How to Use Inventory Statistics to Increase Profits
3 min read

How to Use Inventory Statistics to Increase Profits

Excess inventory can reduce profits and lower the returns from your business. Learn how to use inventory statistics to manage inventory levels.
How to Use Inventory Statistics to Increase Profits

Keeping inventory levels to a low, yet adequate level is a key element to control your cost of goods sold and working capital.

There are many problems that can arise when inventory is too high, like wastage and spoilage of costly products. This hits the bottom line, and also means you have to carry a higher working capital balance by providing more equity than would normally be required.

Nearly all small business owners, managers and operators with a physical product take inventory, but most just use the figure to compute their cost for the period. This means they miss out on using a valuable tool.

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Improve profit using inventory statistics

A great way to get more value whenever you price out a full inventory is to calculate the number of days’ sales represented by your stock level.

To show why and how, let's use an example:

Say you do a physical inventory of all your products at the end of an average 30-day month, the dollar value of your ending inventory is $100,000 and your overall cost for the month is $300,000.

Step 1: Calculate average daily cost

Compute your average daily cost for the month. Take your cost and divide it by the days in the period. In our example that’s $300,000 ÷ 30 days = $10,000. On an average day that month, you used $10,000 in inputs.

Step 2: Calculate average inventory days

Figure the number of days’ sales that you have in inventory. Take your ending inventory value and divide it by your average daily cost. That means $100,000 ÷ $10,000 = 10 days using our example.

In this case, you had 10 days worth of product on hand at the end of the period. For many small businesses, especially ones that sell perishable items, this would indicate excess inventory and be a signal to re-examine par levels by product.

Step 3: Apply industry rules of thumb

Every industry requires a different level of inventory. Here are some inventory statistics from the food industry for a full service restaurant:

  • 6 to 7 days inventory for food.
  • 7-10 days inventory for beer.
  • 10 to 15 days inventory for liquor.
  • 30 to 45 days inventory for wine.

For quick service restaurants (fast food) the rule of thumb for food inventory drops to 3 to 5 days. So you can start picturing the gains that can be made by reducing inventory from 6.5 days on average, to 4 days.

Luckily, every industry has a rule of thumb and you can follow the guidelines on how much inventory (in number of days’ sales) that you can use to calculate what is an acceptable level for your business.

Search “[your industry] inventory benchmarks” on Google to find the most appropriate benchmark simply replacing [your industry] with the industry your business operates in.

Step 4: Act on your findings

Some owners will determine the number of days’ sales on hand every week and use it as part of the incentive system for their employees. They use this to trim their inventories to the lowest possible levels.

This ensures higher quality products (especially for fresh ingredients), a lower cost (by reducing wastage) and frees up cash (through lower working capital requirements).

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Key takeaway

Managing inventory is a key driver of costs and working capital. Use industry statistics to determine the appropriate level of inventory for your business and you will improve your costs and working capital.

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