Preparing Budgets

Difference between Budgeting and Forecasting

Budgets and Forecasts, both relate to the estimation of the future; although conceptually a budget happens to be based on planned events and is constructed based on past actual events whereas, forecasts are just an estimation of uncertain future events to help in planning for the business with such uncertainties in mind.

Budgeting; Why?

The first thing to do is to plan; do it on a month-to-month basis for the entire year. Keep in mind that the sales numbers will be critical since they'll be used to compute the overall production required to keep the company afloat till the next budgeting period; the profit margins, the expenses, receivables, payables and all other ancillary expenses necessary to support the business.

Having said that, how much of your product/service has to be sold will purely depend on the accurateness of the market research conducted for the market in which you operate and how well have you understood the competition, after all, entering in to a price war with a giant monopolist is as good as committing suicide.

Budgeting is the most powerful financial planning tool available to any business. Preparing a budget means arriving at thoroughly planned incomes and expenditures.

Ask yourself the following questions to get that brain working:

• The borrowing costs?  
• What will the taxation affect be? 
• The number of employees needed? 
• The growth in sales over the years? 
• What is the credit policy going to be?
• What payment terms will the suppliers offer? 
• What will the operating expenses amount to? 
• How much will it cost to produce the product/service? 
• How much inventory will there be and would be needed? 
• What is the volume of sales that the company as a whole is looking at? 
• What equipment will be needed to start the business and how much would it cost?

The Master Budget

A master budget is usually classified into two individual budgets: the Operational Budget and the Capital Budget (The process in which a business determines whether projects such as building a new plant or perhaps investing in a long-term venture are worth pursuing). I will be talking of the operating budget in this blog.

The operation budget primarily consists of these individual budgets:

Sales budget: The sales budget shows the expected sales in units at their expected selling prices. The sales budget must be done first so as to identify the expected sales orders before embarking on budgeting  plans for any other departments.

The sales budget will set the tone for the entire budgeting process for the period, how much to produce, how many people required to produce, costs of production, the production schedule itself, all depends on the volume of sales that have been planned.

Production Budget: A production budget is a plan for obtaining the needed resources to carry out the manufacturing operations to meet the expected number of sales. The following sub-budgets also need to be prepared (assuming it is a manufacturing/value adding plant/factory)

1. Direct Material Budget 
2. Direct Labor Budget 
3. Factory Overhead Budget

Selling and administrative expenses budget: The selling and administrative expenses budget gives a comprehensive breakdown of various expenses that would be done in order to boost sales for the budgeted period.

Budgeted income Statement: It estimates the expected operating income from budgeted operations. It also gives the management an idea of the likely operating result for the budgeted period.

Cash Budget: By preparing a cash budget the management will be able to ensure that they have sufficient cash on hand to carry out activities. It will also allow them enough time to plan for any additional financing they might need. 

The cash budget should also include; cash available from operating activities, from investing activities and lastly from financing activities.

Budgeted Balance Sheet: The last step in preparing a master budget is the budgeted balance sheet. This is the sheet that will show the expected financial position at the end of the budgeted period.

There are a few other things that need to be brought up as far as budgeting goes and they will be posted on a later date.

Enterprise Resource Planning

An ERP system is an integrated solution, with a central database and the luxury of updating it at a click of a button through a single entry. Data, in an ERP system has to be entered once; there are security controls for such entries too, a person can enter but cannot post to the system unless it has been approved by a supervisor, thereby, reducing errors, time and manipulation of accounts. Generating reports is more of “a walk in the park” than those laborious hours trying to import data in to spreadsheets (like Excel) processing them and then printing them for reporting purposes. Analysis, planning and management can be done off-screen through ‘mouse-clicks.’

Ultimately, time and resources are shifted to innovation, problem solving and effective customer service rather than spending hours entering data, processing, verifying them.

I am not going to talk about ERP history, or how it came in to being, you have Wikipedia for that

ERP help reduce operating costs


There are two primary cost reductions a company can benefit from, being:


1) Aligned processes

The ERP attempts to integrate business processes across departments in to a single enterprise-wide information system with the sole aim of having uniform processes across the organization; which in turn helps in having fewer, yet common processes, thereby, making work flow faster through the processes.

An organization that flows on a uniform processes set (or tries to operate as close to bringing them to uniformity as possible) wastes lesser time, effectively manages process quality far better than those that work haphazardly and on a “as-and-when-required” attitude.

Job rotation is then easy, unlike, traditional organizations where companies come to a standstill if the relevant person is not available.

