In this guide, we’ll explore how inventory management affects working capital, practical techniques you can apply, and how flexible financing solutions can support your business through short-term cash flow issues.
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Managing cash flow involves almost constant adjustment and calibration. Inventory management is a key element of this process, having a huge impact on working capital.
More small businesses than ever are facing short-term liquidity challenges, And as a result, a big proportion of SMEs now rely on external finance, rising from 41% of SMEs in Q1 2023 to 50% in Q3 2023. Working capital was the main reason for seeking finance (58%, up from 53% the year before).
Working capital is what keeps your business moving. It’s the difference between your current assets (cash, accounts receivable, and inventory) and your current liabilities (accounts payable and short-term debts).
Simply, it reflects the money you have available to run your day-to-day operations. Positive working capital means your business is in a healthy position to meet its short-term obligations, while negative working capital signals cash flow issues.
Inventory management involves overseeing and controlling the stock you have on hand. It’s about maintaining the right balance: enough inventory to meet customer demand without tying up too much cash or risking stockouts.
Poor inventory management can lead to overstock, tying up valuable working capital, or understock, which can mean missed sales and disappointed customers.
Effective inventory management is critical to optimising working capital. Here’s how:
Holding too much inventory locks your cash into products sitting on shelves rather than being used to fund other critical aspects of your business. Overstock increases storage costs, risks obsolescence (especially for perishable or seasonal items), and restricts your ability to invest in growth opportunities.
On the flip side, insufficient stock can disrupt operations and lead to lost sales. Customers who experience delays or backorders may turn to competitors, potentially costing you long-term relationships and revenue.
Optimised inventory levels free up cash, reduce waste, and improve your working capital cycle (i.e. the time it takes to convert inventory into cash through sales).
In this section, let’s explore practical techniques for improving working capital through better inventory management.
You can predict demand by analysing sales trends, customer behaviour, and market patterns. This helps you order the right amount of stock at the right time, reducing overstock and preventing shortages. For example, seasonal businesses can use historical data to plan for peak periods.
JIT inventory involves ordering and receiving stock as it’s needed rather than keeping large quantities on hand. This reduces holding costs and frees up working capital. But it requires reliable suppliers and accurate forecasting to avoid disruptions.
The inventory turnover ratio measures how often you sell and replace your inventory over a specific period. A higher turnover ratio indicates efficient inventory management and improved cash flow.
To calculate it, divide the cost of goods sold (COGS) by the average inventory value. Monitor this metric regularly to identify areas for improvement.
Modern inventory management software provides real-time insight into stock levels, sales trends and reorder points. These tools help you make data-driven decisions, streamline processes, and reduce human error.
Effective inventory management doesn’t happen by accident. Here are some strategies to help you manage inventory in a way that supports your working capital goals:
To improve your cash flow, negotiate longer payment cycles or discounts for bulk purchases. These terms give you more time to sell stock before paying for it, reducing pressure on your working capital.
Regular audits ensure you’re not holding onto dead stock – items that are outdated, damaged, or no longer in demand. Selling or liquidating this stock can free up cash and create space for products that move faster. Dead stock can be cleared through flash sales or can be used as a ‘loss leader’ (i.e. sell the dead stock at a loss but entice shoppers to buy other, more profitable items).
Rely on real-time data to guide your purchasing decisions. Avoid overbuying during sales or promotions, and focus on stocking items that align with customer demand. Accurate data helps you maintain a lean inventory and improve cash flow.
Despite your best efforts, managing inventory and working capital can be challenging, especially during rapid growth or unexpected disruptions (7% of businesses with 10 or more employees reported experiencing global supply chain disruptions as of February 2024).
This is where financial solutions come into play.
Inventory finance is a form of business financing where you use your inventory (products or goods) as collateral to secure a loan or line of credit.
The lender (often a bank, specialised finance firm, or alternative lender) evaluates your inventory to determine its value. You then borrow a percentage of that value, typically ranging from 50% to 80%, depending on the type of inventory and its liquidity.
The terms of the loan will depend on factors like the type of goods, their turnover rate, and your company’s financial health.
The idea is that you’ll repay the loan, often on a short-term basis, by selling the inventory or through regular instalment payments. Once the inventory is sold, the proceeds are used to pay off the loan.
Inventory finance helps free up cash that would otherwise be tied up in unsold stock. But it comes with downsides, too:
If you need to boost cash flow quickly, iwoca offers a more flexible, dynamic alternative to inventory finance. Instead of a loan attached to your inventory, a Flexi-Loan is more like a line of credit.
We'll give you a credit limit when you’re approved for a Flexi-Loan (typically around one month's revenue). You can then transfer money from the loan to your bank account as you need it.
You’re only charged interest on the amount you draw down. And you can repay at any time, with no extra charges. An iwoca Flexi-Loan offers you:
Inventory management plays a pivotal role in improving working capital for small businesses.
By forecasting demand, adopting lean practices like JIT inventory, monitoring key metrics such as inventory turnover, and leveraging technology, you can unlock the cash flow trapped in stock and create a healthier financial position for your business.
When cash flow challenges arise, flexible financing options like iwoca’s Flexi-loan provide the support you need to maintain inventory levels and seize growth opportunities.
By combining smart inventory practices with strategic financial solutions, you’ll be well-equipped to manage working capital effectively and set your business up for success.
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Inventory management directly influences working capital by determining how much cash is held in stock. Efficient practices reduce excess inventory, free up cash flow, and shorten the working capital cycle, enhancing financial flexibility.
The inventory turnover ratio measures how quickly your business sells and replaces stock. A high ratio indicates efficient inventory use, reducing holding costs and freeing up cash for other needs. To calculate it, divide your cost of goods sold by the average inventory value.
Moving dead stock is easier if you catch risks early, which is why it’s important to conduct regular inventory audits to identify items that aren’t selling. Consider discounting or liquidating these products to recover cash and reinvest in better-performing stock.
