Releasing Cash
Reducing inventory may be the quickest way to release cash in your business, but can harm sales or operational performance if not done well.
Reducing inventory is often seen as a quick and effective way to free up cash. A business has cashflow issues and a quick tour of the factory and warehouse reveals seemingly vast piles of material, whether raw materials, work–in–progress or finished goods. Finance complain about the amount of cash tied up and the cost to service it, and a directive is issued to “get it down”.
Sadly, such an approach, coupled with arbitrary decisions about where reductions can be made, often does more harm than good. Shortages of material at any stage of the process can lead to inability to satisfy customer demand, extended lead–times and even more cash tied up rather than less!
Inventory isn’t the problem, it’s a symptom
What is often poorly understood is that inventory isn’t a problem in itself, it’s symptomatic of other issues in a business. So many projects over my 20+ year consultancy career have started with an inventory optimisation project that has subsequently revealed a range of other aspects of the business that are not working effectively and, if improved, will provide better performance with less inventory required.
The true role of inventory
The start point is understanding the true role of inventory. Simply put, it is ‘buffering’ uncertainty, variability and sub–optimal performance throughout the full business cycle – from customer contact to cash received – so that it performs smoothly and delivers the goods in the fastest possible time.
In a ‘perfect’ system – one where every step in the process from extracting raw material from source to delivering to customer – could be carried out as quickly as the customer wanted, no inventory would be required. However, that is almost never the case – for commercial or practical reasons – and so a level of inventory is needed to achieve the level of performance desired.
“The more inventory a company has,
the less likely they will have what they need.”TAIICHI OHNO, ORIGINATOR OF THE TOYOTA PRODUCTION SYSTEM
The key is having the right level of inventory for your whole business system – end–to–end supply chain and customer ‘contact–to–cash’ cycle. Just like oil in an engine, both too little and too much can be a problem. A shortage of material can have a bigger impact on the business’ ability to convert customer interest into cash received than the benefit derived from the inventory reduction. Too much inventory ties up cash and masks other issues in the business.
Considering the ‘whole system’ – from suppliers’ suppliers’ to customers’ customers will reveal how much inventory is required to operate the business effectively as it is today and also surface many opportunities for improvement that will both reduce inventory and improve performance.
The level of inventory required is calculable from a thorough and quantified evaluation of every part of the ‘system’, considering topics such as:
How stable and certain is customer demand?
How smoothly does production flow? Where does material get held up?
How reliable are suppliers in terms of deliver performance? What are their minimum order quantities?
Where are there risks in the system that inventory needs to mitigate?
If inventory isn’t the problem, what is?
“Inventory hides problems. Reduce it and you’ll see
the rocks in the river.”TAIICHI OHNO (TOYOTA PRODUCTION SYSTEM METAPHOR)
The above are only a few of the factors to consider. There is a far broader array of issues that come to the surface when the causes of inventory are examined. For example:
A systematic approach to ‘right–sizing’ your inventory
To address these requires a systematic approach to identify where the issues and opportunities are. It looks at the ‘whole system’, starting with an understanding of customer demand and following this back to the source of materials, looking at the operating processes at each step as described below. The aim is to balance service level, cost and demand uncertainty in a way that’s right for your business.
“Inventory optimization is a balancing act — too much, and you strangle cash; too little, and you strangle sales.”
MODERN SUPPLY CHAIN ADAGE
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Inventory often grows when operational realities don’t match strategic intent (e.g. sales plans, product mix, or supply chain strategy).
Poor alignment between demand forecasting, production planning, and commercial goals drives excess stock and ties up cash.
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Functional silos and local optimisation create handoff delays and “just in case” buffers.
Lack of visibility or accountability causes inventory to accumulate unnoticed.
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Forecasting errors, poor master data, and weak demand signals lead to overproduction or premature procurement.
Lack of confidence in data causes managers to hold extra inventory “for safety.”
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Extended product development, changeover, or supplier lead times force higher stock to protect availability.
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Too many variants, options etc can lead to slow moving inventory, tying up cash and adverse impact on profitability.
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No single owner for end-to-end cash flow and stock decisions.
Finance may focus on numbers, while operations drive output — with no shared accountability for cash release.
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Inventory avoids risk, ‘just–in–case’ mindset or fear of stockouts discourages risk-taking and continuous improvement
Lack of information sharing between functions
Lack of confidence in others’ willingness to work to the required values and behaviours
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Before diving into the analysis, it’s important to understand your strategic goals. For example:
What level of customer service is required? How do we balance that against the cost of provding that level of service?
How important is holding a wide variety of items even if some are disproportionally costly to provide?
