How a company generates cash?
A company can generate cash in several different ways, the statement of cash flow is apportioned into three sections:
- Cash flow generated from operating activities
- Cash flow generated from investing activities
- Cash flow generated from financing activities
The cash flow generated from operating activities indicates how efficiently you’re handling your daily business operations. The statement depicts the cash involved in daily order processing activities, warehouse activities, fulfillment activities and most importantly the activities attached to the inventory operations i.e the amount of inventory you sale against your total purchase.
Why it is advisable to optimize cash flow rather than maximize it?
Understand that cash flow and profit are two different things. While you evaluate your cash flow you may encounter situations where you have made a profit but you are lacking in working capital. Low working capital means that your current liabilities exceed your current assets in this case the company may have outstanding bills to pay.
However, having too high working capital is also not a good sign as it indicates that too much cash is tied with your current assets and the company may have unsold and unused inventories, or receivables, which is clearly an ineffective way of utilizing company resources.
According to Investopedia, a working capital ratios of 1.2 to 2.0 are considered desirable, but a ratio higher than 2.0 may indicate that the company is not making the most effective use of its assets to increase revenues. So rather than maximizing the cash flow, the company should focus on optimizing the cash flow.
The impact of inventory level on the cash flow
Your inventory is one of your biggest assets in your business. Efficient inventory management can boost your cash flow and help you fully optimize your resources.
In this article, we will focus mainly on the inventory operations and strategies which can help you optimize cash
1. Calculate your cash flow in terms of your inventory
Companies calculate the cash flow tied up with the inventory for managing their inventory level. Locate the current year inventory balance from the balance sheet; locate the prior year inventory balance. Calculate the difference in inventory balances, the difference states the amount of cash flow generated by the change in Inventory.
How does a change in inventory impact the statement of cash-flows?
An increase in the inventory at the end of the year indicates that a company has unsold inventory. Unsold inventory means cash outflow.
If the cash outflow increases it is a sign that the company needs to keep track on its purchases and implement proper inventory control policies which help them generate maximum profit with least amount of inventory investment.
There are many modern practical demand forecasting tools available which can help you take a deep analysis of the product demand and help you plan purchases.
2. Re-evaluate your Inventory valuation method in terms of cost of goods sold
As an eCommerce entrepreneur you know you don’t buy items at the same price, the buy price can inflate with a sudden surge in demand or can deflate with a fall in demand. That is why your inventory cost is recalculated every time you make an inventory purchase. To accomplish this, you would take the total cost of the items purchased divided by the number of items in stock.
Your choice of inventory valuation method determines the cost of goods sold which directly influences your cash flow statement.
There are the various method of inventory valuation FIFO, LIFO and Weighted average method. The choice among these methods can lead to a drastic difference in cost of goods sold, inventory value and net revenue. You should carefully adopt an inventory valuation method that fits the nature of your business, although this seems like an obvious thing most companies fail to adopt a method which fits the nature of their inventory operation.
3. Identify the nature of your inventory
Inventory valuation is a strategy you adopt for calculating the monetary value of your goods. The relationship between inventory and cash is largely determined by your choice of inventory accounting method.
Do you manufacture your goods?
For instance, one of Orderhive client uses a weighted average method to calculate its inventory, the reason they are a manufacturer firm and their items gets mingled all the time. Weighted average provides a middle ground for determining net income, ending inventory, and COGS.
You can hire a dedicated resource who can periodically generate an inventory valuation report with adjusted inventory level. However, that can be a little tedious and even prone to human error. The other better alternative is to use an Inventory management software like Orderhive that has been programmed to automatically generate inventory value report based on your preferred method.
Dealing with slow-moving goods?
Slow moving goods tie up your business capital and engage resources that can rather be used for growth. You can either bundle your old stock with your new stock and offer it as a single product to your customers or dispose of it by offering it on discount.
Dealing with perishable goods?
One of the Orderhive clients was dealing in perishable goods, before the end of each sales quarter, they have to make sure that they dispose of the inventory first which are closer to the expiry date.
To fully optimized on the available inventory the items need to get picked, packed and shipped according to the FIFO methodology. With Orderhive Inventory management software, which can automatically generate “Pick List” according to the FIFO methodology, picking and dispatching orders became a cakewalk for the Logistic staff.
Similarly, you can either maintain an excel sheet where you regularly keep track of your expiry product or can make use of an inventory valuation tool.
If you take a closer look at your inventory operations, you will definitely find the operational gaps which are causing cash blockage. Identify the gaps and provide your team with the knowledge and tool to mitigate the gaps and achieve the targeted revenue.