Drowning In Inventory? Simple 80/20 Hack From Cash-Poor To Cash-Rich

The Hidden Trap: How More Inventory Kills Your Business

If you sell products, excess inventory damages your business in two critical ways. It ties up more operating cash, creating a painful cycle: higher sales actually leave you with less cash in hand. 

It leads to more write-offs of dead stock, hurting both your bottom line and cash flow.

The 80/20 Magic: Less Products, More Profit

The solution is straightforward: narrow down your product line using the 80/20 principle. In many businesses, 20% of top-selling items generate 80% of sales. By focusing on fast-moving products, you can dramatically reduce inventory without hurting your bottom line – you might even boost profits.

Let’s look at a real example with 10 items:

item1item2item3item4item5item6item7item8item9item10
Avg Monthly Sales50035040302520151055
Current Inventory1601205050504030201515

In this case, the top 20% of items (item 1 and item 2) generate 85% of sales. The total inventory amount is 550, with top sellers making up only 280 – half your total inventory. Think about this: slow-moving items (15% of sales) lock up 50% of your inventory! Do you realize how much operating cash this traps?

The Minimum Order Dilemma: Why Slow Movers Eat Your Cash 

Look closely at each inventory amount. Wholesalers set minimum purchase quantities. This forces you to buy far more than monthly sales for slow-moving items. However, with fast-selling products, you can order weekly while still meeting minimum requirements. Fast-moving items rarely become obsolete or overstocked. Frequent, smaller orders help you easily handle demand changes and seasonal shifts.

How do we set inventory levels? For items 3-10, we must meet the minimum purchase amounts from wholesalers. These quantities are much higher than our monthly sales – but with slow movers, we’re stuck with these large orders. This is exactly why these products often become dead stock we have to write off.

The Math Behind Stock Levels: Using Poisson Distribution 

For item 1, average weekly sales are 125, but why keep 160 in stock? This comes from the Poisson distribution. The Poisson distribution models random events with known average rates, like customer visits. For example, with an average of 5 customers per hour, you can calculate the probability of different customer numbers with a simple formula. More than 13 is very rare.

Poisson distribution of average 5

Using the Poisson distribution, the chance of selling over 160 units weekly is just 0.1% – letting you maintain minimum inventory without losing sales.

Why Higher Sales Mean Less Cash

By eliminating slow movers, you free up 50% of your cash that’s tied up in inventory. Yes, deliberately cutting your sales might seem insane. But chasing higher sales doesn’t guarantee better cash flow – often it does the opposite. Higher sales mean less cash on hand.

Here’s a simple example: With sales of 100 and inventory of 20, you earn a 3% profit of 3. Double your sales by adding stores, and inventory jumps by 20 (requiring immediate cash out). Profit only increases by 3, leaving your cash flow at -17 (3-20). Higher sales, less cash.

This explains why reducing inventory is crucial, especially during rapid growth. As you expand, inventory and tied-up cash grow with you. Sometimes excessive cash needs can completely block growth. With lower inventory levels, expansion becomes much easier.

Deep Discounts and Write-offs: The Hidden Profit Killers

Another major problem: deep discounts and write-offs. Slow-moving inventory often sits dead in stock. You can’t predict if you’ll sell everything before trends change or seasons end. These items typically harm profits more than help them.

Think about it – when your profit margin is only 3%, offering 20-30% discounts on slow movers or writing them off means losing money on items you’ve already paid for.

The Hidden Costs Beyond Purchase Price 

Even if you manage to sell these items above purchase price, you’re still losing money in hidden ways: for example, staff hours spent managing inventory, valuable floor space wasted on items that barely sell, warehouse expenses, and time spent training staff on too many products. By removing these slow movers, you can boost profitability by eliminating all these extra costs.

By carefully analyzing how cutting slow-moving inventory affects your cash flow and profit, you can transform your business into a more profitable, cash-generating machine.