Inventory: Significantly optimising cash flow by changing the focus - mini-series (Part 1)
This is the first of three posts on the perennial subject of cash flow optimisation, with a focus on manufacturing and Fast-Moving Consumer Goods companies. The central argument across all three is simple: while finance must report on cash flow, operations must own the metrics. For practitioners who know this territory well, the series can serve as a structured refresher. For those who have been keeping cash flow at arm's length, it is a prompt to stop doing so.
Parts 2 and 3 will cover Days Payable Outstanding (DPO) and Days Sales Outstanding (DSO) respectively. Here we start with inventory.
Why cash flow metrics get treated as ugly ducklings
A positive cash flow is not complicated to define: it is what allows a company to service its debts, reinvest, distribute dividends, cover operating costs, and build a buffer against disruption. The COVID-19 period demonstrated this with unusual clarity - companies with disciplined cash flow management largely navigated it intact. As a former colleague of mine put it: "No money, no honey."
What is surprising, then, is how consistently cash flow metrics - Days Purchase Outstanding, Days Sales Outstanding, Days on Hand inventory, Days Working Capital - are treated as secondary concerns in boardrooms where EBIT, revenue, and CAPEX dominate the conversation.
Two reasons explain most of this. First, working capital metrics are true proxy metrics: they reflect the health of the underlying processes in inventory management, payment cycles, and demand planning. Boardroom interventions that target the metric directly - "let's do a cash run on overdues", "cut inventory by 20% this quarter" - address symptoms rather than root causes and produce limited, short-lived improvement. Second, these metrics are instinctively treated as finance territory. The CFO reports on them; Treasury or Real Estate is tasked with improving them. The result is that the functions who actually control the outcomes - sales, procurement, supply chain, manufacturing - are not held accountable for them and do not manage them proactively. That misalignment is where the opportunity is.
Why inventory specifically
Lean methodology has treated inventory as one of the seven wastes for four decades, and for good reason. In the human analogy: inventory is body fat. It is the opposite of agile and lean.
Inventory sits in three places in the value chain: finished goods in the sell process, work-in-progress in the making process, and raw materials in the buy process. An efficient order-to-cash process should be as close to void of buffers as practical constraints allow.
The most advanced position - a negative Cash Conversion Cycle - is worth understanding even if it sounds paradoxical. A negative CCC means customers pay before the business pays its suppliers, while inventory is near zero. It is more common in project-based businesses (design-to-order, engineer-to-order) than in standard production (configure-to-order, make-to-stock), but even companies with a positive CCC can move meaningfully in that direction with disciplined focus.
Ten questions to assess the current state
Are Cash Conversion Cycle metrics linked to the compensation of management and sales, in the same way as EBIT or revenue?
Do you have an inventory turn and Days on Hand target at company level, measured and reviewed regularly at board level?
Do you report inventory separately by Raw Materials, Work-in-Progress, and Finished Goods?
Do you have a functioning Sales and Operations Planning process along the full value chain? (If you need to ask around to answer this, the answer is no.)
Is 90% or more of your production floor space used for production, rather than for storing inventory?
Do you operate without permanent internal or external warehousing buffers?
Do customers or suppliers own the bulk of your finished goods or raw material inventory, rather than you?
Do you run a continuous improvement programme with embedded Lean practices?
Do you regularly review obsolete inventory - which directly impacts EBIT negatively when written off?
Bonus: Is the amount of inventory reported under "Sales in Excess of Billing" minimal? If nobody in the room knows what this means or how large it is, that itself is telling.
A clear yes to most of those means inventory-related cash flow is reasonably well managed. If most are no or unclear, the opportunity is real and the calculation below will show you how large.
Calculating the size of the prize
This is deliberately straightforward. Do not skip it because it looks simple - in many companies the problem is not the metrics but the absence of action.
Start by calculating your average inventory level. Add together the inventory values at the start and end of each month across the year, then divide by thirteen. If inventory does not fluctuate significantly, use the 1 January and 31 December values and divide by two.
Divide that average inventory figure by your annual Cost of Goods Sold. Multiply by 365. That gives you your Days on Hand - the number of days of cost of sales sitting in inventory at any point.
Divide your average inventory by 365 to get your inventory-per-day figure.
Now set a target DoH. For most manufacturing businesses, a well-run operation sits between 30 and 50 days, with inventory turns of seven or more. B2C businesses should target higher turns. The theoretical lower limit is set only by replenishment frequency - a business replenishing three times per day could achieve an inventory turn of over 1,000 per year.
Subtract your target DoH from your current DoH, and multiply by your inventory-per-day figure. That number is your cash opportunity.
A 15-20% inventory reduction in 12 months is achievable for most companies without heroic effort. With sustained focus from operations and sales, combined with improved competency, transparency, and cross-functional discipline, reductions of 50-70% over three years are realistic - with additional positive impacts on revenue and gross margin following from the improved flow.
Setting up the programme
The timeline is 12 to 24 months depending on the current starting point. The sponsor should be the Business President or Business Unit Head - not the CFO. The lead should be the Head of Operations or equivalent business leader. This is an explicit design choice: the point of this programme is to shift ownership of cash flow metrics from finance to operations, and the governance structure has to reflect that from day one.
A weekly cross-functional task force with clear objectives, monthly board-level reporting with clean output metrics - inventory trend, DoH trend, FG/WIP/RM broken out separately - and consequence management when targets slip. The separate breakdown by inventory type matters: it tells you immediately whether the gap is in procurement (raw materials), manufacturing (WIP), or sales planning (finished goods), and therefore who needs to be held accountable.
Note that GAAP standards are designed for financial reporting, not for managing value chain change. You will need supplementary operational metrics alongside the standard financial reporting to see what is actually happening.
On training: invest in it properly. Lean Six Sigma up to black belt level is available from excellent providers, increasingly online, and the ROI on a well-run programme typically materialises within a month of focused application. Role-play and value chain simulation games embed the learning in a way that a video and multiple-choice test never will.
On digitalisation: the opportunity is high. S&OP process and software are chronically underutilised in most companies - not because the technology is inadequate, but because sales and operations are not given aligned incentives to make the process work. Each function optimises against its own KPIs and the S&OP process pays the price. Fusing the two functions at the hip around shared S&OP objectives, set by the management board, is the enabler. Process mining software can accelerate the diagnosis significantly - see the previous post for context.
Watch out for
Expect resistance from business and operations leaders who will argue they have already optimised inventory. The most common objection is that they need current stock levels to compensate for unreliable demand forecasts - which is usually a polite way of saying that S&OP is not working. The second most common is: "Do you want us to focus on selling and making products, or on inventory?"
The answer is both. From now on, both.
Stay safe. Be bold.
Daniel
The views expressed in this post are my personal professional opinions, based on research and publicly available information. They reflect analysis of industry trends and practices, not assertions of fact about specific companies or individuals. Nothing in this post constitutes legal, financial, or investment advice.
