The life blood of a small business is cash.  (Bigger firms also need solvency, but their ability to garner credit is far simpler than for smaller entities.)   And, for startups, it’s not only the lifeblood, it’s the air that it breathes.

And, whether you are a service business, a retailer, or a manufacturer, it all relies on what might be termed “inventory”.   Maybe not in the traditional sense.

Service Business “Inventory”

If you are a service business, your inventory is your people- their ability to provide the service(s) required in a specific time slot.   If you bill by the hour, and you are a reasonable employer, then you can only provide 40 to 60 hours’ worth of service per employee.  More work than that and something will fail.  (I would prefer the employees’ time be limited to 40 hours (32 in less frenetic times)- because even they have administrative functions (like reporting results and time to you.)

Moreover, if it is your time you are selling, you must find a way to work the administrative functions (which can range from 5 to 20 hours a week), as well as the marketing/networking functions.   I’ve seen way too many firms fold because the time demands for client work was negating the capability of the firm to obtain new work.  Because when push comes to shove, the first thing shoved out of the queue is the marketing/networking function.  So, future business is shortchanged- and when the future comes, the firm is simply out of work and closing its business.

Therein lies the balancing act.   Because your employee is to be paid (Weekly? Biweekly? Monthly?), and unless your client is prepaying (as have many of the clients for whom we have performed research),  then you will need cash to front their salary while you await the payment of your clients’ invoices.

Retail Inventory Needs

Now, if you are a retailer, there are other considerations.   You have to determine (that means monitor) the turnover of each of your products and the average daily levels you need to maintain for each product.   (And, if you your vendor has minimum orders, you need to place an order that sometimes means you will have too much of one product and not enough of another.)  You also need to know what the turnaround time is for your vendor- not only how fast an order is fulfilled from when it is placed, but the transit time involved.  To ensure that you can service your clients’ requests with aplomb.  Because a product out of stock is almost always a sales not garnered.

As an example for this case, I will use one firm where I served as a temporary CFO (2 year contract).  If we placed an order with most of our vendors by noon, the order would be ready by the next day.  And, we had arranged with common carriers (three in particular) to ensure a two day delivery guarantee to our office.  So, for their products, our lead time was 3 days.  (We had another vendor that required a 60 day lead time; it was overseas.   As such, our inventory stocking levels for their products was considerably larger.)

The good thing is our sales were basically cash.  Sure, customers bought our products with credit cards, but our Visa and MasterCard deposits took 2 business days.  It was the American Express payments that took around 4- at a much bigger bite of our receipts.  And, this factor meant 86% of our sales entailed 14 days from order to cash in hand.  Thankfully, we also had 30 and 45 day terms from our vendors.  And, our margins were about 30% (net, before taxes and dividends).   So, this meant we could afford to double our sales each 45 days without running out of cash.

Which sounds great – except we actually were growing at close to 150%.  Something had to give.  And, that meant a cash call to our investors AND stretching our payments to vendors to 36 to 52 days.  Until our sales growth dropped to 100%.   (We grew from a five figure sales entity to an eight figure sales entity over the course of my association with the firm.)

Manufacturing Entity Inventory Levels

And, when it comes to manufacturing entities, there are multiple factors that need juggling.  Besides needing enough raw materials (and coping with those inventory requirements), you also have to maintain finished products.  And, depending upon how fast you can obtain raw materials, how fast you can convert those raw materials into finished goods, and how many times you turn over your inventory, your cash needs vary all over the map.

Our manufacturing entity (medical products) had an additional factor with which we had to comply.  Our products required a seven (7) day testing and approval period.  Because one of the critical tests to assure our product quality involved a microbial assay, whereby a week’s incubation period was necessary.

So, this meant we had to get very creative in our efforts.  Because we were a self-funded venture.  One where we used our profits to grow the firm.  So, it would not be unusual for us to make “mixed” batches.  What I mean by that is one of our products could be delivered to the hospital (and the patient) with no potassium, a potassium level of 1 mEq/L, 2 mEq/L, or even 3 mEq/L.  (This product was a concentrate, which was diluted about 36.83 times before it’s use in patient dialysis.)

As such, we would prepare a 2500 gallon (ok, 10,000 liter batch) of product that would have 0 potassium.  We would process 2000 liters of that product.   Then, we would add enough potassium chloride to raise the levels in the remaining 8000 L batch to 1 mEq/L (219.65 kg of potassium chloride).  This was not a big sales product, so we processed 1000 L.  Leaving us with 7000 L in the tank, which we raised another mEq/L (192.2 kg) to make the 2 K product.   And, then,  after processing 6000 liters of that formulation, we would add in (2.746 kg) more potassium chloride to make 1000L of 3 K product.

That meant we didn’t need to maintain high levels of inventory for our slower moving product.  Which cut down the needs for our potassium chloride purchases.  And, that was good, because that product was obtained from a part of the country to which we rarely delivered.   (Our trucking subsidiary delivered products to our customers- and brought back raw materials to our productions facilities on their return runs.)

In so doing, we maintained inventory levels as low as we could (which lowered our  cash requirements) to ensure that we could keep growing the firm at an average monthly rate of about 24% for the first two or three years.   At which time, we had to slow down our growth so as to not exceed the cash coming in.  (Our customers- hospitals and clinics- averaged about a 36 day turnaround from invoice to payment.  And, our vendors provided us terms ranging from 10 days to 55 days.  You can see the cash flow problems right away.)

It also meant we wanted to have our customers use more of our bulk products- the 10, 30, and 55 gallon drums.  Because these drums could be resterilized and reused.  Which cut down our cash demands, compared to needed a 1 gallon container for the non-bulk product.  (This bottle  vendor was one who only proffered 14 day terms; we could buy more expensive bottles at 30 days, but the lower price was a critical portion of our mix.) The incenctive to our customers to purchase the bulk version was that we provided our customers much lower pricing for these bulk products.

Recap

Given these three examples, you should be more able to develop optimal inventory levels for your own product or service business.