Four Important Factors Affecting Inventory Management

Article written by EricBank

Small merchandisers and manufacturers rely heavily on the profitable sale of inventory to stay in business, because these companies often have limited funding and sources of credit. Your gross margin -- the difference between selling price and acquisition cost -- can be affected by several factors, both internal and external. Here are four of the most important ones:

o   Economic Environment: It's always wise to run a tight ship, but never more so than when the economy slows down. In this case, a "tight ship" means buying or making only enough inventory for sale in a relatively short time period. On the other hand, when business is strong, interest rates may climb to the point where you can't afford the interest payments on the money you borrow to acquire inventory. You might have to cut back on your inventory if this happens, an unfortunate decision in a strong economy. Instead, prepare for higher interest rates by establishing a fixed-rate line of credit when rates are still reasonable. If the economy turns inflationary, consider using last-in, first-out inventory costing. By doing so, your cost of goods sold will mirror the most recent inflationary price hikes and therefore result in lower taxable income and income taxes.

o   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, you'll have to mark down its price and take an accounting loss. This means restating your inventory value at the lower of cost or market, which in this case is market. Doing so boosts your COGS 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. 

o   Inventory Management: Shrinkage -- theft, spoilage, damage, short shipments, misplacement -- is a big enemy 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 for year-end inventorying. The sooner you discover a problem, the sooner you can address it. You might have to adjust storage and security procedures, change management or security personnel, choose new suppliers, or perhaps fire a worker or two.

o   Inventory Tracking: Consider automating your inventory tracking from inception (on the manufacturing floor and/or receiving dock) 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. By doing so, you'll always have timely information about goods on hand and COGS. You also might be able to delay physical inventory counts, and in any event, you can integrate the information into your accounting and procurement systems