Managing Stock Levels

Many of us will visit supermarkets on a weekly basis and will normally find shelves that are fully, or close to fully stocked. The store has a vast range of products and a large quantity of each item generally on the shelves. Next time you walk around, stop and picture those items as dollar bills instead, then imagine how much cash that stock relates to.

In a fast-moving consumer goods (FMCG) environment like a supermarket, the stock is sold at such speed that it is quickly turned into cash. Even in this environment, where stock moves relatively quickly, there is still a focus on ensuring that stock doesn’t sit on the shelves too long, hence discounted products that are coming close to their sell by date.

However, in an organization where stock is a slower moving commodity, it is vital that stock levels are managed effectively to ensure that they are not sitting on the shelf longer than necessary while also ensuring that there is sufficient stock available to sell to customers. Ultimately the financial health of your business relies on it.

The Cash Flow Cycle is a measure of how long it takes an organization to convert its initial investment in stock into cash in the company bank account. It basically tells you how long you are having to fund the stock before you receive payment and is calculated as follows:

· Stock Days + Debtor Days – Creditor Days = Cash Flow Cycle

Stock Days

This measure allows you to determine, on average, how long it takes you to sell an item of stock. In the case of a FMCG supermarket, the number should be pretty low while in the case of a large ticket item such as a mining vehicle it could be quite a bit longer if built in advance and not to order. The ratio is calculated as follows:

· Average Inventory / Cost of Goods Sold x 365

Debtor Days

Simply a measure of how long it takes you to turn your invoices into cash. In a fast-moving retail business as above, the debtor days would be very low while in a business to business environment you may have to provide credit terms to your customers of up to 60 days. This can create major pressure on cash flows. Proactive credit control is vital to minimizing the debtor days and getting cash into the business on time. Debtor Days are calculated as follows:

· Average Accounts Receivable / Total Credit Sales x 365

Creditor days

This measure is the reverse of Debtor days and is a measure of how long it takes you to pay suppliers on average. In an ideal world, we would not pay suppliers until we have been paid by customers, and in some cases such as the FMCG environment above, this can be a possibility. But in many instances, this isn’t the case, especially where stock moves more slowly out of the door or we have to give longer credit terms to win business. Creditor days are calculated as follows:

· Average Accounts Payable / Cost of Goods Sold x 365

In all three cases the multiplier is 365 as we measure the ratio’s over a full year to offset any anomalies. Shorter term measures can be introduced to measure fluctuations but each part of the calculation would have to be adjusted to suit.

To bring this together if the above calculations created results as follows:

Stock Days 20

Debtor days 35

Creditor Days 30

Cash Flow Cycle =  20+35-30 = 25

This means that you will have to fund your stock purchases for an average of 25 days in order to be able to effectively manage your cash flow. This can be vital when trying to understand:

· How much stock to buy?

· Ensuring that it doesn’t sit on the shelf longer than necessary?

· How much can you afford to purchase to take advantage of volumes discounts?

· What would be the impact of taking early settlement discounts from suppliers?

· What would be the impact of offering early settlement discounts to customers?