Businesses should carefully consider inventory investment as a way to grow.
Properly managing and strategically allocating resources toward inventory can significantly impact a company's overall financial health and operational efficiency.
This article delves into the concept, explores its importance & benefits, and offers some strategies to decide if it's right for your business.
What Is Inventory Investment?
Simply enough, when a business decides to spend its money to buy inventory.
Inventory investment also refers to a country's gross domestic product (GDP) and national income.
Many entrepreneurs invest in their business inventory when they know a product is highly demanded
. This way, they ensure they always have enough products and don't lose their customers to the competition.
Of course, the goal of an individual firm is to eventually move all its inventory off the warehouse shelves to consumers.
However, businesses often find that they do not sell all their products, and having excess unsold inventories can result in financial losses.
To profit from the inventory
, it is essential to have a good balance, not buying too much but not keeping too little.
Pros And Cons Of Inventory Investment
- It enables more efficient and predictable production, better-planned manufacturing, and steadier supply.
- It also helps build profits by cutting down on wasted products or lost sales.
- Maintaining an optimal inventory level ensures that businesses promptly fulfill customers' orders. With the right final goods in stock, companies can prevent stockouts and avoid lost sales opportunities.
- Proper business inventory management drastically reduces the chances of running out of products or wasting excess.
- Effective inventory investment improves operational efficiency. It enables streamlined production processes by ensuring the availability of raw materials and minimizing production delays.
- It requires more effort on your part. To effectively utilize it, you need to account for the abovementioned factors. You must also predict your inventory needs and keep complete performance records, which can be tricky.
- Miscalculations can be a grave mistake. If you predict the wrong amount of inventory you need, you could easily decline far too much or quickly run short. You could also end up needing more or less financing than you thought.
- Excess inventory can quickly become waste, and shortages can swiftly lose customers. Good inventory management practices help prevent this. Ensure that you understand your business's economy. If your business's finances are unhealthy, it is probably not a good time for inventory financing.
Inventory financing is a way to borrow money to purchase inventory, most often through a short-term loan.
Is Inventory Investment Right For You?
For many businesses, inventory investment is a powerful tool. Companies selling physical products tend to benefit the most, though others can. But to decide if you should invest in your inventory, you need to consider some factors.
Internal Factors To Consider
Your business's inventory directly affects both your profit and cash flow.
Either way, your business loses money.
Before making any investments, look carefully over your projected inventory needs for the future.
Properly managing inventory makes your business more productive, cutting waste and growing profits.
- Keeping too much inventory can mean products become obsolete or too old to sell.
- On the other hand, keeping too little inventory creates the risk that your business runs out and loses profit or customers.
External Factors To Consider
You need to project customer demand as accurately as possible.
This means taking account of your recent financial history compared to the long-term and seeing the rate of change.
Without an accurate picture of future customer demand, predicting your business inventory needs is impossible.
For example, it can be more difficult to project business inventory needs during a recession. It also helps to know if the economy will hit a high point.
While the health of the general economy is important, it pays to look at the health of your business's sector too. The way your industry and the general economy are performing can have major impacts on your customer demand.
Keep an eye on how your competitors are performing.
How To Calculate Inventory Investments
- Determine the Cost of Goods Sold (COGS). Start by calculating the cost of goods sold, representing the direct costs of producing or acquiring the inventory. COGS includes the cost of raw materials, labor, and overhead expenses.
- Calculate the Average Inventory Value. Determine the average inventory value by adding the beginning inventory value to the ending inventory value and dividing it by two.
- Compute the Inventory Turnover Ratio. Calculate the inventory turnover ratio by dividing the COGS by the average inventory value. This ratio indicates how efficiently a company manages its inventory and how quickly it sells it during a period.
- Analyze the Days' Sales of Inventory (DSI). The DSI measures the average number of days it takes for a company to sell its inventory. Divide the number of days in the period by the inventory turnover ratio to determine the DSI.
