How Inventory Impacts Cash Flow

When running a small business, it is vital to understand the basics of finance. You don’t need to be an expert, but there are a few concepts to understand to improve your bottom line.

There are two primary cash flows – inflows and outflows. The Cost of Goods Sold (COGS) typically defines the correlation between inventory and your business’ cash flow.

When you procure inventory for your business, the capital used is your business’s cash outflow. The outflow encompasses all direct costs in producing goods, including materials and labor. You receive an inflow of cash when your inventory is sold to consumers.

Inventory is among the primary catalysts that impact your cash flow. It contributes to how much cash you spend and earn.

Some businesses make the mistake of overshooting their inventory. When your inventory doesn’t match the demand, you could dig your business into a hole. Another common mistake committed by business owners is treating inventory outflow as a regular expense when it isn’t.

Inventory purchases are not a regular expense

Regular expenses are fixed expenses paid regularly, such as rent, utilities, and salaries.

Fixed expenses are where an outflow of your cash goes according to a designated timetable. Scheduled payouts make up a business’ regular expenses.

Your inventory should not fall under this category.

Businesses should not automate purchases made to increase inventory. As demand fluctuates, you cannot accurately predict how much inventory you need to supply to consumers.

The outflow of cash you spend on your inventory belongs under the COGS category. Your business’ COGS metric helps you define its gross profits, financial management, and overall efficiency.

There are many computations COGS is involved in, including determining your net profits. Account for your company’s COGS thoroughly, consistently, and on schedule for better accuracy and less uncertainty.

Beginning Inventory + Purchases – Ending inventory = Cost of Goods Sold

  1. Take your initial inventory recorded at the beginning of your fiscal calendar
  2. Add it to the number of any additional inventory you purchased within the year
  3. Subtract the inventory you didn’t sell by year’s end

Their resulting difference will give you your company’s total Cost of Goods Sold. You can now use it to compute your net income with this formula:

TOTAL INCOME – TOTAL EXPENSE = NET PROFIT

Total income refers to your overall profits or GROSS PROFITS.

Total expense encompasses all six categories cash outflow:

COGS + OPEX + D&A + Interests + TAX + SG&A

Cost of Goods Sold, Operating Expenses, Depreciation and Amortization, Interests, Taxes, and SG&A (selling, general, and administrative expenses).

Operating expenses: includes rent, electricity, water, salaries, and everything else that costs you to keep your business running account for your OPEX.

Your OPEX makes up most of your regular expenses. Expenditures that don’t directly generate sales are considered indirect expenses.

These are the costs of operating your business and don’t factor into generating your business revenue. Accounting for your business’ operating expenses helps you keep track of where your money is going.

Businesses that keep tabs on their OPEX are more adept at reworking and restrategizing according to the evolution of their business.

Depreciation and amortization: refers to the depreciating value of your current assets like goods and finances. Amortization relates to intangible aspects such as financial assets, including loans.

Concerning your inventory, depreciation accounts for the value of your goods lessening over time, including each good or tangible asset used in producing those goods.

Interests: whether simple or compounded interests, these refer to amounts in percentage incurred by loans, bonds, and debts. Interests are non-operative, meaning they are not factored into your expenses used in the daily operations of your business.

Taxes: overall, there are five types of taxes you would potentially pay in running a business. These include income tax, estimated taxes, sales taxes, self-employment taxes, and employment taxes.

Income tax returns must be filed separately from your individual income tax return using the 1040 IRS Form. If you are the sole proprietor of your business, you must file your self-employment taxes.

Estimated taxes are filed quarterly according to your projected year-end income. Suppose your estimated taxes end up lower than your actual filed income for that year. In that case, you will incur penalties on top of their difference.

Depending on what state you do business in, you will be required to collect sales taxes by remitting them to the state.

If you have employees on your payroll, you must file employment taxes. You will withhold a certain amount of your employee’s paycheck to file these taxes. You will pay fifty percent of their dues to Social Security, FICA, and FUTA on their behalf.

SG&A: aspects of your business that indirectly affect your sales and earn you revenue are considered selling, general, or administrative expenses.

Selling expenses are often mistaken as OPEX. Recruiting delivery services, like shipping and handling from your business to the consumer, are not included in your operating expenses.

However, shipping and delivery fall under selling, general, and administrative expenses.

Inventory and Shipping

Your inventory and shipping go hand in hand; the purpose of your business’ logistics is to move your inventory. Improper handling of your stock can result in backlog returns and put your reputation on the line. Reputable freight shipments can cost you more than you can afford, but you can’t always trust cheap courier services.

GoShip.com is an affordable domestic freight shipping service. Smaller businesses can opt for less than a truckload (LTL) delivery service and move on to full-truckload (FTL) option as the volume of their deliveries expands.

Small and mid-scale businesses can entrust GoShip’s forty-two thousand certified carriers with their inventory without worrying about increasing cash outflow to deal with improper handling and shipment. Get a free quote today!

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