The cost of poor inventory management can be staggering

This is a difficult concept to understand. I've found that most people can't wrap their arms around the connection between low inventory turnover (poor inventory managment) and cash flow. Hopefully, a short explanation will help shed some light on why poor control can cost so much.

Consider this example:

On January 1st you buy $10,000 worth of widgets that you mark up 100%. You sell this inventory over the course of the year for $20,000, a $10,000 gross profit, 100% return and the turnover ratio = 1 because you placed only one order during the year for a $10,000 investment.

But what if you had purchased $5,000 worth of widgets on January 1st and $5,000 more on July 1st? You have the same sales volume during the year, $20,000, the same gross profit of $10,000 but now you experience a 200% return! And your turnover ratio = 2 because you placed two orders during the year for a $5,000 investment. You used the same $5,000 to purchase widgets in July that you used in January (remember you sold the January products by July at a 100% markup?)

And if you purchased $2,500 worth of widgets every 3 months? Your return would be 400%, gross profit of $10,000, inventory turnover ratio = 4, total investment of $2,500.

Your cash flow gets incrementally better the more times you order, and sell, during the year.