Have you ever wondered why banks or potential buyers seem so obsessed with the age of your inventory or accounts receivable?
Well, it’s not just a random curiosity; it’s critical to assessing your business’s financial health, because it is – actually – CASH!
It is your cash that is currently not in your pocket or bank account.
(Inventory is your cash lying on your warehouse floor; and Accounts Receivable is your cash sitting in your customer’s pockets.)
So, yeah, the bank cares about it, and you need to as well, especially if you are growing your business.
Because what growth means in most businesses is that you are going to need to put more cash onto your warehouse floor, and more money will be held in your customers’ pockets (sometimes for longer periods than you are used to).
To help you to avoid growing right into bankruptcy at the hands of this hidden business-killer, today I’ll translate what this means for you as the owner of a growing company.
WHY DO YOU CARE?
Understanding Inventory Aging: The Time-Tested Value Checker
If you haven’t heard the term “inventory aging” before, it just means to think of your inventory as if it were a timer.
The minute you receive it into the warehouse, the timer starts ticking, and it keeps on ticking until you send it out to a customer.
The length of time that timer is still ticking is the “age” of that piece of inventory.
When you buy inventory to resell, you are investing in your business’s future, right?
If that timer is ticking for too long, it means your inventory has turned from investment into a financial burden.
For example – when I worked at Tastykake (if you live in or around Philly, you know!) – our cakes had a shelf life of only 10-12 days … And they were particularly good the day they came off the line (the ones they put in our conference rooms were sometimes still warm from the oven!) .
So, since it took overnight to get it to our distributors, and it took them another day to get it delivered to the stores on their routes, by the time the cake made it to the stores, they were already 20% through their entire life span.
Because of this, if we had inventory sitting on our floor at the bakery for more than 2 days, it was worthless.
And every dollar of ingredient and labor that we put into it was just cash on the floor that we would never get back.
When I worked at BobCat, and we were making lawn mowers, it was a totally different story – but believe me, if one of those didn’t sell for a season, it was the same thing…
…because next season it will be obsolete. No one wants to buy last season’s lawn mower, even at a great discount.
Here’s the deal:
Anyone interested in lending money to you, investing in your growth, or potentially buying your business will want to know the age and value of your inventory.
They know it’s cash that you just can’t get your hands on yet.
So, they will help you by giving you cash for it now (at a price, of course).
And to the extent that it’s new inventory, you can use it as collateral for that type of loan.
But the minute it “ages out” – it will be worthless to both the bank, and therefore, to you as well.
Yes, borrowing money to get more inventory is a sound business decision in many cases.
But banks aren’t going to take your word for its value or age.
I’ve seen this play out time and time again, and it usually leads to a loan rejection.
If you’re sitting on a mountain of ancient inventory, they’ll know just as well as you do that it’s not worth as much as you think it is.
And the fact that it’s there at all will cause them to question the financial strength of your company.
And this is one of the main reasons you need to understand your inventory aging. If you haven’t figured it out yet, they will.
HOW DO I DO IT?
Imagine your inventory (the stuff you’ve never sold) on a timeline, stretching from your first inventory purchase to today.
Some items are fresh, while others have been collecting dust.
If you break that timeline up into sections, you have what are called ‘aging buckets:’
(a) There’s the newest stuff that’s less than 30 days old
(b) The stuff that’s 30-60 days old
(c) The stuff that’s 60-90 days old
(d) The stuff that’s older than 90 days
(Depending on what you sell, these buckets could have very different ranges, as mentioned in the examples of Tastykake and BobCat:
Tastykake’s would have been: (a) 1-2 days; (b) 3-5 days; and (c) greater than 5 days.
BobCat’s would have been: (a) 0-60 days; (b) 60-12 days; (c) 120-180 days; (d) 180-270 days; (e) greater than 270 days.)
The bottom line is that the bank is going to give you the most money for the inventory that is in bucket (a) and the least money – if any – for the inventory in the second-to-last bucket.
For example, banks might lend you 80% of bucket (a)’s full value, 60% of bucket (b)’s value, and so on down the line.
Even though you thought you could secure a hefty loan against your inventory, the reality could be quite different.
So, it’s critical that you have a system – whether paper or high-tech – that keeps track of when your inventory arrives at the warehouse and when it leaves the warehouse.
The moral of the story:
Don’t make any decisions about rapidly growing your business until you know what your existing inventory is worth and how old (or young) it is.