Planning for Inventory

Chapter 16: Cash is King - Page 16.8

Planning for Inventory

Inventory (sometimes called Stock), is the accounting term for goods or materials a company holds temporarily and then sells to its customers. For example, inventory in a bookstore is the value of the books the store owns and intends to sell to its customers. Inventory in a car dealership is unsold cars. Inventory in a steel manufacturing plant includes iron ore and coal to be made into steel.

Inventory goes into the financials as an asset when it's purchased. It leaves the company as cost of goods sold when it's sold. The cost of inventory shows up in the cash flow when it's paid for, regardless of when it's sold, usually as cash spending or bill payments.

Not all companies manage inventory. Product-related companies normally do have inventory, and service-related companies normally don't. There are many exceptions, though, so if you have doubt, ask your accountant or somebody connected to your company who knows.

Estimating Inventory

Use simple assumptions to estimate inventory flow and inventory purchases. (Amounts shown in thousands. Numbers may be affected by rounding.)

Inventory gets into your cash flow when you pay for it. Estimate your inventory needs as months of inventory on hand, then estimate inventory flow as a matter of estimating sales and inventory purchases. Payments depend on the rest of your payments policy, because inventory purchase amounts enter the system when an invoice is received, but they are paid when the related invoices are paid.

In the illustration above, the beginning inventory balance supplies the amounts required until the third month, when additional inventory is purchased. That purchase goes into accounts payable, and is paid as part of the normal flow of bill payments. Inventory purchase is the bulk of the $346,000 new obligations in March shown in the Payments Details illustration on the previous page.

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