Current assets are resources that an organization anticipates will be changed into cash, sold or realized within a one-year timeframe. Typical current assets include cash, accounts receivable and inventory.
Inventory management is an integral component of current assets, which in turn has a detrimental effect on liquidity, profitability, and operational efficiency. Effective inventory management is critical to a healthy balance sheet that maximizes current assets.
Inventory management provides assurance that a business has the needed inventory to service the market without being over-invested in inventory pending sale. Below, we will explore the impact of inventory management on your current assets and overall financial health.
How Inventory Management Affects Current Asset
Understanding how inventory fits into a company’s overall asset structure is essential. Inventory is considered a current asset, and its management directly impacts a company’s liquidity and profitability.
Appropriate inventory management involves more than just how accurate the inventory count is, it relates to the larger financial position of the business. Poor inventory management may not only tie up cash, but may create other losses, and in some cases it may effect the business’ financial statements.
On the other hand, a well-designed inventory management improves liquidity, reduces costs, and improves the operations of the business in general. Listed below, are the top applicable ways that inventory management can make your company’s current assets more productive.
1. Liquidity and Cash Flow
Overstocking capitalizes on funds which could otherwise be used to invest in other areas of the business (paying suppliers, business expansion, etc.). Conversely, if Inventory levels are too low, it results in lost sales opportunities and customer complaints. Companies need to find the optimal inventory level to maximize cash flow.
2. Inventory Valuation and Financial Reporting
The way in which the inventory is valued and managed will impact the author’s financial statements. For example, accounting treatments like FIFO and LIFO will mean something different for cost of goods sold (COGS) and net income. Proper valuation of the inventory will ensure that the company’s financial condition is being reported accurately.
3. Preventing Obsolescence and Shrinkage
Having too much product or overstock negatively impacts the inventory as it becomes obsolete and aged product diminishes in value. Shrinkage, in the context of a physical retail store and managed inventory, means loss of inventory due to theft, loss, or damage; this reduced asset value will incur cost as well. Allowing strong visible inventory tracking and strong inventory security will eliminate these types of issues.
4. Maximizing Profit Margins
Lower cost of storage, spoilage, and markdowns are possible when the inventory is optimized. By leveraging historical sales data trends, analyzing sales trends, and forecasting demand, firms can hold optimal amounts of stock at all times to maximize profit.
5. Building Stronger Relationships with Suppliers
Good management of inventory will support timely reordering processes while product shipment arrives in an efficient system. Depending on the relationships that the firm creates with their suppliers, they will be in a better position to negotiate terms, cut down costs, and maximize efficiency.
Best Practices for Effective Inventory Management
Companies can implement proactive stock management techniques to maximize working capital and maintain uninterrupted processes. Best practices enable waste minimization, financial loss prevention, and increased efficiency.
Here are several of the most notable methods to improve the management of inventory.
- Use inventory management software: Automate tracking, planning, and replenishing to keep optimal levels of stock.
- Utilize Just-in-Time inventory: Buy stock only when needed, thus reducing holding costs.
- Perform periodic audits: Cycle counts and reconciliations to inventory records to avoid discrepancies.
- Review sales data: Figure out slow-moving stock and adjust purchasing methods accordingly.
- Increase Supply Chain efficiency: Work closely with suppliers for timely deliveries and reduce interruptions.
Conclusion
Regulating inventory involves more than simply monitoring the number of items on hand; it is an essential component in improving profitability for a company. Good inventory management will also help a company’s cash flow, minimize loss, and create inventory that builds profit margins.
Implementing best practices such as automation, scheduled counts, and planned purchasing will help businesses feel comfortable knowing they have plenty of inventory while leveraging owned assets. Plus, smart business owners understand that good inventory management creates new business in a fiercely competitive economy.
On the other hand, inventory management means managing your assets more effectively in an ever-changing market, and establishing sound financial principles. Treating inventory like a priority now will deliver better financial stability and a more successful business in the future, regardless of whether you’re a “mom and pop” business or a global organization.
