afford the expensive and sophisticated tools that Walmart and The Home Depot acquired found themselves progressively less competitive because they were burdened by expensive legacy infrastructure that resulted in expensive operational processes and the requirement of maintaining greater-than-optimal inventory levels, tying up large amount of working capital in the process.

Free cash flow is the amount of cash a company can generate (excluding amounts spent on capital projects, such as buildings and equipment). Effectively, it’s cash that can be used for anything and especially for things that can help the business to grow and prosper in the future. Take a dollar out of inventory and that’s a dollar you can put into a new machine, or a new product, or process. It could also be distributed to stockholders, or used to increase salaries. Regardless of the purpose to which it might be put, it’s a dollar the company did’t have yesterday.

Basically, your supply chain improvements provide the financing for future projects. It’s the cheapest bank you will ever find. Optimal management of your inventory levels is undoubtedly the most impactful element of supply chain management.

The good news is that improved inventory management is available with new, sophisticated yet affordable software solutions. The really good news is that that same software also provides enormous improvement in process automation, accuracy and productivity. The software allows you to reduce facility requirements proportional with inventory level reduction, speed picking processes, increase picking accuracy, improve shipping efficiency and reduce shipping cost dramatically.

When Walmart and The Home Depot were developing their solutions, the cost was in the millions. Today, a truly awesome system can be acquired and implemented for under $250,000. Every company has to do their own math, but the ROI on such an investment is often less than one year. In addition, the range of collateral benefits of an excellent warehouse management system is often hard to anticipate. But, these benefits are real, making the ROI even better.

If you can ship faster and more accurately, you will improve customer satisfaction, which will lead to increased sales. If you can reduce inventory and facility cost, you can pass those savings along to customers and make your company more competitive. If you can monitor picking speed and accuracy, you can quickly manage personnel challenges and build the most productive team of warehouse staff, further improving accuracy and picking speed. Damage to inventory will be decreased. Integration with peripheral software systems is seamless and automatic, resulting in better financial control, better purchasing decisions, optimal customer service integration and superior visibility into inventory velocity (e.g., which items are selling fastest and with what other items? Inventory velocity is a challenging thing to analyze. A simple example serves to illustrate this. Sometimes, it is a combination of items that drives sales. By seeing the sales rate of only individual items, it is possible to overlook such a connection. Knowledge is power.)

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Cash is King.

Inventory is cash.

Reduce inventory, increase cash.

Pretty simple.

How can you accomplish this?