The problem of Inventory

Excess Inventory is a problem

Operations Manager of a manufacturing company who is a dear friend came to me and said, “ Our company recently underwent a major restructuring. During the process many people quit and few moved to different projects. I got promoted in the process but the problem is I find it hard to run the show with allocated budget.I am thinking of quitting.”

I told him to cool down and started with making them learn about basic financial statements. During the process we found out that this company had nearly $400,000 worth stock in the warehouse. They were still ordering more stock. Immediately I called the warehouse manager and asked him about the stock. He said that he had been given this position recently and was not sure what the previous warehouse manager was doing. He was not sure what needs to be done and just follows the orders from the operations manager.

This is when I told the warehouse manager to make a list of all the stock, whatever is in the warehouse. Then next to it you have to tell whether it can be used in the next production cycle. He had to tell whether the raw material in the warehouse could be used in the manufacturing process? If not could it be sold directly to the customers or some other company? Or could we exchange it with the supplier? This decision had to be made by the operations manager as they deal with the suppliers.

Within a week the warehouse manager came with this list and we found out that there was no need to order more raw material. There was enough in the warehouse for 6 to 8 weeks. After two months when we looked at the financial statement, the Bottom-Line had a positive impact and the company was making much profit. They said we had done magic. Of course it was no magic, it happened because we made sure that the company was making more money than it was spending. The stock that was in the warehouse we just used it.

Working Capital Cycle

Working Capital Cycle

Cash-to Cash cycle is also known as working-capital-cycle. Cash becomes cash each time the cycle goes round. Cash-to-cash cycle starts when business use(Assets / Expenses) cash sourced (Liabilities) to produce a product/service till it receives cash(income) by selling that product/service which again (retained profit- Reserves & Surplus) gets used in next cycle.

When business is using money, it means money is going out of business. When money goes out it either becomes Expense or creates and Asset. The business is using the money it has sourced. These are the liabilities. When it sells a particular product/service and customers pay, the company will receive money. This is when money comes in. This is called Income. The money that the business receives after paying all the expenses, overheads, tax and interest will be left in form of Profit.

Profit cannot be withdrawn completely. A substantial portion of it has to be retained for the business to continue the operations. The retained profit is called Reserves and Surplus.

If you take a closer look there are only three kinds of business in the whole world. It is true just read on.

  1. Business that makes money by selling a product, which is manufacturing business.
  2. Business that makes money by offering a service, which is Service business. And
  3. Business that makes money by selling the product and providing service to the product. Largely it will be wholesalers and retail business.