Inventory is the largest use of working capital in most product businesses, and the least examined. Money spent on stock is money not available for wages, tax or growth, and stock that does not move is a loss that has not been recognised yet.
The measures worth knowing
Stock turn — cost of goods sold divided by average inventory value. It tells you how many times you sell through your stock in a year. Higher is generally better, because it means less cash is tied up for each dollar of sales.
Days of inventory — 365 divided by stock turn. More intuitive: how many days of sales you are holding. A business with 90 days of inventory has three months of cash sitting on shelves.
The cash conversion cycle — days of inventory, plus debtor days, minus creditor days. This is how long money is tied up between paying for stock and being paid for it, and it is the number that determines how much working capital growth will consume.
A business with 60 days of stock, 45 debtor days and 30 creditor days has a 75-day cycle. Every dollar of growth requires 75 days of funding before it comes back.
ABC analysis
Inventory is never uniform. In most businesses a small proportion of lines generates most of the value.
Classify your stock:
- A items — roughly the top 20 percent of lines by value moved, typically around 80 percent of turnover. These justify tight management: accurate forecasting, frequent counting, close supplier relationships.
- B items — moderate value, moderate attention.
- C items — the long tail. Many lines, little value. Managing these intensively is a poor use of time; simple reorder rules are enough.
The common error is applying the same process to everything, which means A items get the attention a C item needs and vice versa.
Safety stock is insurance with a price
Safety stock covers variability in demand and in supply lead time. It has a genuine purpose and a genuine cost.
The right level depends on three things: how variable your demand is, how variable and long your supplier lead time is, and what a stockout actually costs you. That last question is the one businesses rarely ask.
A stockout on a fast-moving A item may cost a sale and a customer. A stockout on a slow C item may cost an apology. Setting the same service level for both wastes capital.
For New Zealand businesses importing goods, lead time variability is the dominant factor — shipping schedules, port congestion and biosecurity inspection all introduce uncertainty that a domestic supplier does not.
Dead stock
Every business accumulates stock that will not sell at the price it is carried at. The instinct is to hold it in the hope of eventually recovering the cost.
The arithmetic argues otherwise. Dead stock consumes space, ties up capital, is at risk of further deterioration or obsolescence, and is being carried at a value the market has already rejected.
Identify it deliberately — anything with no movement in a defined period — and clear it. Cash recovered now, at a discount, funds stock that actually sells. The loss occurred when the stock stopped moving, not when you finally wrote it down.
Counting
Inventory records diverge from reality through damage, theft, miscounting, wrong picks and receipting errors. Businesses that count annually discover the accumulated gap once a year and cannot explain it.
Cycle counting — counting a portion of stock continuously, with A items counted most frequently — finds errors while the cause is still traceable and avoids a full shutdown.
Where inventory meets the rest of the business
- Purchasing. Volume discounts are only worth taking if the holding cost and obsolescence risk are less than the saving. A 5 percent discount for six months of extra stock is usually a poor trade.
- Sales. Salespeople promising availability that does not exist create both stockouts and excess.
- Finance. Inventory appears as an asset. Overvalued inventory overstates profit and can mislead a lender.
- Suppliers. Shorter, more reliable lead times reduce the safety stock you need to hold. That is worth paying for, and it is a legitimate negotiating objective alongside price.
Practical starting point
Calculate stock turn and days of inventory. Run an ABC classification. List everything with no movement in six months and decide what to do with it. Then set reorder rules by class rather than by habit.
Most businesses doing this for the first time free up a meaningful amount of cash and find they are holding too much of what does not sell and too little of what does.
business.govt.nz publishes inventory and cashflow guidance for small business, free.
