Internal & External Factors That Affect Inventory Management

A business that manufactures goods or sells merchandise relies on selling inventory for more than the cost of acquiring it. The difference between selling price and cost is your gross margin, and if your margins slip, you could find yourself in serious trouble. To keep your business running, you must respond to external factors that affect inventory while actively managing the internal factors under your control.

A slow economy can put a damper on sales, which means you need to run a tight ship -- acquiring only the amount of inventory you are likely to sell in a reasonably short period of time. If interest rates are high, you might find it too costly to finance as much inventory as you would like. In this case, you might find it beneficial to establish fixed-rate lines of credit when interest rates are low. During times of high inflation, you’ll want to adopt last-in, first-out costing, so that your cost of goods sold reflects the most recent and highest prices, thereby minimizing your taxable income.

The public can have fickle buying habits,. meaning today’s hot item might be passe tomorrow. When the price of obsolete inventory falls below your acquisition costs, generally accepted accounting principles call for you to mark down your inventory to the lower of cost or market. By doing so, you increase your COGS and thus reduce your taxable income. Other external factors that affect the market for your goods include government recalls and product bans, international boycotts, technological improvements, tariffs and bad publicity. In some cases, you might need to write-off part of your current inventory and shift your focus to other products.

You can take steps to minimize inventory losses stemming from theft and spoilage by ”cycle counting.“ In this procedure, you physically count a portion of your inventory every day until you survey the entire lot and then start over again. The quicker you become aware of problems, the sooner you can take corrective action. Many factors affect inventory management, including the quality of supervisory and operations personnel, counting and auditing procedures, security precautions and your relationships with suppliers. A business owner must assume responsibility for all these factors and ensure operations are as foolproof as possible.

One way to improve operations is to set up automated inventory tracking from the time you accept merchandise at the receiving dock or factory floor to the sale of your goods. You can adopt a perpetual inventory system by using bar codes or radio frequency identification technology to track all inventory movements. In a perpetual inventory system, you keep tabs on you inventory in real time, so that you always know the value of inventory on hand and cost of goods sold. This kind of system allows you to delay or even suspend physical inventory counts and can be integrated with you general accounting system. In this way, you can automatically reorder items as stock levels fall and update revenues and accounts receivable whenever a sale occurs.