A few days ago I spoke with a CEO about his company’s inventory. He has quite a lot, and inventory turns of less than two. That means it’s turning over less than twice per year or, put another way, he has over 180 days of inventory. I asked if he was concerned about the amount of money that was tied up and he said, “no, it isn’t my money; it’s financed.”
This is a very bright person who is running a successful company and apparently doesn’t understand the covenants with the bank. Most banks will lend only around 50% on the value of the inventory in the bank line of credit, so in his case 50% of the money is in fact his. The bank loan 50% is accumulating interest at 4%, which, in his case, is over $100,000 per year. His money (the other 50%) is accruing 0% return on assets. What a deal!
The sad thing is that if he could reduce his inventory just one turn, even by selling it at a discount (but still at a profit) he would free up a great deal of cash to:
1) Pay down the line and recover some of the interest expense
2) Invest in the business
3) Return a dividend to the owners (in this case him)
As long as he communicated his actions to the bank, they wouldn’t be too concerned about the margin erosion so long as the company took action to prevent slow moving inventory from building up in the future. Slow moving inventory not only eats up cash that could be better spent elsewhere, but it grows bigger over time.
Do you have very slow moving inventory? Do you have a plan to prevent it from growing? Do you have a happy banker? Would you like more money to invest in your company’s growth? Visit my web site or contact me to discuss how to free up some capital and have a healthier company.
© 2014 – Rick Pay – All Rights Reserved