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While profit can be a great way to measure the success of your business, 

 is essential to keeping your business running. And if you’re a product-based business, your inventory is one of the biggest factors for managing cash flow. It’s easy to tie up a lot of cash in inventory, and optimizing your inventory management process lets you keep enough free cash available for other operational expenses.

Having the right strategy to manage inventory will push your cash flow in a positive direction. It’ll help you keep the right products in stock, avoid excess inventory, predict cash flow, and understand the best time to order new inventory.

So, how do inventory and cash flow work together? Keep reading to find out.

Why cash flow is so important for businesses

Cash flow is the money that flows in and out of your business, reflected on your cash flow statement. Cash flows in from product sales, investment income, and asset sales—while it flows out through inventory purchases, interest payments, rent, and salaries.

Good cash flow means you can pay your bills and keep investing in growth. When you have money coming in and good cash flow projections, you can invest in product research, test product categories, research new designs, and build marketing campaigns.

Poor cash flow will impact your ability to operate and grow. Even if you have good 

, if you can’t reliably collect money from customers and other sources, you don’t have a predictable source of cash to cover expenses or re-invest. One late invoice payment means you may struggle to pay expenses and be unable to buy the inventory to sell to customers.

Inventory is one of your greatest assets as a product business. You need enough stock to fulfill orders, and if you run out, you run the risk of missing sales and losing customers—or at least losing out on customer satisfaction.

The problem comes when you don’t accurately predict how much inventory you need. Buying too little inventory saves money but increases the risk of out-of-stocks. If you purchase too much inventory, your company may tie up cash in products that sit on the shelf and may even need to be discounted to sell before they expire or go out of style.

Inventory optimization will help you maximize your company’s cash flow. You can use current 

and historical data to determine how much you can expect to sell monthly. This information will give you insight into the optimal inventory to buy to avoid running out or keeping too much in stock, giving you an ideal inventory level.

Inventory management tips for improving cash flow

So, now you know why inventory management matters for cash flow. What are a few ways to optimize inventory for better cash flow? Let’s take a look. 

One of the first steps to smart inventory management is understanding how much product you’re currently selling. Use your inventory management software to create a report covering how much of each product SKU you’ve sold.

You can use different timeframes to gather further insights—daily and monthly reports can help you see how effective your current advertising tactics are. Yearly reports will help you see trends over time and historical order volume during different points in the year.

Your goal is to determine how much inventory you sell each month. This number will help you determine how much inventory you need to order from suppliers and how frequently you need to order.

Track this data regularly and keep an eye on the reports to see trends and make smart decisions based on those changes. This will keep you from overstocking and understocking items that have changed in popularity.

As time passes, you’ll probably see a few of your products do better than the rest. These best sellers will generate the bulk of your company’s revenue. These are the products you’ll need to keep the most of in stock. They’re not only the SKUs you’ll sell most from day to day and the biggest risk for out-of-stocks, they’re also the least likely to cause overstocking problems, as you can sell through any excess quickly. If the 

 holds true (and it usually does), you’ll see 80% of your sales from about 20% of your products.

But that doesn’t stop some companies from stocking many products that underperform. Instead of varying their inventory stock levels for products that don’t sell well, companies still purchase too much, hoping an unpopular product will have future demand and sell more. Companies also consider bulk discounts and believe that saving money on inventory means their business is better off overall. But this isn’t always the case. 

While stocking up in bulk may give you a wider 

, it can cause more problems than it’s worth. More inventory can result in dead stock and excess products, which tie up your cash. You can’t pay the bills with extra widgets, so you often end up discounting them to bring in much-needed cash. Those products that don’t sell well will sit in your warehouse, wasting space, which also costs you money because you’re paying for more warehouse space than your business actually needs. 

Instead, focus on keeping inventory levels up for your best products and reduce the space used for storing inventory items that don’t sell well. Doing this will free up cash flow to experiment with other products or invest in other profitable business activities to fuel growth. (If you sell a ton of shoes but only a few pairs of socks, don’t tie up your cash by buying too many socks. That way, when black socks go out of style and red socks are the new trend (or your supplier gives you a great deal on shoes), you’ll have the cash to order what you need and won’t be stuck with inventory you can’t move.  When Thing 2 becomes the newest trend, you don’t want to be stuck with 1000 units of Thing 1 and no cash to stock up on Thing 2.)

How to calculate inventory turnover ratio 

While there are many granular ways to look at inventory, SKU-by-SKU, one great way to get an overall look at your inventory management is to calculate your inventory turnover ratio. Essentially, this ratio tells you how often you turn over your total inventory, on average, during a certain period. For example, if you measure the inventory turnover ratio for the full year, the ratio will show how many times you’ll sell through the entire stock in a year. A low number may indicate slow sales, but often indicates excessive inventory (i.e., stocking enough to last you months when you can easily restock more often). A high ratio, then, can indicate strong sales or possibly too little inventory on hand, if quick turnover leads to out-of-stocks. 

