Warehouse management in an SME. How to increase margin, improve cash flow and reduce the cash tied up in stock?
Many business owners treat their warehouse as a place for storing goods. Yet effective warehouse management in a company has a direct impact on the business’s profitability, its level of working capital, its liquidity and its ability to fulfil customers’ orders.
Stock levels reflect a concern to meet the needs of the market, but they are often also evidence of mistakes in demand forecasting, excessive sales ambitions or poor purchasing decisions. In many cases the warehouse becomes a place where the company stores not only its products but also its own mistakes.
In my consulting practice I often see that it is the warehouse that holds the greatest potential for improving a company’s profitability. The problem is that many entrepreneurs concentrate on sales and operating costs and ignore the effect of the warehouse on cash flow and profit.
Why does a company need a warehouse?
The basic function of a warehouse is to make sure that the products and raw materials customers need are available. Being out of stock means lost sales, dissatisfied customers and the potential loss of future orders.
That is why maintaining adequate stock levels is necessary. The key, however, is to strike a balance between product availability and the amount of capital tied up in stock.
Well-run stock control makes it possible to avoid both stock shortages and overstocking. The aim is neither an empty warehouse nor one overflowing with products, but optimisation of stock levels that matches real demand.
The first SME mistake: no stock in the accounts
One of the most common mistakes is not keeping stock in the accounts.
Purchases of goods and raw materials are charged straight to operating costs. In the short term this means lower tax and an apparent improvement in liquidity.
After a while, however, a more serious problem appears. The company no longer knows:
how much the goods it sells cost,
what the real margin on a product was,
which products generate the highest profitability,
how the product margin changes over time.
Not keeping stock in the accounts means losing control of one of the most important indicators in business: product profitability. And a lack of control over the product margin is usually far more costly than a short-lived tax advantage.
You cannot manage effectively what you do not measure.
Why do warehouses grow faster than sales?
In most cases the problem is not a warehouse that is too small, but excessive stock levels. The reasons are very similar across industries.
Purchasing without knowledge of sales
The people responsible for purchasing often have no access to full sales data and demand analysis. So they buy on the basis of intuition, experience or expectations that are not borne out by reality.
Purchasing for ambitious sales plans
Owners and managers draw up ambitious budgets. The problem arises when the warehouse is stocked for a sales plan that is never achieved. Sales do not grow, but the stock remains.
Maximising the purchase discount
The supplier offers a bigger discount for a bigger order.
The company focuses on saving a few per cent on the purchase and ignores the fact that some of the goods may sit unsold for many months or even years. That is how the classic problem of cash tied up in stock arises.
Not daring to sell off surplus stock
Many entrepreneurs are unwilling to accept a loss on old stock. As a result, slow-moving goods are moved from place to place instead of being sold at a lower price and turned into cash. It is a situation in which ego loses out to economics.
Bonus schemes that reward the wrong behaviour
In some companies bonuses depend on the margin achieved on new purchases. They do not, however, take account of the cost of holding old stock. The result is simple. The warehouse grows, but the company’s working capital deteriorates.
Warehouse management is not logistics. It is cash management
When a company sells a handful of products, the situation is relatively easy to control.
With several hundred or several thousand SKUs, effective stock management requires suitable systems and analytical tools.
It is not only about:
goods received,
goods issued,
shipments,
transfers between locations.
The real challenge lies in managing:
product margin,
product profitability,
stock turnover,
working capital,
cash flows.
Every product held in stock for a long time means cash that is not working for the company. That is why the warehouse and liquidity is one of the most important relationships that every business owner should understand.
The warehouse hidden in the balance sheet
One reason why the warehouse problem is ignored is the way financial data are presented.
The profit and loss account shows revenue and the margin achieved, but not the make-up of the stock.
Stock sits in the balance sheet.
What you cannot see there, however, is:
which products turn over quickly,
which are gathering dust on the shelves,
what proportion of the stock is not moving,
how much time has passed since the goods were received.
Only when old stock is sold off at reduced prices does the real problem show. That is when the margin falls and the wrong purchasing decisions become visible to everyone. That is why, for many companies, old stock turns out to be a real cuckoo in the nest.
Stock ageing: the report that tells the truth
One of the most important tools supporting stock controlling is stock ageing.
The report should show:
the value of stock up to 30 days old,
the value of stock 31 to 90 days old,
the value of stock 91 to 180 days old,
the value of stock more than a year old,
the amount of cash tied up in old stock.
Regular stock analysis makes it possible to identify slow-moving products quickly and to make decisions about promotions, clearance sales or cutting back on purchases. Without such data, a company operates more on intuition than on business sense.
How do you measure warehouse efficiency?
Effective warehouse management in a company requires monitoring key indicators.
The most important include:
the stock turnover ratio,
the average time stock is held,
the value of slow-moving products,
the order fulfilment rate,
the share of stock in working capital,
the profitability of individual SKUs,
the amount of cash tied up.
Analysing these indicators regularly makes it possible to increase warehouse efficiency, improve cash flow and reduce the risk associated with obsolete stock.
The warehouse is also a problem in the mind
The hardest aspect of warehouse management is neither logistical nor financial.
It is the owner’s psychology.
Slow-moving stock is often physical evidence of:
wrong demand forecasts,
excessive optimism,
ill-considered purchases,
misjudged business decisions.
Admitting these mistakes takes courage.
It is much easier to pretend the problem does not exist. Unfortunately, the company pays the bill for that attitude every day, in the form of poorer liquidity and lost opportunities for growth.
How can you improve warehouse management?
In management practice, it is worth putting a few basic rules in place:
Keep stock in the accounts.
Analyse margin at the level of products and product groups.
Monitor stock turnover regularly.
Introduce a stock ageing report.
Link purchasing to actual sales.
Base purchasing decisions on data, not intuition.
Take old stock into account in bonus schemes.
Make quick decisions about slow-moving products.
Treat the warehouse as part of cash management and working capital optimisation.
Use SKU analysis to make better business decisions.
Summary
The warehouse is an operational, a financial and a strategic issue all at once. It determines how well customers are served, but also how much cash the business has available.
In many companies the greatest potential for improving profitability lies neither in sales nor in cutting administrative costs. It lies on the warehouse shelves, among products that have been waiting months or years for a customer.
The truth is simple. Well-run stock control, regular turnover analysis, proper demand forecasting and active management of the product margin can bring a company several extra percentage points of profit and significantly improve its liquidity.
If you want to improve your company’s results, start with a simple question:
How much money is sitting unnecessarily on my warehouse shelves today, and for how long?