How do we proritise customer service, stock holding costs and cash flow?
It’s important to set Key Performance Indicatoprs (KPIs) that will provide the right feedback on how well these goals are being achieved.
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Gathering good data from all areas of your business is key to an effective analyis. Typically you’ll be looking for:
Demand data: sales history (units/time), returns, seasonality.
Lead times: supplier delivery performance, variability.
Inventory records: on-hand, on-order, backorders.
Cost data: ordering costs, holding costs, stockout penalties.
Other relevant data: promotions, market trends, economic indicators, weather, etc.
It’s important to clean the data – checking for missing values, anomalies and outliers – and ensure that units of measure, time etc are consistent.
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Poor sales forecasting is a common source of issues. Generally, historical data can be a better guide than many sales forecasts, suitably modified for any known changes, trends etc. Typically you’ll look for:
Volumes by item, suitably grouped
Patterns of demand (seasonality etc)
Variability, trends etc
The output is a forecast of expected demand and its uncertainty (standard deviation or confidence intervals). The uncertainty is key to determining the correct levels of inventory. This will apply both to finished goods and their constituent components, leading to forecasts for each internal manufacturing process and demand on suppliers.
Analysis can range from a simple spreadsheet (often enough to make a big change where this activity has not been done before) to sophisticated models using statistical and machine learning methods.
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Understanding the capabilities of the ‘supply side’ of your business is also key, both for internal processes and suppliers. Items to consider include:
Average lead–time and lead–time variability
Minimum Order Quantities (MOQs) or Economic Batch Sizes.
While these can be challenged and changed over time, the initial calculation must recognise the current capabilities.
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The statistical calculations for inventory levels, including Safety Stock (another widely misunderstood parameter), Reorder Point (ROP) and Economic Order Quantity (EOQ), are well known and applicable whether simple manual systems (e.g. kanban) or more complex analytics are to be used.
Models exist to run ‘what if’ scenarios, both to balance service and cost possibilities and the performance of the system under different demand and lead time scenarios
From these analyses, the required inventory levels for each part can be determined and compared against current actual inventory level, from which a plan to adjust the levels can be created.
It’s not just about the numbers
However, it’s not simply about getting the inventory numbers right. At all of the stages above, it is important to engage and involve all of those who will be required to operate the improved system. It requires confidence and trust both in the validity of the analysis and the operating principles behind it and agreement that all functions will work to maintain the inventory levels identified.
Without this, shortages may arise or ‘just–in–case’ inventory will start to creep back in.
The benefits
If all of the above is executed well and consistently, the benefits are significant:
Better use of cash – ability to invest rather than support day–to–day
The right level of availability to provide the required level of customer service
Stronger balance sheet through better inventory governance
Want to explore further?
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In the course of the above analysis a number of opportunities to improve will have been identified. Establishing a prioritised programme of improvements to optimise performance is a logical next step, considering benefit vs. cost/difficulty of implementation.
Equally, ongoing monitoring of performance, using the KPIs identified above as a key metric, is essential, as is periodic review of the continued appropriateness of the parameters used for the analysis.
Feedback from the various functions involved will aid further refinement of the models and identify continuous improvement opportunities.
“Just–in–Time” (JIT) is perhaps the ultimate measure of how well an organisation can manage its inventory. The idea that materials arrive at the workplace just when they are needed sounds logical and desirable, but can be very hard to do in practice.
Last year, on my Japan Study Trip, we visited a company that has this down to a fine art. A supplier of pressed metal parts and sub–assemblies to a Toyota first–tier supplier, they have no goods in or goods out warehouse – just a small space in the yard – and minimal in–process inventory. And – unlike the attempts we made at JIT in the early days – does not rely on vast warehouses of parts between them and their suppliers or storage at their customer.
They rely instead on having a strong management system that knows what is required from the customer day by day, a highly engaged, capable and productive workforce, well–maintained equipment that’s highly unlikely to break down and, most importantly, an obsession to identify and eliminate the many small problems that could disrupt smooth flow through engaging and involving all operators.
Mr. Umemura, the president of the company, echoed a statement made the previous day by Mr. Matsudaira of the Toyota Management Institute, “Inventory is a measure of your fitness to do Just-in-Time.”
“Inventory is a measure of your fitness to do Just-in-Time.”
YASUHITO MATSUDAIRA – TOYOTA MANAGEMENT INSTITUTE
In other words, the more we understand and master our own processes – including those of our customers and suppliers too – the more confident we can be about our inventory levels. So a drive to optimise inventory is actually a drive towards understanding and mastery of your business.