To calculate the inventory ratio, divide your COGS by your average inventory value.

Inventory Turnover = COGS / Average Inventory Value

This formula makes use of COGS for comparison, because inventory is recorded at cost in your accounting system. These are the costs directly attributed to manufacturing or acquiring the goods. Average inventory is calculated by simply adding your beginning and ending inventory for the period and dividing by two.

When optimizing inventory management, your ultimate goal is to minimize the amount of cash you have tied up in inventory. You want your inventory to sell quickly, giving you the cash required to buy the next batch of inventory for future customers.

This means reducing your order size as much as possible. You only want enough stock to satisfy your current customer demands without running out of stock before your next order.

Remember that this process can take time to get up and running, including dialing in:

Don’t be afraid to liquidate poor-performing products

As a business owner, you won’t always get it right when it comes to ordering or predicting trends. A new product may not sell as well as you expected, but that doesn’t mean the unsold inventory should keep haunting you for months to come. Liquidating old products will help you free up inventory space and generate cash flow for better-performing inventory. 

Your relationship with your supplier may be one of the most essential factors in helping you optimize your inventory management. When you start working with a supplier, there may be little trust. A supplier doesn’t know if you’re a good customer yet, so you may not get the best terms.

But as time passes and trust builds, you can start working to change those terms. One example of this is supplier lead times. Receiving your ordered products quicker will allow you to stock fewer products and have more confidence in maintaining a just-in-time inventory control system.

Net terms are another thing to negotiate with trusted vendors. Again, you’ll get standard terms to begin with, but you can ask to improve them as you build trust with the vendor. For instance, if you’re purchasing inventory on net 30 terms, and your supplier lets you increase to net 45, those additional 15 days can make a huge difference. 

Better terms are a big plus if you have a fast-selling product. You can quickly sell your inventory and pay some or all of your inventory and shipping costs without sacrificing cash flow. As your cash flow improves, you may also be able to get discounted terms by paying 

For instance, 2% 10 net 30 terms would give you 30 days to pay or a 2% discount if paid within 10. This is one way better inventory management and improved cash flow can also grow your profit margins. 

Many of the tips above have focused on avoiding excessive inventory. While tying up your cash in too much inventory is a huge problem, many businesses also struggle to have enough inventory to meet demand. Inventory financing can be the solution to accessing cash flow when you need it so you can order on time.

Improving your inventory turnover by keeping lower stock levels—especially on slow movers—and ordering just in time, you can give your cash flow a huge boost. By partnering with a working capital provider, you can accelerate that cash flow to keep you running smoothly through all the ups and downs of a product-based business. 

Having a financing partner in place, so you can access working capital quickly, on an ongoing basis, makes it simple to tap into cash flow when you need it.

While profit can be a great way to measure the success of your business, cash flow is essential to keeping your business running.

The right inventory management strategies can dramatically improve your cash flow. Find out how just-in-time ordering and inventory turnover impact your cash. 

Improve your cash flow through better inventory management 

How optimizing inventory management can improve your cash flow 

How Optimizing Inventory Management Can Improve Your Cash Flow

As a business owner, tending to your cash flow and profit is one of your highest priorities. You need both to have 

. Knowing these numbers will also help you understand your company’s performance and reach your goals.

Cash flow and profit aren’t the same thing, but it’s not uncommon for business owners to mix up the two. Unfortunately, doing so can lead to costly financial mistakes.

Here, we highlight the differences between profit and cash flow—and how to accurately analyze these metrics to guide your future decisions. The short answer? It’s possible to have cash flow without profit, and vice versa. Profit means your revenue is bigger than your expenses, leaving you with something at the end. Cash flow is all about timing. Even if you earn a profit, you can have negative cash flow if you haven’t collected the cash from those sales yet. Let’s take a closer look.   

Cash flow is money that flows in and out of a business from operating, investing, and financing activities. It’s not the amount of cash you have left in the bank after everything is said and done—it deals with the movement of cash during a specific period. 

So, why is cash flow important? Because you can’t keep your operations running without it. Vendors don’t want to see your P&L statement, they want to be paid, which takes cash.  

Let’s start by looking at the different cash flow types.

Operating cash flow is the money that comes and goes directly from the production and sales of goods from normal operations. It’s also called cash flow from operations and helps determine if your company has enough cash to cover all the bills. If you see a negative cash flow from operations, it’s a sign that you may not be able to sustain your business long-term.

A few examples of operating cash flow include:

, determine how much cash you received from sales and subtract your operating expenses paid in cash during that time. You can calculate your net operating cash flow monthly, quarterly, or annually, and you’ll want to keep an eye on it regularly to anticipate any issues.

Many companies invest in securities and make other investments related to their businesses. These investments allow companies to use surplus cash and create added cash flow to fund other parts of their businesses. 

