Founder and CEO of Fintrepid Solutions, an award-winning firm delivering customized solutions to support business growth and sustainability.
Many sectors in the U.S. economy right now are experiencing bloated levels of inventory as the supply chain has caught up and demand in spots has cooled, leading to a bit of a perfect storm. Seemingly long forgotten are the persistent supply chain bottlenecks that disrupted the flow of just about every good resulting from the pandemic.
The tide has now swung in the other direction. The supply chain side has not only caught up but is even getting ahead, meaning more and more goods are reaching U.S. warehouses. Labor tightness is still an issue, so the processing of inventory, once it reaches warehouses, has been slow. Coupled with softening demand (especially in the retail sector), businesses are now finding themselves in a new quandary.
We have seen customers of ours experience timing holds on new orders as their customers work through their own backlog. This is on top of the lighter-than-expected holiday season and consumers that have been buying less.
There are even more potential consequences that businesses could be facing. Because of the widespread nature, we are seeing vendors beginning to get tighter on payment terms. If you have large vendors or heavy concentrations with particular vendors, you could find yourself in a tougher spot managing accounts payable.
Even worse, you may have more cash tied up in inventory, and if turns are slowing, the velocity of that capital is slowing down. This could impact your ability to borrow on your line of credit. Many businesses are bumping up against their line limits already—not to mention the credit tightening that has accelerated with bank lending, affecting businesses and their customers.
As always, the nature of the small business and its limited resources requires diligent attention to market dynamics, careful planning and nimble action. What does a business do? Start by asking questions.
• How much cushion do you have? Do you have availability on your revolving line of credit? How much cash do you have on hand? How strong are the margins in your products? The strength of these answers will go a long way toward determining how long you can ride out the current environment. You don’t want to damage your brand, but you also must survive.
• Understand carrying costs. This is an area we see small businesses often underestimate. Do you know how much it costs you to keep the level of inventory you maintain? Not only is a material amount of company cash tied up in inventory, but there are additional costs to factor such as labor, storage, interest, shrinkage and obsolescence. What’s the cost of holding inventory within your business? Could you accept lower margins potentially and still end up ahead? The answer, in many cases, is surprising. You should know where you sit.
• What is normal? Market dynamics have been anything but normal over the last few years. As best you can tell, what is your baseline for metrics like inventory turns? They were likely vastly below that during the pandemic, but where are they today? Many businesses, to their surprise, find themselves back to normal even though short-term memory would dictate this is a drop-off from the last couple of years.
• Watch your market. Both the big picture and your specific market constantly warrant a look. Is a key competitor flooding the market with product? What does that mean for your revenue, your margins or your ability to reduce your own inventory levels? Could you find creative opportunities to do special pricing in certain instances, such as volume, without giving bulk more public discounts that might damage your brand?
• What is the window of execution? Companies can have long buying cycles or sales cycles as well as seasonality. Is your customer selling direct to a business or consumer—and if so, what is their sales cycle like? A company with 30-day lead times on product can move much quicker than one with 180-day lead times. Understanding the various timing components is critical. If you wanted to make a change in inventory strategy, how quickly could you? Time may or may not be on your side.
• Understand your lender and loan structure. Do you know how your loans are structured? Line of credit facilities often has other caps on inventory levels relative to the number of accounts receivable or total borrowings, so you may think there is availability only to find a hard ceiling. How does your bank view your collateral? How does it feel about your business overall? Be proactive; at a minimum, you will get clarity, but you might also be able to get creative in supporting the execution of your strategy.
• Strengthen your forecasting and analysis muscles. With the answers to all of these questions, you are now in a position to do the math using more solid assumptions. It may be time to get conservative. What would it mean to alter your buying patterns or maybe even throttle sales growth back? What does that do to revenue or cash flow? What is the longer-term waterfall of inventory with inflows and outflows based on your new assumptions? This will show you possible outcomes, adding confidence to the decision-making process.
The most powerful question of all is, “What if?” Use it.
At the end of the day, it’s all about the different levers you can pull to execute with the highest potential for success. It could be a slowdown in buying coupled with a targeted discount strategy and a renegotiation of your credit line. You may also find you have enough dry powder to hunker down and be in a position to strike down the road. The right answer for your business is there—starting with the right questions.
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