Make better business decisions with inventory management

inventory managementBusiness decisions have the ultimate goal of improving profitability. Decisions concerning inventory management too impinge on the profitability of a business. Money tied up in inventory is a ‘dead’ investment as it does not yield any income. Therefore, the investment in inventory should be kept at the optimum level. This is all the more important if the inventory is purchased out of borrowed funds, as a higher investment in inventory would increase the finance costs and reduce the profit. However, care should be taken to maintain the adequate level of safety stocks so that the company does not lose any business opportunities due to paucity of inventory. An effective stock management system therefore needs to be put in place to improve the profitability of a business.

Deploying inventory management software that gives the online, real-time status of inventory can help to obviate the costs associated with unnecessary ordering and carrying of inventory. Another important factor is that, the lower the amount of average inventory held, the lesser will be the loss on account of obsolescence, damage, deterioration or theft and therefore, the higher will be the profit.

The cash conversion cycle (CCC) of a company is a metric that is indicative of the length of time between the date of purchase of inventory and the date of realisation of cash from its receivables. In other words, it is the sum total of the average number of days for which money is tied up in the inventory and the receivables less the average time taken to pay its suppliers. Therefore, a longer cash conversion cycle adversely affects the profitability a business.

As the amount of inventory held is a major component of the cash conversion cycle, an effective inventory management method has an important role to play in reducing the cash conversion cycle and thereby increasing the profitability of the business. If the business is managing its operations using borrowed capital, an effective inventory management is crucial in reducing finance costs too.

A shorter cash conversion cycle is also indicative of efficient working capital management. By resorting to better inventory management techniques, the working capital can be deployed in activities that fetch a better yield rather than investing in huge amounts of non-yielding inventory. An increase in profit can boost the profitability indices such as the Return on assets (ROA) and the Return on equity (ROE).

The various stakeholders associated with the business have different interests. While the shareholders are interested in higher dividends and share price appreciation, the suppliers are interested in the liquidity of the company which would ensure realisation of the credit extended to the company. The lenders on the other hand are interested in the debt servicing ability of the company which is indicated by its liquidity and solvency.

The above facts emphasise the importance of managing working capital and cash flows effectively in order to increase the profitability of a business. Good inventory management is a critical part of this and vital from the point of view of making better business decisions.