DEMYSTIFYING THE BALANCE SHEET - Understanding Inventory

Welcome to blog 3, in this sales training series on Demystifying Financial Statements.

If you are new to our blog – thank you for joining us – it’s great to have you here.

You can read previous blogs at our blog page: https://www.castcommercialacumentraining.blog/blog

A new training blog in this series is released every Monday, which includes a structured exercise to build your knowledge and embed your learning by incorporating it into your customer engagement planning.

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Today's blog focuses on inventory.

Inventory or stock (if you are in the UK), refers to the goods and materials a business holds for resale at a profit. There are three primary types of inventories you may come across in your conversations with customers - raw materials, work in progress (WIP), and finished goods.

As an example, if we consider a biscuit making company like United Biscuits, raw materials could include eggs, flour, salt, sugar, and packaging; WIP could include biscuits part way through their production process; finished goods could be biscuits packaged and ready to ship to distributors.

What type of asset is inventory?

Inventory is classified as a current asset.

Remember, a current asset is a short-term asset that is cash or can be turned into cash within 12 months.

Many companies around the world are selling their inventory in exchange for cash, on a daily basis - this is why inventory is classified as a current asset.

Here’s how to do a quick and dirty review...for inventory.

An important point to note is that not all companies will have inventory in their balance sheet. This is simply because they don’t hold any. This is often the case for service companies. However, for those companies that do hold inventory, I recommend the following quick and dirty (Q&D) approach, which is purposefully similar to tangible assets, to help embed your learning of a new skill.

When you review and hypothesise about inventory, you are brainstorming ideas and gathering insights into a company’s inventory management system, which may highlight areas where your customers need help to improve efficiency, update or change systems.

Here are the steps in order for the Q&D review:

Step 1

Download the financial statements for one of your favourite customers who hold inventory. From the contents page, turn to the balance sheet. If possible, I would recommend using the same customer’s balance sheet as you did for your review of tangible assets in our last blog as it helps to build familiarity and understanding of your customers business.

Step 2

Scroll down to current assets until you find the word inventory or inventories (see image 1). If you are in the UK, the description may be classified as stock.

Image 1.

Once you have located inventory in the balance sheet, familiarise yourself with your customers business by asking yourself, what kind of inventory do my customers sell. Which items would be high-margin products, and which would be low-margin. There will be different types of inventories for different types, and sizes of business.

Step 3

To start and complete your Q&D review for inventory, answer the following four questions:

i. Compare the current year inventory number with the prior year number. Ask yourself, has the number gone up, gone down, or stayed close to the same? Make a note of the movement.

ii. What can you hypothesize about the movement.

If it’s gone up, what could this mean? Here’s a couple of ideas:

- If a company is showing signs of growth e.g., through increases in sales revenue, and/or investment in tangible assets, it would make sense that it would hold more inventory because it is a bigger business.

- Or, it could mean the company has purchased more goods than it can sell, which could indicate inventory management or control issues.

Similarly, if inventory has gone down or stayed close to the same, what could the reasons be for this?

- Are they scaling back and consciously holding less inventory, if so, why?

- Are they seeking to stabilise the business, retaining cash for future investment in other areas, if so, why? During covid which crossed financial years 2020 and 2021 a lot of companies decided not to hold as much inventory as in previous years.

- Are they outsourcing their supply chain? If so, why? Is there a change in company structure and/or strategy?

- Is your customer selling more and not yet replenished the inventory?

- Has there been a fire or flood in a warehouse? If so, what are the potential consequences to meeting customer demand?

Remember - You don’t need to have the exact answers, you just need to be curious about ‘why’ the movement could have happened, and brainstorm ideas to explore further.

iii. What questions could you ask your customer based upon your hypothesis and ideas to learn more about their business?

iv. Finally, based upon your hypothesis and questions, how could your products or services help your customer?

So, how long should this Q&D review take?

The first time you do an inventory review, it’s likely to be clunky, bumpy, and slow. Allow 20 minutes. With repetition, you will be able to do the review in just 5 minutes.

It’s now time to practice and play...

Repetition is mastery of all skill...so practice! practice! practice!

Download the financial statements for your top five favourite customers, who businesses you are familiar with. Then play and practice each of the above steps. Using your top five customers will mean you can apply the above steps to five different businesses. This will give you different perspectives, different questions, new insights, and fast track to mastery.

Trust your instincts...

One final point, which is very important when doing a Q&D review is to trust your instincts. If something doesn’t feel right, or doesn’t make sense, you are probably right. Make a note of it and ask your customer questions about it. Use it as an opportunity to learn more about their business. Curiosity is key, and they will love your interest in them and their business.

What's the next blog in the series?

Next week, our training blog focuses on accounts receivables. This is one of the more important numbers to look at in a balance sheet as it starts to tell the story about a company's cash flow, cash management and cash collection protocols. Next weeks blog shows how you can use your products or services to help ease, manage or resolve any cash pressures your customers may be experiencing.

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