Managing inventory productively

From Wikimedia Commons

One of the most challenging aspects of running a business is managing inventory in a productive way.

First of all, what is inventory?  These are the products that you have purchased which you plan to resell to customers.

One new-wave approach to inventory management is “made-to-order.”  This means that you produce products when customers order them.  A great example of this is Lulu or CreateSpace, which will manufacture books as your customers order them.

Another approach is to sell products that can be costlessly produced.  For example, many web entrepreneurs sell PDF files of books. These files can be produced and made available for download an infinite number of times at no cost.

But not every product can be made to order or costlessly produced.  Many inventory products must be produced in quantity before they are ready for sale.  Suppose you run a farm.  Before you can sell a vegetable, you must plant a seed, grow it, harvest it, and get it to market.  Other products must be manufactured in bulk, perhaps in the Far East.

The trick here is to produce and stock the right amount of inventory, not too much and not too little.  Stocking too much inventory absorbs your cash flow (and can lead to high interest expense), requires storage costs, and creates risk of spoilage or obsolescence.  Stocking too little inventory may cause you to run out of product that your customers want, hurting your sales.

What makes this even trickier is that you must stock the right quantity of inventory of every single item you sell. The farmer needs to sow, grow, harvest, and get to market the right number of tomatoes, cabbage heads, squash, and everything else.  Too much of any specific item? It will spoil, unsold.  Too little? Lost sales.

To monitor how productively you’re managing inventory, keep an eye on inventory turnover ratio or number of day’s inventory. This financial statement ratio can signal whether your inventory levels are too high or low.