One of the most bewildering aspects to managing a business that stocks and sells physical goods (as opposed to selling only electronic downloads, or items drop-shipped directly from manufacturers to customers) is understanding the huge importance of inventory that you keep on hand to sell.
It’s entirely possible that at some point your accounting software will tell you that your business is making a healthy profit, yet there’s no cash on hand to pay your bills. How is this possible?
It can happen because the finished products you buy and stock to resell (or the components that you assemble) are likely to tie up more and more of your profits, and perhaps personal savings, as your business grows.
This could put you in a position where you don’t have the cash you need to pay suppliers or even the IRS – because so much money is tied up in physical inventory on your shelves. And the concerns don’t end there.
- As your business grows you’ll likely need to keep an ever greater value of inventory to maintain a constant number of days’ supply, since running out of products will lose customers and waste advertising dollars.
- Many local property tax districts require you to file a report – separate from your home appraisal – showing the value of your business inventory at the end of each year so that they can collect additional property tax.
- Once the inventory you keep on hand grows to a value that you can’t easily replace, you should seriously consider buying business insurance so that fire, theft, and accidents won’t shut you down.
Avoiding the Trap
Many online stores limit their inventory costs by drop shipping products directly from manufacturers to their customers, without ever handling the products themselves. While drop shipping can eliminate inventory costs, there are several disadvantages.
- You’ll likely pay more for products that manufacturers drop ship to your customers, compared to items that you buy for stock.
- You’ll lose control over the quality and promptness of the shipments that manufacturers send directly to customers.
- Your website could have too little differentiation with other retailers who likely publish similar descriptions, and offer the same stock status and delivery times, provided by manufacturers who drop ship.
In the case of our business, we chose to ship our own manufactured goods and stock items, and to make it a priority to proactively manage inventory.
Next we’ll discuss some of those strategies to control inventory costs.