The Cash Bonus of Matching Stock with Sales Demand

Many businesses that trade in a number of products often find that the stock available on-hand for the best sellers is often lower than desired [and 'stock-outs' cost sales], while lower volume products often suffer from 'inventory build up' - which means that cash is often tied up in slow moving stock! 

Any business offering a "range of products" will often face the challenge of maintaining a constant financial balance between sales ratio and stock mix, particularly for the top 10 products.  

A consistent lack of balance between sales and stock often results in both a reduced gross margin from missing out on sales AND having cash assets tied up in products that are selling slowly or not at all.

For businesses offering 20 - 200 products, inventory management and control is a critical function, particularly considering the cash invested in the asset value of inventory.  In a business that trades in high numbers of products [e.g. 1000+], at any one time there is likely to be 10-15% of "redundant inventory" which will be tying up considerable cash assets.  Balancing inventory to product demand usually means saving vast sums of working capital.

The following example shows the benefits of getting this challenging commercial issue right. 

There are three sections in this process:

1.  Current Product Sales:  In this section the annual (or quarterly) sales value and the gross margin, per product, of the top products are entered (preferably in descending order) in the second and third columns.  The sales mix is calculated using the “Total sales” value for the period as the base value.

The above example shows annual total sales of $4,600,000, with products 1's sales value of $525,000 therefore being 11.4% of total sales. 

This product has a gross margin of 24.5%.  (i.e. Sales price less cost of sales divided by sales price)

2.     Current Inventory Mix:  The latest stock-take value (or cost of sales) for this product is $38,000. This value of stock, if sold at full margin, represents $50,331 ($38,000 / (1 - 0.245)) in sales value and equates to stock-on-hand of:
$525,000 / 52 weeks = $10,096 per week;  $50,331 / $10,096 per week =

4.985 weeks
 
The stock value ($50,331) represents 6.6% (50,331 / 763,334) of total stock, thus we can say that this product is currently below its sales mix level of 11.4% of sales.  Normally, stock of top selling products should closely reflect the demand and in this case, it is below that point.  This may result in lost sales opportunities.

3.     Target Inventory Mix:  This section is where the stock mix is “re-apportioned” to better reflect the existing sales mix AND can be further adjusted to a ‘specific number of week’s sales cover desired’, depending on the financial objectives of management regarding cash-flow and inventory in the balance sheet.

In our Product 1 example, with the weeks stock cover value set at 6, the corresponding sales value of product is calculated as:
$525,000 / 52 weeks = $10,096 per week; X 6 weeks = $60,577

The ‘stock value’ of this ‘sales value’ is thus:  e $60,577 X /(1 - 0.245)) = $45,736
 
You can now calculate what it will actually “cost or save” the company to carry six weeks stock for Product 1. 

In this case, that amount is:
$38,000 (= current stock) less $45,736 desired stock or a cost of $7,736.

The model can be used to vary the stock cover for each individual product by selecting a different number (of Weeks) to insert into the Target Stock Mix box.

For example, you may decide that product 1, as your best seller, should always have 8 weeks cover.

That stock cost is an extra $22,981 however, it may be better to put the cash resources into that product and take it out of the savings from slower selling products.  

If you significantly lower the asset value of your inventory, it means you should carry fewer liabilities in your balance sheet to ‘balance’ the lower inventory value, or you could convert the saving in inventory into other assets.  At least you can free up the cash sitting in “wasteful inventory” for better use in the business.

Remember, “cash is king ” as the life blood of any business!

  DSBN Premium Members can access the new Sales Mix vs Inventory tool to re-adjust stock to save cash and lower inventory value.

Source:  The Business Solutions Shop   thebizshop.com.au

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