How to Find Your Inventory Sweet Spot

By Zeynep Ilgaz on

Few things are more exciting than ordering your first big batch of inventory. You daydream about unpacking box after box and then watching your profits soar once it begins selling like hotcakes.

But in the heat of the moment, perhaps you got a little overzealous. You ordered way too much and put your startup in a tough bind. All its cash is tied up in inventory, and you’re stuck in neutral until you sell a healthy amount of goods.

In the search for the sweet spot, entrepreneurs too often only see the cost of not having enough.

Striking the right balance between cash flow and inventory is no easy task. The average small retailer devotes 70 to 80 percent of its assets to inventory, which is a high number to begin with, and there always seems to be a good reason to buy more stuff.

In the search for the sweet spot, entrepreneurs too often only see the cost of not having enough, and that could be a major reason why approximately half of all new small businesses fail within their first five years.

You can’t beat the odds while mismanaging 80 percent of your assets. If you want to boost your startup’s chances of survival, it’s crucial to understand the downsides of carrying too much inventory.

Inventory Overload

The first and most obvious danger of excess inventory is the financial cost. You already spent a pretty penny on shipping, sorting, stocking, and insurance, and your excess product is now just sitting idle and depreciating.

There’s also a high opportunity cost of having too much inventory. Every dollar you spend on it represents a dollar that could have been devoted to other important areas such as marketing, product development, payroll, or, if things are especially desperate, your electric bills.

There is no one perfect percentage or dollar amount of inventory that’s right for every startup.

There is no one perfect percentage or dollar amount of inventory that’s right for every startup. It all depends on how quickly you can turn it over, which brings us to another danger: time. Some businesses — such as fashion or food retailers — are especially sensitive to this, as inventory can go from being fresh to stale in a matter of months. Products with expiration dates literally have to be thrown in the garbage if they aren’t sold.

Excess inventory is sometimes the result of an impulse buy, but it’s more often a symptom of a larger problem. Your young company may lack good processes and infrastructure, your forecasting and production scheduling are likely skewed, and you probably aren’t tracking the right (or any) performance metrics.

Optimizing Your Levels

Because inventory is so tied to every area of your startup, there’s no silver bullet for achieving a perfect level. But the good news is that there are many ways to make it better:

Upgrade your supply chain management system. Thanks to big data and countless technological advancements, supply chain management and logistics systems have come a long way over the past few decades. Today, a good option will include a quality management system that analyzes historical trends and installs inventory buffers that effectively meet customer demand while minimizing your costs. It will assess your business — step by step, internally and externally — to determine your greatest failure risks, from product quality to legal compliance.

Follow quality schedules and forecasts. If your business is anything like mine, you have long lead times for your products. Much of our manufacturing is done in China, and it can take three months to get a product to us once it’s scheduled. When that’s the case, it’s pivotal to create and follow mid- and long-term forecasts for your inventory. This will help ensure you never have too much or too little stock on your shelves.

Implement performance metrics. Performance metrics are essential for any line of business. Key measures related to inventory include turnover (a ratio that compares the cost of the goods you sold to the value of the goods that remain on your shelves), turnaround time (how long it takes for an order to leave your warehouse), completion percentage (how often orders are filled completely), and punctuality (how often your shipments arrive to consumers on time).

Take a walk. It can be just as useful to forget about all the digital tools you have access to, pull your head out of your computer, and take a walk around your production or warehouse facility. Assess your workflow, talk to your team, and take a look at your inventory levels with your own eyes. Sometimes, seeing is believing.

Taking these steps and precautions may seem like a lot of work, but given the alternative, it’s the smartest way to run a startup. Having systems in place that ensure optimal stock levels, high-quality production, and punctual delivery will free up time and cash that you can devote to the fun part of your job: growing your budding business.

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