If you're a small business owner who sells products, you've probably asked yourself, "How much inventory should I carry?" Good question. Too much inventory ties up resources and space, but too little could disappoint customers and send them elsewhere if you don't have the item they want in stock.
Because retail sales can fluctuate depending on the season and customer demand, it's important to create an inventory plan that will help you sell as many products as possible without having to apply heavy discounts later. While there's no one-size-fits-all way to determine exactly how much inventory to carry, there are some best practices you can follow to find the sweet spot.
Set up an inventory management system
Every business needs an inventory management strategy. With this plan, you can track sales and notification patterns to answer the question, "How much inventory should I carry?"
Inventory management shouldn't just be a task done quarterly or annually to help you fill out your tax returns. Depending on your business type, you should track inventory weekly or even daily. If you track inventory frequently and efficiently, you can adjust your inventories more quickly.
Years ago, businesses needed to do physical inventory counting with pen and paper, but today hardware and software solutions like itinventory management systemsstreamline the process. In fact, several point of sale systems have this feature built in and automatically adjust inventory when an item is sold in your store or online. While you should still do a physical count to make sure numbers match and to identify shrinkage, data reports can reveal subtle patterns that aren't easy to spot just by hand counting.
An inventory management system identifies the best-selling products as well as items that could be considered obsolete. You may know which products are in high demand, but a system also gives you reliable trends to monitor, e.g. B. how seasons or holidays affect your inventory.
Once you spot patterns, you can set up a reorder point for each product to ensure you don't run out of the items you want. This is especially helpful when some suppliers take a few days to deliver. When you know the days of pen and paper are behind you,equipment financingcan help you afford the software you need to effectively manage your inventory.
Consider your industry
Your industry often dictates how much inventory you need. For example, if you sell clothing, you need to stock different sizes and consider how fashion trends can affect sales. If you own a restaurant, your inventory consists of the ingredients you use and you need to consider the expiration date of perishable foods. If you own a hair salon, your inventory consists of the beauty products you sell as well as the products you use on clients.
Consider all the external forces affecting the question "How much inventory should I carry?" For example, the time of year can affect your industry. If your business is going through slow cycles, you can reduce your restocking rate, but you want to be more active during peak seasons, e.g. B. Holidays, place higher orders.
Innovations can also impact inventory needs depending on the industry. Some products may be almost obsolete, such as B. 35 mm films or VHS cassettes. If your business sells items that are constantly being updated or changed, you may want to limit your investment so you don't have too much inventory on hand.
Determine inventory costs
The cost of your inventory determines the answer to our main question, "How much inventory should I carry?" But the cost goes beyond the price per unit. You also need to consider whether the product is seasonal or has an expiration date, and you need to calculate storage costs.
How you place your order also affects the cost. Retailers often get a discount when ordering large quantities, but if you own a small boutique or want to try a product, it would be wise to pay more for a smaller order. You don't want to be stuck with too much inventory if the item doesn't sell, no matter how good the discount is at a higher quantity.
Also consider the opportunity cost. If you order too much of an item, you won't have the resources to order something else. Investing in more inventory can mean bigger profits, but only if you can actually sell those products. In order to make an informed decision about additional quantities or new products, it's important to determine how much you can afford to spend without impacting your bottom line.
Know your inventory turnover rate
With ainventory management systemOn the spot, it's time to calculate your inventory turnover ratio. This number will help answer the question "How much inventory should I carry?" Use this equation to calculate your ratio:
Cost of Goods Sold (COGS) ÷ Inventory = Inventory Turnover Ratio
“COGS” is the cost of your inventory and “inventory” is the value of your products. Calculating your inventory turnover rate tells you how many times you've sold and replaced inventory over a specified period of time.
If your business has seasonal peaks, using your average inventory can appropriately account for the fluctuations at certain times of the yearInvestopedia. For example, retailers could have higher inventory levels before the fourth quarter and lower inventory levels after the holiday. Calculate the average inventory by adding the beginning and end of year inventory numbers and dividing the total by two.
If your cost of goods is $200,000 with an average inventory of $40,000, then you turn your inventory five times a year.
Most companies consider a turnover rate between 6 and 12 desirableInvestopedia, but that can vary greatly. Fashion retailers average between 4 and 6, grocery stores often around 14, and a store that sells high-priced items, such as a car dealership, often only 2 to 3, he reportedTradeGecko.