Investing cash flow also includes investments in your core business, such as research and development. A negative cash flow from investments isn’t necessarily a bad sign—especially if the investments lead to growth.

Some examples of investing cash flow include:

Cash flow from financing is cash in and out from external financing, including borrowing and repaying debt, as well as infusion of cash from equity investors. 

Looking at cash flow from financing gives you a better view of how you manage your 

. You can see which parties (lenders and investors) are drawing cash away—which provides a starting point for reducing financing expenses (such as paying off high-interest debt). 

As you can see, investment and financing activities are an important part of running a business and can be crucial to optimizing your cash position. However, cash from these “irregular” activities can easily cover up the fact that your day-to-day business is actually operating with negative cash flow, which isn’t sustainable for very long. 

Profit is what remains of your revenue after covering certain expenses (which expenses you subtract depends on the type of profit you’re talking about; more on that in a minute). It has nothing to do with your total incoming or outgoing cash—just the difference between income and expenses.

Profits are distributed as payouts to business owners and shareholders or reinvested into the company through research, development, inventory, and marketing.

Several profit calculations can provide insights into your company’s financial health—and how each function of your business contributes to your company’s overall profit. Here are the three main types you should consider.

Gross profit is an essential financial metric that helps businesses understand their profitability. It is the difference between revenue from sales and the costs of goods sold (COGS), excluding other fixed costs like rent and salaries. Essentially, it tells you how much money you're making after accounting for the direct expenses that went into producing or acquiring the goods or services sold.

A positive gross profit gives you something to work with to cover your operating expenses, while a negative gross profit indicates that your business is operating at a loss, even before covering your cost of doing business. It's crucial to track your gross profit over time to ensure your business is making money, and to ensure you have a healthy margin to keep operating.

Calculating gross profit is relatively simple; it involves subtracting the cost of goods sold from total revenue. However, it's essential to ensure that the COGS is calculated accurately to obtain an accurate gross profit figure. COGS should only include those costs that are directly attributable to the production of your goods or services, not indirect overhead costs. 

For example, if you run a bakery, your COGS might include ingredients, cake boxes, direct labor costs for your bakers, and supplies like parchment paper. It wouldn’t include indirect costs like your rent, your marketing expenses, or the wages of employees not directly involved in baking, like your bookkeeper.

Operating profit is another crucial financial metric that tells you how much money your business is making from its core operations. It measures the profit generated by your business's operations after accounting for operating expenses, depreciation, and amortization.

Operating profit is useful because it shows how much money your business is making before considering non-operating expenses such as interest payments, tax payments, and asset sales. This provides a clear view of how much money the business is generating from its core operations and helps determine the effectiveness of your cost management strategies.

To calculate operating profit, you start with your gross profit and subtract those operating expenses you left out of the gross profit calculation—things like rent, utilities, administrative salaries, and marketing costs. 

Net profit, also known as the bottom line, is the profit that remains after accounting for all the expenses associated with running a business. It is the most comprehensive measure of a business's profitability, as it considers all revenue and expense streams, including taxes, interest payments, and asset sales.

Net profit shows how much money a business is making or losing after accounting for all expenses and provides a clear view of the business's financial health and profitability. It's essential to track your net profit over time to ensure that your business is profitable and to make informed decisions about allocating funds.

Calculating net profit involves subtracting all expenses from all revenue, including taxes, interest, and other non-operational expenses. A positive net profit means you have money left at the end of the year to invest in growing the business or reward owners for taking the risk of entrepreneurship, while a negative net profit means the business is losing money.

Cash flow and profit are both key ways of measuring financial health. However, they measure different aspects of a business's financial performance, and their importance depends on the business's current situation.

Cash flow measures the inflow and outflow of cash in a business, while profit measures the business's revenue and expenses. Cash flow is essential because it ensures that a business has enough cash on hand to pay its bills, meet payroll obligations, and invest in growth opportunities.

Profit, on the other hand, is important because it measures a business's overall potential to generate returns for the owner and is necessary to sustain the business in the long run. A business cannot survive on cash flow alone, and a sustained lack of profitability can lead to business failure.

Tapping into working capital to manage cash flow

Cash flow and profit work together to keep your business healthy both now and in the long run. Tapping into an external source of working capital can help you close any cash flow gaps to keep your business running smoothly and also enable you to invest in your company’s future growth and increased profitability.

 can be slow and clumsy when you need fast access to 

, and bringing in cash from investors can compromise your control and ownership. Alternative options like 

 can be the perfect solution, letting you access capital when you need it, based on your revenue and the health of your business.

As a business owner, tending to your cash flow and profit is one of your highest priorities. You need both to have healthy financials.

Understand the difference between cash flow and profit and how to use both metrics to run your business better.

Finances

How optimizing inventory management can improve your cash flow

What’s the difference between cash flow and profit, and why does it matter to your business?

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Finances

How optimizing inventory management can improve your cash flow

What’s the difference between cash flow and profit, and why does it matter to your business?

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