2) Paperless environment

Going ERP is almost as good as going Green. It’s like going paper-less. From your paper purchases to printer cartridges to the millions of trees, you will feel the difference (at least the earth will).

ERP help facilitate day-to-day operations

One point of entry and the data can then be processed in different ways to convey different information to different stakeholders. A sales entry can mean increase in revenue for the sales and accounting manager but will also mean a rise in the accounts receivables for the later as well as it will also mean target achieved during the period for the sales manager. Credit controller also now has to add another name to his list if the collections are not in time. The salesmen can log in to see how much commission they will be earning for the period.

Over and above, sales then can be broken up, in to product, category, location, margins and even on a sales man basis; enabling learned decision-making.

ERP provide Real-time online updated records

When companies work across geographical locations, they need to know exactly what is happening on a real time basis. This is more important for a trading/retail company. If it has a real time availability of its inventory stored in warehouses 100 miles from the sales office, it is still in a position to bid for the order aggressively unlike any other that would have a stores within its vicinity but no updated real time records.

ERP enable strategic planning

• Reduce risk
• Optimize IT spending
• Retain top performers
• Improve productivity and insight
• Support changing industry requirements
• Reduce costs through increased flexibility
• Improve alignment of strategies and operations
• Provide immediate access to enterprise information
• Improve financial management and corporate governance

The ERP Perfection


ERPs come from different vendors with different variations, some may be good for a trading enterprise, where as another may suit a manufacturer better, likewise, one may suit a services provider better than the other two.


Which ERP would suit you better is something that would come up after a thorough analysis of the business and its needs.


Some companies buy the ERP software, whereas, some develop it in-house with the supervision of experienced consultants.


Like in my first blog (right at the bottom of this page) you would notice I have talked of an ERP in supply chain management. Aligning your SCM to almost perfection is just one example of having a well implemented ERP.

 Below is a list of few modules of an ERP to help ascertain the strengths and benefits of an ERP to the business.

1. Treasury
2. Human Resource
3. Plant Maintenance
4. Production Planning
5. Quality Management
6. Financial Accounting
7. Sales and Distribution
8. Materials Management
9. CRM (Customer Service)
10. Logistics Information System
11. (Project Management Systems)
12. Supplier Relationship Management
13. SCM (SAP Supply Chain Management)

Would you have any queries please feel free to write to me and/or my friend, Mr. John McGrann, CEO of Drive ERP, we would appreciate the opportunity to help you.

Change Management

Change management is an ability in which managers need to be proficient. It is more or less like Exodus where you are playing Moses and the people following you through the water walls in to the Promised Land. People Management is the key.

We will talk of this walk and how to manage people and their reactions to changes they want and what they are actually getting.

Always keep in mind that:

1. Different people will certainly react differently to change
2. Everyone has perceived needs that have to be met
3. Change often involves a loss
4. Expectations have to be managed
5. Fears have to be dealt with

Different people react differently to change

Change can be presented on a continuum like:

Different people have different preferences for where they like to be on this continuum. Some people like to be at the stability end of the continuum - they like things to be the way they have always been.

Then there are those who like to be at the change end - they are always looking for something different, new and challenging.

Problems arise when the individual's preferences differ from the situation they are put in. Meaning to say that, where :

• a stability-oriented person finds that circumstances are changing quite rapidly, or
• a change-oriented person finds that everything is the same and there is nothing new

In these situations, the individuals involved usually experience:

• strong dissatisfaction even to the point that it evolves in to frustration
• stress
• negative attitudes towards individuals, work and the management in general
• resistance to change
• de-motivation

People tend to resist.

 Everyone has fundamental needs that have to be met

Psychologist, Will Schutz identified three basic needs that people have in interpersonal relations. These basic needs are also of fundamental importance in people's reaction to change:

• The need for control
• The need for inclusion
• The need for openness

Every human being processes his needs and wants through his frame of references; these references pour from the individual’s likes and dislikes to which his brain has been tuned over years. On the other hand, a person’s attitude towards change is also a very important factor. Therefore, when you have look at a person’s attitude towards change you would have almost solved the change management issue, as I said earlier, attitudes are behavioral patterns that are exhaustively dominated by an individual’s frame of reference. In any change process there is always some degree of need for control over one's environment, even participation in the events leading to the change, expectation of clear and precise information of the change and its processes otherwise, it is likely to run into an array of negative reactions, ranging from anxiety, stress, frustration through resistance to partial resentment.

Change often involves a loss

The relevance of the "loss curve" to a change mature and extent of the change. If someone is promoted to a senior position, the change is rarely an issue because it has been replaced by something better. But if someone is made redundant with little prospect of getting a new job, there are many losses (income, security, working relationships) that can have a devastating effect.


