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Manage Your Inventory Wisely to Reduce the Working Capital

Narendra Kumar

| Updated: Aug 01, 2019 | Category: Finance

Inventory Management

For every business, working capital is required for operating the business of the Company. Rotating of the fund in the business is very important. If the circulation of the fund is not done properly the business might run into negative cash flow. For every business to manage the inventory plays a crucial role. To control the inventory the purchase volume should meet with the sales and the forecast.

Meaning of Inventory

Inventory is the term for the raw material used for the production of the final product to sell. Inventory is termed as one of the important assets of the business because it generates revenue and subsequent earning for the business.

Nature of Inventory

  1. Raw Material Inventory

Raw Material is the basic material for manufacturing the final product. It is important to keep the minimum raw material inventory. For example in the food industry the ingredients which are used are perishable it should be used within a specific period of time, if it gets expired then the ingredient can’t be used which results in the loss. Thus the raw material inventory is very important.

  • Work in Process Inventory

It comprises partly finished goods, in this process the raw material is put in the process for the production of the final product. It is most desirable that the volume of inventory that is lying in the form of work in progress should be kept at a minimum and the time taken to convert into the final product should also be minimized so that the amount invested in the raw material can be realized as quickly as possible.

  • Finished Goods Inventory: Finished goods are the final products

They are the saleable and their sale contributes fully to the revenue from the core operations of the Company. It means the production is completed and ready to sell.

Types of Inventory

  1. Transit Inventory

The inventory which is taken from one place to another either through Pipeline, road, railway, shipping or by air will result in some transportation time involved for getting the inventory delivered. For example, the petroleum Company’s transports are done through various modes i.e. pipeline, roadways or shipping, etc. The inventory might take days or weeks to get delivered.

  • Buffer Inventory

Inventory sometimes are stored in excess to meet the uncertainties or to meet the possible future events. This stock has been created to protect against uncertainties or unpredictable events.

If the buffer inventory stock is higher, better the firm customer service. Buffer inventory is stock kept to meet future demand. To meet customer satisfaction it is necessary to provide the services promptly.

  • Anticipatory Inventory

The firms or the Company purchase the inventory above current need to meet the possible future event. Such an event may include a price increase, a seasonal increase or any other un-circumstances event which may occur. For example, during the summer season, the demand for Mango increases or any festival which comes nearer the demand increases accordingly. Therefore to smoothen the process any business person maintains a balance between the demand and supply.

What are the techniques to manage your Inventory?

  1. Keep the Inventory at the minimum level:

The business person must purchase the inventory at a minimum level, so the amount of capital remains to unblock and can run the business smoothly. According to the demand and supply in the market, the inventory should be kept.

  • Management of Receivables:

The term receivables mean debt owed to the firm by the customers resulting from the sale of goods or services in the ordinary course of business. The policy should be framed like within a certain period of time the payment should be made against the goods purchased.

  • First in First out approach:

For every business, it is essential to maintain a system on a FIFO basis i.e. any product purchased first should be sold out first so that existing product does not get expired, damaged, etc.

  • Inventory software:

The software should be maintained in the business to keep track of the inventory. An effective software will lead you to manage the time and money. It will give a clear idea of your stock report.

  • The Stock should be audited at a certain interval of time:

Depending upon your business size the audit of the Stock to be carried out, to check whether the stock report carried out through the inventory software matches with the audit report carried out at an interval period of times.

  • Analysis of Stock:

The Stock should be analyzed, if the stock which has not been sold for a longer period of time then the strategies should be framed like Special discount, promotional schemes, vouchers, etc.

So that the inventory can be managed and loss of capital reduces at a minimal level.

How improper managed Inventory can affect your business?

  1. Inventory not properly managed:

In business either the stock is not maintained according to the demand of the customer or the overstock is maintained it can lead the business into the negative.

  • Stock not delivered at the proper time:

If the stock is not managed properly then it becomes impossible to deliver the stock at a time. In Unmanaged inventory, it becomes difficult to track the inventory available in the warehouse and as a result, the delivery of the orders got delayed.

  • Customer not satisfied:

Not only inventory but certain aspects affect the quality of the product, not delivered on time, high cost and the customer loses the loyalty and faith which leads to customer dissatisfaction.

Inventory should be managed wisely to reduce the working capital:

  1. Cash Flow Management

If the working capital has been blocked in purchasing the inventory then it becomes quite difficult to survive it may result in it into the Cash crunch. So the cash flow must be managed accordingly so if any future contingency arises the business can survive if cash flow is managed properly.

  • Payment Delays

In many industries, it happens when the inventory is sold there are delays in receiving the payments which may lead to the block of working capital. Therefore it is essential to keep the credit policy so that the payment model remains stagnant.

  • Improve creditworthiness

By managing working capital it affects the credit cycle of the Company which in turn improves the status of the Company in the market attracting more potential in the market from supplier to the end-users.

Notes:

How the Working Capital is calculated:

You can calculate the working capital by using the following formula:

Working Capital= Capital Assets- Capital Liabilities.

Let’s take the example, by going through XYZ Private Limited Balance sheet

Assets   Liabilities  
  Amount (in Rs.)   Amount(in Rs.)
Cash 50,000 Payables 30,000
Receivables 25,000 Expenses 22,000
Inventory 80,000 Long term Debt 40,000
Total 1,55,000 Total 92,000

So the Total Working Capital of XYZ Private Limited

Working Capital =Rs. 1,55,000- Rs.92,000 = Rs. 63,000

It reflects the positive working capital and also indicates that the Company can repay its liabilities within a short period of time. If the working capital is negative it indicates that a Company is not able to pay its liabilities.

Now let’s take the example of e-commerce industry how the inventory is managed

For each product it will show the following breakout:

  1. Availability: The current product ordered by the Customer and shipped to the Customer.
  2. In process: The status of the product which has been ordered to check whether it is in transit or under shipping or currently processed at the warehouse.
  3. Not able to deliver: The Inventory ordered by the customer is currently available but not able to sell due to damage or for any other reasons.
  4. Reserved: The product which has been ordered and received at the center which has been reserved for the current order or in transit.
  5. Fulfilled by: It depends upon whether the product delivered is fulfilled by concerned e-commerce industry or they give the platform to the third parties to fulfill the product.

Through this process, the inventory is managed which results in managing the working capital.

Also, Read: Inventory Audit: Purpose of Inventory Audit.

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Narendra Kumar

Experienced Finance and Legal Professional with 12+ Years of Experience in Legal, Finance, Fintech, Blockchain, and Revenue Management.



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