The essentials of working capital management (3)

For companies that sell physical products or goods, stock management forms an important part of their operations. Having excessive or large quantities of inventory can place a heavy burden on the financial resources of the company. On the other hand, keeping very low levels of inventory can result in lost sales because of an inability to meet customer demand hence reduced profit. The key is being able to reconcile the inventory levels of your products with customer demand and establish the rate of turnover (the number of days your products sit on the shelves before they are sold to the ultimate consumer).

It is important to reconcile each item of stock with customer demand to avoid incurring overstocking or understocking costs. By overstocking, you risk:

1. Incurring high insurance costs as you need to protect the goods from damage or theft.
2. Incurring high storage and maintenance costs.
3. Incurring high disposal costs due to stock getting obsolete or damaged
4. Having much of your cash resources tied up in unsellable stock. These financial resources spent buying stock could have been better spent elsewhere.

Looking at the other side of the coin, by understocking you also risk:

1. Incurring increased re-ordering costs because of the need to meet unmet customer orders.
2. Losing customers to your competitors thereby harming the reputation of your business.
3. Losing production resulting in you paying for idle labour even if nothing is produced.

To avoid incurring all or some of the costs above, it is essential that effective stock management practices are in place. Some of the practices that your organisation can use to manage and monitor inventory levels include:

# Implementing a Just-In-Time (JIT) purchasing approach: Instead of buying raw materials or physical products for stocking, JIT will help you purchase raw materials (for manufacturing purposes) or physical products (for resale) only when there is demand for the products. In other words, there should be evidence of confirmed customer demand for the products hence no need for large storage facilities. This minimises stock holding costs and allows cash to be freed for other profitable purposes.

# Monitor your security: Sometimes it could be that there is massive understocking due to stock leaving the organisation through the back door. There is need to tighten up security controls to minimise chances of inventory getting stolen or sold at knock-down prices by employees.

# Establish good supplier relationships: This is very important especially if your organisation uses just-in-time approach. As raw materials will most of the time be purchased when there is demand for the product, developing excellent supplier relationships is essential to ensure the supplier will not let you down but deliver the materials or physical products of the right quality and quantity at the right time and place.

# Know your stock turnover rate: Having a clear idea and picture of how long it takes for each item of stock to leave the company’s shelves will help when deciding how much quantity of each item to keep in stock. The rate of turnover could be in days. Thus, the fewer the number of days it takes for a product to shift from the company’s shelves into the hands of the customer the better. This implies revenue generation which can then be used for other investments.

# Review other suppliers: Stock management is about having materials or products of the right quantity and quality at the right time and place to satisfy customer demand. Problems arise when some suppliers become unreliable thereby affecting your sales revenues and ultimately profit. If this is the case, then it is advisable to switch suppliers. It easier to lose an unsatisfied customer because of an unmet order than it is to convince a defector to come back. Have a clear understanding of your supply chain and how it impacts your business.

# Offer discounts for slow selling merchandise: There are some products that might have been in stock for a long time. Instead of allowing these products to go obsolete, why not offer discounts to clear off the stock? The longer you keep them in storage, the more difficult it becomes to sell them.

How else can an organisation manage its inventory (stock)?

Comments and questions are welcome.

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