Turning stock into working capital

Most businesses have stock or goods for sale, unless they’re purely service based. Obviously stock is required to be available for sale when your customer is ready to buy. The aim of the game is to have the stock on the shelf ready for sale for the shortest possible time, because it costs money to have stock sitting around. Stock sucks up precious working capital that could be used for other things like advertising, salaries and expansion costs. Stock can cost you interest if you have borrowings in your business. If you can get into the habit of thinking of stock as 50 dollar bills piled up in your stock room this gives a really good incentive to manage every stage of the process where stock is concerned. Vital to this objective is to know the sales cycle of your products – i.e. how long does it take from when the goods arrive into stock until they are sold. You may have historical data upon which to calculate the sales cycle. If not, you need a way to calculate how long goods are sitting in stock so that you can minimize the length of time and maximize your available working capital. This is called ‘Stock Days’ and is an average of all stock lines. One way to calculate ‘Stock Days’ by using your financial reports is as follows: Stock on Hand ÷ Cost of Goods x Time Period = Stock Days Stock on Hand means the dollar value of stock in store at a given date – e.g. 30th June. Cost of Goods means the direct costs of getting the goods ready for sale – e.g. purchasing the goods, freight inwards, store costs but not fixed overheads like wages or advertising. Time Period is the reporting period upon which you are basing the above two numbers. A business with $150,000 in stock at 30th June and Cost of Goods for the year of $400,000 has ‘Stock Days’ of 137. $150,000 ÷ $400,000 x 365 = 137 This means that, on average, stock in this business takes 137 days from when it arrives into stock until it is sold. Once you know this number you are then in a position to manage the situation and work on shortening the cycle. You may think this is a ‘no-brainer’ and that all you have to do is sell stock quicker. We all know how hard it is to sell anything; otherwise everyone would be doing it. The real trick to shortening the ‘Stock Days’, is to carefully manage when the stock is coming in, as well as focusing attention on when it is going out. You need a system for purchasing stock – not just buying when the sales rep calls. If you have a ‘model supplier’ who knows your sales cycle and only supplies when you need it, great – but if not, you need to create your own methodology. Record-keeping This first thing you need is a good record keeping system that tells you what is selling, what isn’t selling, what are slow moving items, what has become obsolete, what are the trends/seasons, what are your margins on items, and what is it costing to store stock. All of the above needs to be known for individual items as well as item groups. Once you know the above you are well on the way to being able to manage stock at optimum levels. You can determine your minimum and maximum stock level requirement for various item lines. This makes it much easier for staff to know what, how much and when to order. Many businesses buy when the sales rep calls in or if they get offered a discount. You should buy stock when it suits you and your needs, not those of your supplier. Discounts can also be a big trap. Ask yourself “Why are they discounting?” Do they know something you don’t? Is there a new product coming up that will supersede the existing one? Measure the cost of having that stock sitting around sucking up working capital against the discount being offered. It may be tempting to swap cashflow for potential increased profits, but if it’s going to cause cashflow problems perhaps it’s not worth it. Stocktaking Stocktaking is a necessary evil in any business dealing with stock. You need to regularly check stock levels, not only for tax purposes, but for knowing your business profitability. You can do this by keeping a continuous record, also known as ‘Perpetual Stock Method’ or by regularly counting stock levels. There are literally thousands of Stock Management systems available which should reduce the need for manual stock-takes. It may seem like a pain and expensive to install – but the dividends far outweigh the cost. Such systems will report on all aspects of stock management including stock searching, stock receiving, bar-coding, special pricing, sales orders, picking and packing, dispatch register, order fulfillment, product specifications, manifests as well as reporting on stock usage and reordering requirements. Many systems will also help you manage sales prices based on cost prices so that your margins are always maintained. They will automatically adjust sales prices without your having to constantly recalculate them. Obsolete stock can be a real ‘hiding place’ for cash. It can be heartbreaking to have to sell items at a loss, but if they are going to sit there forever, you may as well turn them into working capital to spend on better selling items. If you have good records you are also in a position to know just how much you are purchasing from suppliers. This puts you in a better bargaining position when renegotiating prices and terms. A really great tool you can use to manage your ‘stock days’ is Industry Benchmarks. Good Benchmarks should include ‘stock days’ for the low, average and top performers in your industry. This gives a real clue to why some businesses are in the ‘top performers’ category. You will find their ‘stock days’ are less than those in lower categories. Sue Hirst is with CAD Partners. For a free e-book on cashflow control go to www.cadpartners.biz/e-book.htm