Expectations need to be managed

The relationship between expectations and reality is very important. You can see this in customer relations - if a supplier fails to meet expectations then the customer is unhappy; if the supplier exceeds expectations then the customer is happy the same applies to change. If their expectations are not met, they are unhappy. If their expectations are exceeded, they are happy.

What managers have to do, however, is make sure they don't over-promise. Expectations have to be set at a realistic level, and then exceeded. The wiser thing to do.

This also reminds me of one of my clients, I was reviewing their cost budgets and their actual performance all round was just excellent, they had been phenomenal. I tried to learn the secret of their success and I did, their budgets set goals too low, therefore, under normal production they were able to beat their budgets and a little effort helped their cause. I brought this point to light in the board meeting and tore off the budget sheets, since then the CFO and COO never spoke to me, although the CIA and CEO have become very good buddies of mine.

Fears have to be dealt with

Where significant change rational thought is not clearly understood nor absorbed people often fear the worst - in fact, they fear far more than really required, their subconscious minds suddenly become illogical and see irrational consequences which just goes on to add on the anxiety and stress:

• Our company is reducing staff, which means...
• They will make people redundant, and...
• I'll be the first to be kicked out, and...
• I'll have no hope of getting another job, and...
• I won't be able to pay the mortgage, so...
• I'll lose the house, so...
• My family won't have anywhere to live, and...
• My wife won't be able to cope, etc.

Such fears (primarily negative thoughts) should be addressed, eg by helping people to know what is happening and that one individual is being made redundant will find a better job with better pay and have a huge lump sum in their pocket.

Always:

• Give people information - be open and honest about the facts, do not promise that cannot be delivered.
• For large groups, produce a communication strategy that ensures information is disseminated efficiently and comprehensively to everyone. This, however, should be followed up with individual interviews to produce a personal strategy for dealing with the change. This helps to deal appropriately with individual reaction to change.
• Give people choices to make, and be honest about the possible consequences of those choices. 
• Give people time to express their views and support their decisions, providing coaching, counseling or information as appropriate.
• Where the change involves a loss, identify what will or might replace that loss - loss is easier to cope with if there is something to replace it. This will help alleviate potential fears. Also give individuals opportunity to express their concerns and provide reassurances - also to help assuage potential FEARS.

Where you are embarking on a large change programs, you should treat it as a project and bring about all the functions of project management.

How Interest Rates Affect Our Purchasing Power

Before we see how interest rates affect our purchasing decisions, we need to talk about the Messengers of Death and understand how they affect us. Yes I am referring to interest rates and inflation.

What is interest?

An interest rate is the percentage of the debt that is charged as interest. Every loan, mortgage, credit card etc. that you ever will receive will have an interest rate associated with it. These can vary wildly between financial products, and also between consumers based on their credit histories.

What is Inflation?

Inflation is a constant increase in the prices of all goods and services produced in an economy. Money loses purchasing power during inflation periods since each unit of currency buys progressively fewer goods.

Suppose the overall price index increased by 3% during the past 12 months. If a typical household spent AED 4,000.00 during the first month for all household expenses, then they must budget AED 4,120.00 during the last month for exactly the same quantity of goods and services.

In simpler terms, it can be said like

3 Liters of milk cost AED 10 earlier now costs AED 15 or you can now buy 1 Liter only for AED 10 This is often described as "too much money chasing too few goods.”

The interest rate is a monetary policy tool used to achieve price stability and sustainable growth. Changing the interest rate influences the money supply, beginning with banks and eventually trickling down to consumers.

Governments and Central Banks in particular lower interest rates in order to stimulate economic growth. Lower financing costs can encourage borrowing and investing. However, when rates are too low they can spur excessive growth and eventually inflation as has happened during the 1990s to 2006. Inflation eats away at purchasing power and could undermine the sustainability of the desired economic expansion plans set forth by countries. Meaning to say many countries draw 20 year economic targets and in order to achieve them they design and develop fiscal and monetary policies; if forecasting and subsequently economic planning had been poor, anything can go wrong: inflation, deflation, stagnation all of this in a nation.

On the other hand, when there is too much growth Central Banks raise interest rates. Rate increases are used to slow inflation and return growth to more sustainable levels.

Lower interest rates allow more people to buy and more people to purchase more expensive commodities like homes, cars etc. The negative about low interest rates is that it has a tendency to push prices of commodities higher because there are simply more buyers. It is a "supply and demand" thing.