- Assess the Inventory Holding Costs. Consider the carrying costs associated with inventory, including warehousing, storage, insurance, and opportunity costs. These costs are the expenses incurred by holding inventory over a period.
By following this economic analysis and regularly reviewing, firms can gain insights into their inventory management practices, identify areas for improvement, and make informed decisions to optimize inventory levels, reduce costs, etc.
Types Of Inventory
Productive inventory moves off the shelves and makes a profit, ensuring that cash flow remains reliable.
Even if your inventory is doing well, it is still a good idea to review it every now and then to know what you are doing right and what you are doing wrong.
Dead inventory refers to the stock customers do not buy for whatever reason.
That means it remains sitting in storage without ever bringing you a profit. In fact, it hurts your profits since it takes up money and space that you could use for other products.
Most estimates define dead inventory as the stock that has not moved off the shelves in the last six months.
Some businesses struggle with dead inventory because they know they will sell their stock eventually, but they certainly do not sell it frequently. That means that most of the time, it sits on their shelves and serves no purpose.
The usual solution is to save this inventory for special orders that customers can place as needed. That way, you don't waste time, space, or cash.
As for other inventory that meets the requirements for "dead," try marking it down to see if you can incentivize customers to buy it on a quick sale.
And if that does not work, your final and wisest option is to note it as unsellable in your inventory records.
At this point, you can contact the dealer to see if you need or want a return. If that is not possible, consider donating the item to charity as a tax write-off. With dead inventory, it is all about taking what you can get and avoiding the same mistake in the future.
Some types of inventory don't qualify as dead, but they are not productive either. They are slow-moving.
Slow-moving inventory can be hard to categorize and identify.
Recessions and other criteria can turn normal inventory into slow inventory. This puts a damper on your business's cash flow since inventory is sitting and transactions are idling.
As for your investors, they will look at slow-moving inventory and see a lower return on equity.
However, you must review your stock and other companies in your industry and market to identify your slow-moving inventory.
A Great Way To Finance Your Inventory
Business loans can help companies pay for the inventory they need.
At Camino Financial, we design our inventory financing options to be flexible, with loans for entrepreneurs of all types.
We can guide you through every step of inventory investing and help you plan ahead.
Apply For A Business Loan!
Is inventory a short-term investment?
No, inventory is not a short-term investment. It represents a business's goods and materials for production, sales, or distribution purposes.
Unlike short-term investments, which are financial instruments with a one-year or less maturity period, inventory is a tangible asset that is part of a company's operational activities.
How to find inventory investment?
To calculate it, you must consider the cost of acquiring or producing inventory, the carrying costs associated with holding inventory (such as storage and insurance), and any additional expenses related to managing and maintaining inventory.
Subtract the value of ending inventory from the value of beginning inventory during a specific period to find the change in inventory value.
Is inventory an investment?
Yes, inventory can be an investment for businesses. It represents a significant portion of a company's assets and is essential for meeting customer demand and generating revenue.
However, unlike financial investments such as stocks or bonds, inventory is a tangible asset directly contributing to a company's operational activities.
How does inventory affect cash flow?
Inventory directly impacts cash flow as it involves cash outflow for purchasing and holding inventory. In contrast, slow-moving or excessive inventory can tie up cash and limit its availability for other purposes.
Efficient inventory management, timely sales, and balancing inventory levels are essential to optimize cash flow and ensure a healthy financial position for businesses.
Is inventory investment positive or negative?
Inventory investment can be both positive and negative, depending on various factors.
Positive inventory investment occurs when a company increases its inventory levels to meet anticipated future demand. This investment aims to capitalize on potential sales opportunities and customer needs.
Conversely, negative inventory investment refers to decreased inventory levels, which may happen when a company reduces excess stock or adjusts its production and distribution strategies.
What is the difference between investment and inventory investment?
The main difference between investment and inventory investment lies in the nature and purpose of the assets involved. Investment typically refers to financial assets or capital allocation to generate returns or future income.
On the other hand, inventory investment pertains specifically to acquiring, managing, and controlling a business's tangible goods and materials.