Latest / Cash Flow Conversations with Fexingo: Working Capital, Receivables, and Small Business Finance / Why Inventory Is Eating Your Cash Flow
Transcript
- Lucas: There's a number I think about a lot when I look at small business balance sheets, and it's almost never the first thing people mention. It's not revenue growth or profit margins. It's inventory days. Luna: Inventory days — meaning how long your product sits on a shelf before you sell it? Lucas: Exactly. And the reason it matters is simple: cash that's tied up in inventory is cash that can't pay your rent, cover payroll, or take advantage of a supplier discount. For a lot of small businesses, especially product-based ones, inventory is the single biggest use of working capital. We're talking thirty to fifty percent of current assets in some cases. Luna: That's huge. But isn't inventory just a necessary cost of doing business? You can't sell what you don't have. Lucas: Right, and I'm not saying hold zero inventory. But there's a difference between strategic inventory and bloat. I was looking at a case recently — a specialty coffee roaster in Seattle. They had about $400,000 tied up in green beans, roasted coffee, and packaging materials. Their inventory turnover ratio was about 2.5. That means they were turning their inventory over every 146 days or so. Luna: Almost five months. That's a long time for coffee, especially if it's roasted and starts losing freshness. Lucas: Exactly. They were holding way too much roasted coffee because they'd overestimated demand from a new wholesale contract that never materialized. By the time they realized, they had to discount the older stock by thirty percent just to move it, and some of it had to be written off entirely. That one inventory mistake cost them an estimated $120,000 in a single quarter — about three percent of their annual revenue. Luna: Ouch. And I bet they didn't even see it coming because their sales looked fine on the surface. Lucas: Sales were up year-over-year, actually. That's the trap. Growing revenue can mask deteriorating cash flow if inventory is piling up faster than you're selling. The metric that flagged it was days inventory outstanding, or DIO. For that roaster, DIO went from 55 days to 146 over six months. That's a red flag that their cash conversion cycle was stretching out dangerously. Luna: So DIO is the number to watch if you're a product business. But what about service businesses? They don't carry physical inventory. Lucas: They do carry a form of it — unbilled hours. If you're a consulting firm and you've done the work but haven't invoiced yet, that's work-in-progress inventory. It's the same principle: time you've paid for but haven't collected cash on. One marketing agency I know had over 60 days of unbilled work sitting in their system. They were effectively financing their clients' projects with their own payroll. Luna: So the concept of inventory days applies to any business where you spend money before you get paid. The medium just changes. Lucas: Exactly. Now, the standard advice is to calculate your inventory turnover ratio. Take cost of goods sold, divide it by average inventory. A higher number means you're selling faster. But what's 'good' varies wildly by industry. A grocery store might turn inventory every 15 days. An auto dealership might be closer to 60. A furniture maker could be 90 or more. Luna: So you have to benchmark against your own sector. But even within a sector, there's a range. What's the rule of thumb for when it becomes a problem? Lucas: I like a simple one: if your finished goods inventory sits for more than 60 days on average, you should start asking hard questions. Because you're not just tying up cash — you're incurring holding costs. Storage, insurance, spoilage, obsolescence, and the opportunity cost of that cash not earning anything. Those costs can add up to twenty to thirty percent of the inventory's value per year. Luna: That's a huge hidden expense. And it's not on the income statement as a line item — it's buried in cost of goods sold or operating expenses. Lucas: Right. So one of the first things I'd recommend to any business owner is to run a simple inventory aging report. Break your stock into buckets: under 30 days, 30 to 60 days, 60 to 90, over 90. If you've got a significant chunk in the over-90 bucket, you've got a problem. That's where the risk of write-offs is highest. Luna: And that's exactly what happened with the coffee roaster. Their over-90 bucket was massive. Lucas: It was. So what did they do? First, they stopped buying green beans for a month. That's counterintuitive when you're growing, but they had to slow down inflows to drain the reservoir. Second, they offered volume discounts to existing wholesale clients to move the aged stock. Third, they implemented a demand forecasting system that tied orders to actual sales data, not just sales targets. Within three months, they got DIO back down to 65 days. Luna: That's a solid recovery. But it required them to actually look at the data. I wonder how many businesses never even run that aging report. Lucas: A lot. And it's not because they're lazy — it's because inventory accounting can feel complicated. But the basic question is simple: what do I have, how long has it been here, and what is it costing me? You don't need a fancy system. A spreadsheet works. The key is to review it monthly, not once a year. Luna: You mentioned opportunity cost earlier. Can you put a number on that? Lucas: Sure. Let's say a business has $100,000 tied up in excess inventory. If they could free that up and invest it at a 10% return — maybe in marketing or equipment — that's $10,000 a year in lost potential. Over five years, compounded, that's over $61,000. The inventory itself might also be losing value, so you're getting hit twice. Luna: So the real cost is much higher than just the purchase price of the goods. Lucas: Exactly. And there's another angle: the faster you turn inventory, the less you need in absolute terms. If you can reduce your average inventory from $200,000 to $150,000 by improving turnover, you've freed $50,000 of cash permanently. That's like getting an interest-free loan from your own operations. Luna: So the goal is not just to avoid excess — it's to actively drive turnover higher. But how do you do that without risking stockouts? Lucas: That's the classic tension. You need enough safety stock to cover demand variability, but not so much that you're drowning in product. One approach is to categorize your inventory by velocity — the Pareto principle often applies. Twenty percent of SKUs generate eighty percent of revenue. Those fast movers can justify higher stock levels. The slow movers should be kept lean, maybe even made to order. Luna: So focus on the tail. Cut the slow movers ruthlessly. Lucas: Ruthlessly is the right word. If something hasn't sold in six months, it's not going to. Discount it, donate it, write it off. That's cash you can redeploy. I know a hardware store that did a one-time clearance of every item that hadn't moved in a year. They recovered $40,000 in cash and freed up shelf space for higher-turn products. Their inventory turnover went from 3 to 5 in six months. Luna: And they probably improved customer perception too — nobody likes looking at dusty merchandise. Lucas: Right. So to tie this back to the broader cash flow picture: inventory is the lever that many business owners ignore because it feels like a fixed cost. But it's not fixed at all. You can actively manage it. And when you do, you shorten your cash conversion cycle, improve your liquidity, and reduce your risk of a cash crisis. Luna: So the takeaway for our listeners: if you haven't looked at your inventory aging report in the last month, that's where to start. Lucas: Start there. Calculate your DIO. Compare it to industry benchmarks. And ask yourself: is my inventory working for me, or am I working for my inventory? Because the answer will tell you a lot about the health of your business.