Inventories and cash flows

Now that year end is over, many companies that sell physical products are valuing their year-end inventories. If they have work in process, the accounting staff may have spent quite a few more hours to determine the value of their semi-finished materials.

Much of that valuation process looks at determining how old the items are, or how often they turnover each year. That information is often used to determine the inventory valuation allowance to determine the net realizable value of the inventory. That is the accounting method, traditional and auditable.

However, that does not really address operational or business cash flow issues directly. More importantly, from a cash flow and business profitably standpoint, the business should be tracking inventory turns by SKU/item at least monthly the entire year.

Is the business purchasing/making too much of certain SKU/items? Does the company have updated and accurate reorders or minimum restocking levels established? Are sales not selling these items? With that specific knowledge, management can make decisions to alter the inventory more quickly to reduce or increase it. With an impact on cash flows and margins.

Are the margins (sales minus the costs of goods (COGS)) increasing or decreasing on the items that are in order of turn over. Why or why not?

Remember, inventory consumes cash, and even once sold takes even more time to convert an accounts receivable sale into cash. So, for even a business with very, very high turnover (52 x year of inventory and 30 day terms) a sale would not convert to cash for almost 40 days. And that is far from a normal turnover for inventory for many businesses.

So, use your ERP and other systems to track inventory turnover by SKU/item, know your COGS by SKU/item to help manage the inventory levels. Or, just wait for year end and the accountants to figure it out, and by then, you could have had items sitting in the warehouse for a year…or more – wasting cash and not earning a return!