How does inventory tie up cash, and what does that cost you?
Stock is cash converted into a form you cannot spend, and the cost of holding it is consistently larger than businesses estimate — commonly a fifth to a third of the stock's value per year once every component is counted.
What holding stock actually costs:
Capital. Money in stock is unavailable for anything else — the opportunity cost, or the actual interest if the stock is financed.
Storage, including space, handling, equipment and utilities.
Insurance and security.
Obsolescence and deterioration, which dominates in fashion, technology, food and anything with a shelf life. This is frequently the largest single component and the least tracked.
Shrinkage — damage, loss and theft.
Administration — counting, systems, reconciliation.
The measures that matter:
Inventory turnover — cost of goods sold divided by average inventory — telling you how many times stock cycles per year. Higher is generally better, but too high means stockouts.
Days inventory outstanding, the same figure expressed as days of stock held.
The cash conversion cycle, which is the one that actually explains cash pain: days of inventory plus days to collect from customers minus days you take to pay suppliers. A positive cycle means you fund the gap, and a growing business with a long positive cycle can be profitable and run out of money — which is the most common way viable businesses fail.
Why some businesses have it easy. Supermarkets and many subscription businesses have a negative cycle: they are paid before they pay, so growth generates cash rather than consuming it.
What actually reduces the problem:
Segment your stock. A small proportion of lines usually accounts for most of the value, and deserves tight control while the rest does not.
Reduce order quantities and increase frequency, where supplier terms allow.
Negotiate payment terms, which moves the cycle directly.
Deal with dead stock decisively. Holding it hoping for full price costs more than discounting it — the money is already spent.
Forecast honestly, since optimistic forecasts become stock.
General information, not financial advice.