INVENTORY: It’s Near Cash, But Not Cash


INVENTORY: It’s Near Cash, But Not Cash

Robert Inkaka Kanyamanza

All the row materials you buy will soon be processed and sold, but until that happens, it represents a drag on your cash flow. That is why the inventory turnover ratio is considered a measure of a healthy business. The formula is:

Cost of goods sold
______________________              = number of inventory turns

A higher inventory turnover ratio means that you need a smaller investment in inventory. By comparing yourself to others in the industry, you can get an idea of how well you are balancing inventory and sales volume – that is, whether you are keeping too much inventory and tying up too much capital.

If inventory level are too high compared to your industry, you may have a lot of hard-to-sell goods – in which case you might consider conducting a clear-out to gain use of the cash value, whatever it may be. You may have over-valued your inventory, in which case you may also to reduce prices to lower volumes. It is also possible that you have over-bought.

Keep in mind that high turnover rate may also pose a risk, if you have lower-than-industry-average levels of inventory you could be caught short if sales rise or suppliers experience labour or distribution problems.

Since a large part of capital goes into inventory, how the inventory position is managed will palsy a major role in determining the day-to-day viability of your business.

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