What’s an appropriate inventory investment? This is a question that all businesses visit from time to time. Determining the right amount of inventory to carry may take some time but it’s so important you figure it out. Carrying too much inventory can cause companies to fail or suffer cash flow problems. It may be tempting to place a larger order and receive discounts from your supplier but be careful. While you always want to find the cheapest way to obtain inventory, over purchasing inventory is not the answer. Whether you are going to use inventory financing or pay cash for inventory you need to determine how much inventory you should carry at a time.
How much inventory should you carry?
Knowing how much inventory to carry is key for optimizing sales and operating a profitable business. There’s a difference between how much inventory you should carry and how much inventory you can carry. Business owners should set aside the financials for a bit and calculate how much inventory they should carry. To do this you should start by analyzing past and current inventory data to discover sales patterns. Next, you’ll need to determine your inventory turnover ratio (inventory turnover ratio=COGS/avg cost of inventory on hand). After you have determined the turnover ratio you should consider supplier lead time and internal lead time. If it takes your team one week to process 70 units and you receive about 140 orders per week, you’ll need to carry at least 140 units. Lastly, businesses should determine how much safety stock they need to cover emergencies or seasonal changes. Once business owners have determined how much inventory they should carry, they can move onto determining what it will cost to purchase and store the inventory. If businesses are unable to afford enough inventory, they may need to turn to inventory financing.
How do you calculate inventory needs?
The main part of calculating inventory needs is determining the turnover ratio:
Inventory turnover ratio = COGS/average value of inventory on hand
For example, if your COGS was $50,000 and the value of inventory held was $10,000, your inventory turnover ratio would be 5. This means your company should sell out of stock 5 times a year. If you compare this figure to national inventory turnover averages for your industry, you can learn a lot. If your ratio is low compared to industry averages there’s a good chance you may have extra inventory. This can cause funds to be wasted as well as storage space. If your ratio is much higher than industry averages, it may mean that you are not holding enough inventory.
What is a good inventory percentage?
Maintaining an inventory turnover ratio between 4 and 6 should mean that your restock rate and sales are well balanced. However, businesses can differ. In addition, if your inventory systems are not accurate it can lead to incorrect calculations which can disrupt inventory. The goal is to find a ratio that allows your company to neither run out of product or have a surplus of product. You want to find a way to meet demand efficiently.
How much does inventory cost for a small business?
When it comes to calculating inventory costs, you’ll need to consider more than just what the actual product costs. It’s important to also consider shipping, storage, and other costs associated with inventory. Retailers typically allocate 17% to 25% of their budget to inventory. However, this figure can drastically vary depending on the type of products you sell.
What are inventory costing methods?
In addition to effectively calculating inventory turnover ratios, small businesses should choose the appropriate method of determining the cost of inventory. The four inventory costing methods we are going to discuss are first in first out (FIFO), first in last out (LIFO), specific identification method, and weighted average cost method.
If you sell perishable products this is probably the method you’ll use. However, FIFO is gaining popularity for other types of products too. It’s known for being simple yet intuitive and accurate. The concept behind the method is simply, sell old inventory first and know that not all inventory is created equal. FIFO usually results in higher profit margins and is generally calculated by multiplying the cost of oldest inventory by the amount of inventory sold.
Rarely do retailers choose LIFO over FIFO, but it is an inventory costing method so we’ll discuss it. LIFO is the opposite of FIFO. Companies using LIFO sell the newest products first. Some businesses may choose to use LIFO for accounting purposes but FIFO is usually more effective.
Specific identification method:
Small businesses can achieve very accurate numbers by using the specific identification method. This method requires every piece of inventory to have a specific cost assigned. Balances are adjusted as inventory is bought and sold. If you have high-volume operations this method may not be feasible.
Weighted average cost method:
The weighted average cost method is one of the easiest ways to track and cost inventory. In a nutshell, this method averages the price of all purchased inventory. When items are identical or very similar this method can work well. The weighted average cost method assumes all items are equal, thus if prices vary you may have inaccurate inventory stock and costs.
What is inventory turnover?
By now you probably realize how important knowing your inventory turnover is. But what exactly is inventory turnover? According to Investopedia, inventory turnover is the rate at which a company replaces inventory in a given period due to sales. Inventory turnover can help companies determine how much inventory to carry as well as improve pricing, manufacturing, marketing, and purchase decisions.
How do I calculate inventory turnover?
Inventory turnover ratio = COGS/average value of inventory on hand
Is it better to have high or low inventory turnover?
In most cases, businesses are better off having high inventory turnover. High inventory turnover usually means a business is selling goods promptly and demand is healthy. If a company over estimates demand and over purchases inventory, this will result in a low inventory turnover. Having a higher inventory turnover should mean that you won’t miss out on sales opportunities. The key to achieving high inventory turnover is to ensure that sales and purchasing departments are in sync. Achieving the perfect match of sales and inventory should result in healthy cash flows and well managed operating costs.
Grow your business with Kickfurther
Stocking enough inventory means taking advantage of every sales opportunity. However, stocking inventory can tie up cash flow and be costly. Most companies need some type of inventory financing. For small businesses, it may be challenging or too expensive to secure inventory financing. Yet, somehow you need to find a way to finance inventory to grow your business. If you’re looking for affordable inventory financing, Kickfurther is the answer. We take a unique approach that allows supporters or backers to purchase inventory on consignment. Therefore, businesses can get the inventory financing they need without giving up equity in their company.
Kickfurther can help small businesses that need inventory financing. In addition to providing affordable inventory financing, Kickfurther has favorable repayment options. Depending on your expected cash flow, you can set the repayment schedule between 2-10 months. Kickfurther supporters are repaid in full plus dividends. Kickfurther was created by Sean De Clercq, an entrepreneur who struggled to find affordable inventory financing for his own business. As an entrepreneur, he found a problem and was determined to provide a solution. With 800+ deals funded and a 99.5% success rate, there’s no doubt that Kickfurther can help your business get the inventory financing it needs.