A consumer's purchase power is seen here in the graph between QQ/SS/YY/XX the shaded area. As long as the interest rates are with the consumers'/firms' reach there is tendency to spend as it appears on QQXX but the moment RR goes above the purchase budgets B, at SSYY, the spending comes to a halt, here then, the Indifference curves and the Budget Lines re-align themselves for the consumer to adjust his optimal utility derieved from various combinations of available commodities from his newer and scarce resources.When interest rates are changed, demand can be affected in various ways.

 

1. Income = Expenses + Saving
2. Quantity of money
3. Exchange rates

Income = Expenses + Saving

Against a certain level of income, for firm or a consumer an increase in interest rates will attract saving and should theoretically reduce borrowing.

This will tend to reduce current spending, by both consumers and firms; this includes spending by consumers in the shops and spending by firms on new equipment, ie investment in newer assets or expansion in to newer markets. Conversely, a reduction in interest rates will tend to increase spending by consumers and firms.

Quantity of money

A change in interest rates will affect consumers' and firms' cash flow, ie the amount of cash they have available. For savers, a rise in interest rates will increase the money received from banks and co-operative society deposits. But it will also mean higher interest payments for people and firms with loans - debtors - who are being charged variable interest rates. These include many consumers with mortgages on their homes.

Exchange rates

In practice, the exchange rate will be influenced both by expectations about future interest rates and any unexpected changes in interest rates. That is because if investors expect interest rates to rise, they may increase the amount they invest in a currency before interest rates actually rise.

"If something will cost far more than it is worth because you do not have the money to buy it, then you should wait until you can afford it and stay out of debt."



Write Probate Wills: Don't die Intestate

A Will is a legal document that sets forth a person’s wishes regarding the distribution of his/her property and the care of any minor children (a guardian). A Will provides the manner in which a person’s property will be distributed after death. A Will contains instructions and wishes as to how the property and assets are to be distributed.

Any person, of any age (after 18: in some countries after 21), should seriously consider writing a Will at the earliest. People die at all ages and a Will is needed especially if you have assets and property to be allocated to those you wish to benefit.

Why Write a Will?

A Will is the expression of the person's wishes concerning how their property is to be distributed.

It is a:

1. written statement
2. signed in compliance with the various formalities covered by legislation
3. It is a legal document containing the names of the people you want to benefit
4. details of your possessions at the date of your death: the people you want to benefit are called beneficiaries

Property or possessions include everything you own, such as your home, land, vehicle(s), bank account(s), benefits of insurance policies, furniture, boat(s), investments such as shares, personal jewellery, all forms of royalties received on intellectual property and so on.

A Will also clearly states the manner in which the person wishes to be put to rest after his death. He/she may choose to be buried or cremated is also clearly stated in the Will.

If you are charitably inclined, a Will lets you direct your assets to the charity of your choice. Likewise, if you wish to leave your assets to an institution or an organization, a Will can see that your wishes are carried out.

If you do not have a Will?

Legally, you die intestate. In such a case, the State will oversee the distribution of your assets according to the laws prevalent therein. Contrary to popular opinion, the State does not inherit your assets, but rather distributes them according to a set formula. Such a scenario can result in the sale of the family home or other assets, negatively impacting the surviving spouse. Further complications can arise if your children are minors, as the Court will appoint a representative to look after their interests.

In the United Arab Emirates, the bank accounts (operated singly and jointly) area all frozen by the banks till the Court instructs the banks to release the amounts, this court order arrives only after the Will has been carried out which may take any number of days.

Power of Attorney

It is also possible that you may have an accident, are in a coma and no one but you had the access to the bank, now what happens to your wife and the children, in this case it is wise to write a Power of Attorney, authorizing her to use the banks in case you are incapacitated.

A lawyer friend of mine also said and I quote, “If you don’t trust your wife, just don’t give her a Power of Attorney.” So just be careful to whom you give them out to.

Modus Operandi


Step 1: Planning and an Introductory Meeting

I begin each Will with a Planning phase, which requires the involvement of the person who’s Will is being prepared. Detailed discussions are held with the person to exactly understand his/her wishes and desires and by enabling the client to better understand the implications of dying intestate along with the advantages of having a probate Will.

Step 2: The Documentation

These meetings typically last no longer than couple of hours and take place at your office, if possible. At this time you have the opportunity to ask questions about the upcoming work and its process.

I encourage you to discuss any concerns that you may have and any areas or businesses that you would like me to address effectively.

At this time, you may also provide e with the information I request before work begins -

Step 3: Fieldwork

In this step, the actual work of the Will is performed from the already gathered information about your desires and wishes regarding the execution of the Will.

