When Inventory Becomes a Liability
Inventory is meant to become revenue and, ultimately, cash. But when it sits too long, even an asset can become a burden on the business. Understanding the supply chain, cash conversion cycle, and timing of inventory purchases is critical to keeping capital moving.
Inventory, for any business, small, medium, large, new, or established, can be a make-or-break situation.
There are plenty of automated inventory systems available to help businesses track and manage inventory, including reorder points, inventory on hand, inventory conversion, safety stock, lead time, and lag time. Together, these factors are part of managing the entire supply chain, from vendor to customer.
It is no surprise that there are so many software integrations and point-of-sale systems designed to track inventory. But regardless of the technology being used, the bottom line remains the same: the longer inventory is held, the more debilitating it can become to a business.
Inventory is purchased with one primary objective: to convert it into sales and, ultimately, cash. The faster that happens, the more effectively inventory functions as an asset rather than becoming a liability.
Keeping Inventory Moving
So, how do you keep inventory functioning as an asset? Specifically, how do you move it as quickly as possible from purchase to sale?
Driving revenue is obviously part of the equation, but businesses also need to be intimately familiar with their supply chain and the market in which they operate.
In today’s market, it is not surprising to see so many businesses running sales and blowing out inventory: last year’s models, last year’s collections, and merchandise that simply did not move as expected. Supply chain disruptions have left many businesses needing to pivot and convert the inventory they are holding back into cash.
In many cases, that means selling inventory at break-even. Sometimes it means selling below cost and taking a loss.
The longer inventory sits within the cash conversion cycle, the heavier the burden becomes. That inventory was originally purchased to generate sales. When it does not move, capital remains tied up in products instead of becoming cash that can be used elsewhere in the business.
Stay One Step Ahead of the Supply Chain
Businesses need to stay one step ahead of their supply chain.
That means knowing the exact reorder point and understanding how much inventory is truly necessary to meet demand. Depending on the business, it may also mean moving toward a model in which purchases are made through pre-orders with a sales commitment or using a just-in-time inventory model designed to move products through the business more efficiently.
Software can help tremendously, but businesses also need to understand the financial measurements behind the software. Ratios and metrics such as inventory conversion and days inventory outstanding provide tried-and-true ways to evaluate how efficiently inventory is moving.
The goal is not simply to have inventory available. The goal is to convert inventory into sales and sales into cash as efficiently as possible.
Businesses that understand their supply chain, monitor inventory closely, and make purchasing decisions based on real demand are in a much stronger position to protect cash, remain profitable, and continue operating as a thriving company.
If you have financial statements but aren’t getting meaningful insight from them, it may be time for a deeper conversation about what the numbers are telling you.
