How Inventory Management Can Make or Break Your Small Business
All small businesses are focused on driving sales in order to boost revenue, but businesses that sell goods rather than services have the unique challenge of managing their inventory in a way that maximizes their profits. Small business owners rely heavily on the profitable sale of inventory to grow and stay in business. Gross margin — the difference between an item’s selling price and its acquisition cost — can be affected by several factors, both internal and external. How a business owner thinks about and handles inventory decisions and accounting can affect the bottom line, and it involves more than just deciding what to buy and when. Here are four of the most important factors related to inventory management:
- Economic Environment: It’s always wise to run a tight ship, but never more so than when the economy slows down. When sales slow down due to the economy, a “tight ship” means buying or making only enough inventory that can be sold in a relatively short time period. If the economy turns inflationary (costs of goods increase faster than expected), consider talking to your accountant about “LIFO” inventory management. Using a last-in, first-out inventory costing approach allows your cost of goods sold to mirror the most recent inflationary price hikes. This can benefit your business because it can lower your taxable income and income taxes.
- Market Environment: Today’s taste may be tomorrow’s waste — that’s the way it can go with a fickle consumer base. When some of your inventory goes out of style, your best move is often to mark down prices and take an accounting loss. The result is you restate your inventory value at the lower of cost or market, which in this case is market value. The benefit to your business by doing so, is that it boosts your COGS (cost of goods sold) and thereby cuts your annual taxable income — or even hands you a net loss for the year. Either way, it reduces your tax bill. You might have to write off inventory because of external factors like product recalls, boycotts, obsolescence, bad publicity and tariffs, to name a few.
- Shrinkage: Shrinkage – no, we’re not referring to George Costanza here — theft, spoilage, damage, short shipments, misplacement are all big enemies of profits. Fight back with cycle counting, in which you perform a daily physical count of a different part of your inventory. Repeat the cycle until you’ve surveyed all of your inventory, then begin again. The advantage is that you’ll detect shrinkage much sooner than if you had waited until the end of the year to perform an inventory check. The sooner you discover a problem, the sooner you can address it. If you uncover an issue, some potential ways to address it include adjusting your storage and security procedures, changing management or security personnel, finding new suppliers, or at worst, fire a dishonest employee.
- Inventory Tracking: Even if you’re running a small business, you can still consider automating your inventory tracking from inception to sale. High-tech features such as bar code scanners and radio frequency guns can track all movements of your stock items, allowing you to establish a perpetual inventory system saving you buckets of time that can be invested elsewhere to grow your business. Making investments in inventory tracking pay off with timely, accurate information about goods on hand and COGS. You also might be able to delay or reduce time spent on physical inventory counts. To maximize your benefit, take the extra step to integrate the information into your accounting and procurement systems.
Just remember, inventory management is all about maintaining and maximizing your margins. Being mindful of your economic or market environment can help you plan ahead, and implementing proper tracking can help you use all your inventory to its full potential.
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