As always, cash is king. In today's volatile economy, companies need to take a serious hard look at their working capital and where it is sitting in the business. Just how much of your capital is frozen in an iceberg of inventory? And how much of that can you turn into liquid cash?
Over 90% of an iceberg’s volume is underwater and totally invisible at first glance. Only when you do a deeper dive, do you see the true magnitude of that iceberg. The same concept holds true for your operations -- there’s a lot going on underneath the surface level. It’s time for a deeper dive.
Frozen capital is defined when excess cash is invested in or used by assets that are not producing income. In the case of a manufacturing or distribution company, this usually equates to an overabundance of cash tied up in inventory.
Before we get into the details, let’s look at this helpful illustration from our colleague
Michael's illustration perfectly highlights the situation here (and
Ad hoc inventory practices, particularly for inventory replenishment, will freeze massive amounts of capital in places you can't immediately see. Without visibility, it's easy for that iceberg to grow...and grow...and grow. That's what we mean when we talk about "frozen capital."
Now let's get into just a little bit of the details here on how your cash flow gets frozen in the first place.
If your cost of goods sold (“COGS”) is 2,400,000 per year, and your average inventory is 600,000, your inventory is turning four times (COGS divided by average inventory). If you were to increase the speed that your inventory turns by one turn, your average inventory would be 480,000. (COGS divided by five turns).
That one-turn increase unlocks 120,000 from your inventory. Think about what you could do with a 120,000 injection of cash into other areas of your business.
The complexities of managing inventory can be daunting. Balancing what you have versus what you need can be tricky for even the most seasoned inventory planner. What starts out as manually managing a few miscellaneous items here and there can quickly grow into a serious amount of inventory that becomes frozen capital.
Without proper stocking criteria guidelines, you’re forced into a process of random and inconsistent decision making. When this happens, you end up stocking items that you don't need while not properly stocking items that you do need. Ultimately, this means you’ve tied up your cash AND you’re disappointing customers at the same time.
If you find yourself in an overstock situation, here are some handy tips to help you get rid of your excess stock.
- Call your customers and ask if demand has changed
- Promote a sale through your social channels
- Place your excess stock close to your best sellers
- Bundle in with a complementary product
- “Dial for dollars” -- selling the inventory at cost will unlock cash
- Run a competition and use the excess inventory for prizes
- Use excess as freebies for industry influencers or customers that you want to impress
- Donate to a charitable cause
This immediate approach of resolving your current excess/obsolete stock problem is only treating the symptom. What you ultimately want to do is treat the root cause and create long-lasting improvements. Our goal at
Be sure to remember that when you have frozen working capital, you are putting your business at risk. In part two of this blog post, we will share some best practices and criteria guidelines that you should use to avoid further excess stock and frozen capital dilemmas.