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Inventory Management Strategies to Improve Cash Flow

Inventory balances are on the rise. This point has been made clear after both talking with a number of manufacturing companies in Central Pennsylvania and reviewing industry data across the country over the past couple of months. According to the U.S. Census Bureau’s most recent Manufacturing and Trade Inventories and Sales report, inventory levels for manufacturers and wholesalers is up 9.0% and 15.9%, respectively, from November 2020 to November 2021. This should come as no surprise, as several factors have caused this increase:

  • inflation is driving up unit costs;
  • demand has rebounded from the pandemic, resulting in more customer orders;
  • staffing constraints have exacerbated the backlog of orders, resulting in extended lead times; and
  • an unreliable supply chain is tempting companies to overstock certain materials in hopes of avoiding further disruptions in fulfilling customer orders.

As inventory accounts for a larger portion of a company’s balance sheet, it is critical to spend time analyzing whether this increase is a good thing or something to be remedied. Maybe your company’s increase in inventory is an intentional business decision made by management to position your company to grow while continuing to meet existing customer demands. If it is, consider the sustainability of these elevated inventory levels given the current resources you have at your disposal (i.e. limited staff, limited warehouse space). Maintaining higher levels of inventory not only negatively impacts cash flow, but it may also lead to increased costs due to writing off slow moving/obsolete inventory or even needing to spend significant money to expand your warehouse.

For most manufacturers, the increase in inventory was unintended, and there is a desire to free up additional capital by implementing inventory management strategies such as the following:

Maintain Accurate Inventory Records

Before you can move on to other inventory management strategies, this first step is critical. Without visibility to your inventory levels, you will be blindly managing a critical part of your operating cycle. One necessary step to maintaining accurate inventory records is to perform regular cycle counts to test the accuracy of your inventory system. The process for selecting items to cycle count can either be done at random or by utilizing a systemic approach such as the “ABC” method. This method starts by identifying those inventory items which only take up 20% of your total inventory count but represent 80% of your sales (“A” items). Your “B” items may take up 30% of your total inventory count, but account for 15% of your sales, etc. When determining which items to cycle count at each period, you will focus most of your sample of “A” items and less of your sample of “C” items.

Invest in Technology

The software you are using to manage your inventory must fit the size and complexity of your company. It is neither quick nor easy to upgrade to a new inventory management system or enterprise resource planning (ERP) system. However, if you have experienced significant growth in the last 5 years it may be worthwhile to do a cost benefit analysis of upgrading your ERP system to fit your organization today. A good inventory management or ERP system will give you the visibility you need to avoid overstock, limit slow moving/obsolete inventory, and capitalize on all sales opportunities by having enough inventory on hand to meet demand.

Another aspect of investing in technology as an inventory management strategy is to invest in artificial intelligence (AI). This is especially relevant today, as manufacturers have experienced a number of disruptions over the last two years. Nick Boyer, Director of Strategic Consulting at PROS, recently summarized the benefits of AI for manufacturers:

“AI can respond more quickly and accurately to disruptions than a human can, adjusting pricing immediately, across a portfolio of products, to accounts for supply chain issues, inflation and other external factors. It can also predict how demand will respond to price changes in these volatile times, helping manufacturers to ensure price moves do not result in demand that ultimately cannot be satisfied.”

Centralize Distribution Centers

While this recommendation is certainly not fit for each company, one inventory management strategy is to move toward aggregating inventory into one location rather than spreading it across multiple distribution centers. While multiple distributions centers can allow you to better serve multiple geographical markets, it also requires extra inventory on hand to ensure each location is adequately stocked. Furthermore, each additional distribution center requires more effort from your team to appropriately monitor inventory levels across multiple locations.

Determine Economic Order Quantities

Depending on how quickly your inventory turns over and to what degree you have warehouse capacity restraints, the storage costs you incur by having inventory overstock may outweigh the discounts you receive when you buy in bulk. Economic Order Quantity (EOQ) is a complicated calculation which determines the most cost-effective inventory quantity to order. EOQ quantifies the point at which the holding costs (includes a portion of rent, inventory write offs, etc.) matches the ordering costs (direct and indirect costs incurred each time you order inventory). That point represents the ideal order size to minimize costs for your company. Many inventory management systems and ERPs automate the complex EOQ calculation, which again points to the importance of investing in technology to assist in inventory management.

These are just a few inventory management strategies to improve cash flows. Please contact us if you would like to learn more about how our team of manufacturing experts can assist your company. You can also visit our webpage to learn more about the manufacturing services our team provides.

About the Author

Brett Bauer

Brett joined McKonly & Asbury in 2011 and is currently a Director with the firm. As a member of the firm’s Audit & Assurance Segment, he serves clients in the manufacturing and distribution industry. At McKonly & Asbury, Brett… Read more

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