By Sandra Taylor-Sawyer: CNJ Columnist
Have you heard the story about the young man who walked into the grocery store and was astonished to see pile after pile of salt bags?
The young man exclaimed to the owner, “Boy! You must sell a lot of salt.”
“No, I hardly ever sell any salt,” the store owner replied. “But you should see the guy from the salt company who comes here every week. Now he sells a lot of salt.”
Unfortunately, this is a big obstacle small-business owners face — controlling inventory.
Inventory is like the other items in a business (e.g., employees, sales, recordkeeping). If you do not control it, it will control you.
A business should have the appropriate quantity of products available for sale. However, too much inventory can make the business “cash poor,” which will affect other areas of the operation.
There is hope in the quest for inventory control. A good tool to use is the Inventory Turnover Ratio, a basic computation that can be done weekly, monthly, yearly or bi-annually. The best time frame is monthly.
To compute the Inventory Turnover Ratio, the Cost of Goods Sold (COGS) is divided by Inventory Value.
The first step is to determine the Cost of Goods Sold for last year. The COGS can be found on a financial statement or tax return.
The second step is to determine the value of inventory.
For example, let’s use $500,000 as the COGS for last year and $250,000 for the inventory value.
Computation: $500,000 divided by $125,000 = 4.
The Inventory Turnover Ratio is 4, which means on average you sell your entire inventory four times a year or once a quarter.
Is a ratio of four good? It depends on your cash flow and type of business.
The goal of any business owner is to control inventory by keeping a minimum stock on hand to satisfy customers’ needs. However, it is not wise for business owners to have all of their cash tied up in inventory, which makes a business cash poor.
Sandra Taylor-Sawyer is director of the Clovis Community College-Small Business Development Center. Visit the center at www.clovis.edu/sbdc or contact the center at 769-4136 for an appointment.
This article was adapted from information by Jim Casey, Tillamook, Ore., SBDC director.