We have too much inventory and not enough cash, what can we do?

This article first appeared March 23, 2011.

For businesses that carry inventory it is often a millstone around their neck, with stock levels which are way too high. It’s not unusual to find SME businesses with a pile of inventory equivalent to the profits of the last three to five years.

I have visited businesses where you literally could not move for inventory. In fact, one notable occasion saw me using the most enormous roll of tweed cloth as my desk and chair – the office furniture having been moved out to make way for a surplus of stock.

Why do inventory levels get so high? Mostly through a combination of over estimating customer demand, misunderstanding the specifications of goods that the customer actually wants and, that old chestnut, a ‘bargain’ from a supplier that simply had to be had.

Every so often businesses with a surplus of inventory and a shortage of cash will look to get their inventory holdings down. The CFO or CEO may come up with an arbitrary goal of say decreasing stock levels by X thousand/million dollars or by reducing the inventory days (the number of days that inventory is held by the business before it is sold) to a specified number.

Armed with this random target employees get rid of old and obsolete inventory, inventory levels come down a little, and the management team breathes a sigh of relief. The pressure is then off inventory, everyone goes back to the usual way of doing business and inventory levels climb again.

Setting arbitrary goals for inventory levels and focusing on quick ways to get inventory down is a waste of a great opportunity to make a fundamental improvement to the business.

If you are always struggling with inventory it’s probably time to challenge and change your business model. Instead of just aiming to decrease inventory levels, ask the question, “If we were starting in business today, what are the minimum levels of inventory we should have to run an efficient business?”

And don’t just accept that high inventory levels are characteristic of your industry. In fact, if they are it represents an even bigger opportunity – the chance to do something truly different to your competitors.

Dell and Costco are two large businesses that are famous for having low inventory levels. But if you are a small business is it really doable? Yes. Take heart from the small pet shop that started asking customers to pay for birdseed a year in advance. By doing this, the shop was able to accurately forecast demand, buy inventory as needed and reduce the stocks of birdseed on hand. But that was only half the story; in getting the customer money upfront the shop was able to negotiate a great deal with the birdseed supplier by paying in cash – a deal which was passed back to the customer in low prices.

There you go, a new business model and everyone was happier.

Julia Bickerstaff’s expertise is in helping businesses grow profitably. She runs two businesses:Butterfly Coaching, a small advisory firm with a unique approach to assisting SMEs with profitable growth; and The Business Bakery, which helps kitchen table tycoons build their best businesses. Julia is the author of “How to Bake a Business”  and was previously a partner at Deloitte. She is a chartered accountant and has a degree in economics from The London School of Economics (London University).