Calculate your stock sale days
Another formula to help you understand how often you cycle through products is Days Sales of Inventory (DSI). Just take the number of days in the year and divide it by your inventory turns.
In our $200,000 example above, it would take 73 days for your current inventory to sell out, or about two and a half months (365 ÷ 5 = 73).
While a lower DSI is ideal, your industry can affect this number, as can your inventory turnover ratio.
A real world example
To put numbers in context, consider this example fromtarget. In 2018, Target reported annual sales of $74,433,000, with year-end inventory value of $9,497,000 and annual cost of goods sold of $53,299,000.
Target's inventory turnover for the year is:
53.299.000 $ ÷ 9.497.000 $ = 5,6
Its DSI corresponds to:
365 ÷ 5.6 = 65 Roofs
That means Target replenishes its inventory 5.6 times a year and it would take 65 days to fully liquidate it.
Understand the numbers
If you know your inventory turnover ratio, you can see how well you are converting inventory into sales. This allows you to determine if you are at risk of having too much stock on hand or if you need to add more products. You may also need to invest in sales training for employees. Having to discount your prices results in a lower inventory turnover rate. And a higher inventory ratio could indicate that you need to sell your full-priced items frequently and add more products.
Remember that your inventory turnover ratio and DSI are averages and not every product on your shelf will sell. The reality is that some items sell quickly while others take a while. Consider industry averages to compare your inventory turnover to your competitors. You can usually find these averages on market research sites such asCSI Markt. You want to be close to the average, but every company is unique. Tracking your own sales is the best way to make informed inventory decisions when you're wondering, "How much inventory should I carry?"
Correct inventory management errors
So what should you do when you find that you have too much inventory on hand? Too many inventories on your balance sheet can affect your company's financial health. The more money you have tied up in products, the less money is available for other operating expenses such as rent, wages or working capital. They also need more space to display or store inventory.
If one of your inventory items is perishable, you need to keep track of dates and switch items in and out. Expired items result in a loss.
Consider offering discounts or special offers on goods. Also, determine if you can freshen up the products by creating more attractive displays or by placing them in a more prominent place, such as in a store. B. at the end of an aisle or on a table in the middle of your location.
Another way to liquidate inventory is to bundle items and apply a discount when a customer buys multiple items or when they buy a kit or set. For example, a gift shop might group three candles as a set, or combine a notebook and pen.
You could also offer inexpensive items as freebies or incentives with larger purchases. You can even donate items to a charity that will earn you a tax write-off as well as some marketing for your business.
Finally, you should consider liquidating inventory through an online marketplace such as eBay or Amazon. You can also sell your inventory to liquidation companies. While this can result in a loss, it will also free up cash flow and provide valuable lessons in answering the question "How much inventory should I carry?".
Of course, having too much inventory on hand is only one side of the coin. What if you don't have enough? If you sell out an item too quickly, customers will have to go elsewhere. You could gain a reputation for not having enough inventory, resulting in lost sales.
Finance your inventory
After answering the question "How much inventory should I carry?" You must determine how you will pay for it. Some suppliers offer companies a line of credit or payment terms for their stock orders. This depends on the length of your relationship and financing rates may vary.
Setting one up may be a better ideasmall business loan. If you have cash on hand, you have an easy way to pay for inventory when you order it. Some suppliers offer a discount if orders are paid for before shipping. And with a business loan, you can stock up for your peak season without worrying about monopolizing cash flow.
It is best to provide financing before you need it. This way you can act quickly when you get a great deal on products that you know will sell well in your store. A loan also allows you to expand your product offering, expand to a second location, or start an e-commerce division without worrying about not having enough products on hand.
Find your sweet spot
Knowing the answer to our question of the hour, "How much inventory should I take with me?" becomes easier over time. Regularly tracking your inventory gives you a wealth of data that can help you make decisions about your products.
Good inventory management will help you build your company's reputation. If customers love what you're selling, they'll be happy to come back to your location to see what's new. Keeping your inventory up to date can also help you grow your business. Set out the steps to create a planInventory management for small businessesThe operation.
Once you've found your inventory sweet spot, you can focus on providing great customer service - in addition to amazing products.