I also prepare a Power of Attorney in favor of your wife, so that if the need be she can exercise her right to secure herself legally and take care of the funeral/repatriation of the body; relevant procedures and all incidental expenses.

Step 4: Probate your Will

After the fieldwork is completed and the Will and the Power of Attorney have been reviewed with you, at your option, either you or I will have the Legalization done from all the Government offices so that the Will is effectively carried out by the Courts after your death.

Inventory Management: Tips

Keeping track of their supplies

It really does not matter what line of business you are in; from a steel mill to a ghetto workshop, a law firm to libraries or schools for that matter everyone needs to have a good track of things that they need on a “as and when required basis.” As I just said, law firms, libraries and schools do not print text materials nor do they print note books and other relevant stationery, but they need to ensure that an adequate amount of the items that really matter, things that are prime to their operations are on hand at all times. This goes without saying that it does not mean that they have to be overly prepared by holding excess amounts of inventory all the time. They need to develop a system for keeping track of their supplies; check on the history and observe the consumption trends and perhaps there on build from there on.

Here are a few tips on how you can better manage your inventory


1. Consolidate

If you don’t already have one, create a centralized storeroom, when you have your inventory scattered all over your facility creates confusion; consolidating into one location creates clarity and reduces cost and downtime.

2. Catalog

Once they are all together in one place, create a list of all items identify them your Unique Product Identifiers (UPI). Your UPI may also be something on the lines of your SKUs.

3. Count

You should have a full count of all the items physically lying in the central location. If a specific product comes in different dimensions it should be counted separately and be allocated a UPI. Aggregating them to quote or sell is another thing but when they are in your warehouse they are different “people” within themselves and have to be treated accordingly, with care and respect.

4. Calculate

Go through your records and see what materials do you require frequently and how much of it do you really ever require, if they are fast moving items perhaps you would have some inventory lying in the warehouse all the time but then this also comes from certain calculations so as to ascertain how much do you really need in the first place and it is also possible that some items although fast moving may be too big to have in the warehouse all the time, those are then to be procured on a “as and when basis".

Inventory management is about intelligently reducing costs without any serious compromises on product quality and in all of this striking a balance between reducing costs and arriving at the optimum level of inventory levels required.

5. Computerize


Have a good application in place where in it gives you the facility to create bar codes and keep a track of what item occupies which shelf in which warehouse, the more specific the better.


6. Continuity

Having bought a machine and the computer wizards come in, install the application, print bar codes, sticking them on the inventory and after a few weeks its all back to square one, does not really do the trick. Continued use, updating at every transaction is ideal but then the sooner the records are updated the effective the control the business has on its inventory. There is no management if there is no control to begin with.

This closes the series on Inventory Management. If ever there is something relevant I would be writing about it again so but for now, its too much (of inventory).



Inventory Management: Inventory Replenishment

Companies may choose to have a periodic or a perpetual system for their inventory replenishment. A periodic system is where a company purchases all inventories required for the year and feeds its production department or retail out lets from there in. A perpetual system is where in raw materials are bought as and when the company feels the need to do so and in my experience so far, I have not come across any company that operates on a periodic inventory system, perpetual is the preferred system so much so that a relatively newer technique, the JIT (just in time) is being practiced by many companies, big and small.

Inventory Replenishment is predominantly based on historical to determine inventory requirements; this in turn is equally applicable to one stand alone site or multiple sites across the locality, country and even the globe.

Impact of under-stocking

Inventories are essentially the lifeblood of a business therefore, it is imperative that inventory is available when required unless circumstances adversely affect the availability or that the materials have to be ordered to specific specifications; otherwise, customers often will not tolerate product unavailability and/or delays in delivery beyond a stipulated time. In some cases, a shortage may be only a small inconvenience (such as wanting a particular flavor of ice cream), while sometimes it may cause a severe problem (such as interrupting production-line activity at a factory that manufactures customized luxury yachts). On top of that periodic shortages can be expected, but then these recurrent shortages may in due course eat into a company’s reputation and condense their market share.

Impact of over-stocking

Likewise, overabundant, slow-moving inventories can place a serious strain on a company’s resources and negatively affect the company’s ability to take advantage of other business opportunities.

Frequent shortages or excessive inventories are telltale signs of a company headed in the wrong direction moreover, many businesses have the misconception that high levels of customer service can be provided by keeping an abundant supply of products on hand to meet expected demand. However, keeping excess product on hand is very expensive, resulting in eventually write-offs.

When ordering, holding, and stock-out costs are all known, Replenishment Planning can be used to calculate optimal inventory replenishment. However, estimating stock-out costs can be difficult.

Forecast demand

Track usage and vendor performance statistics to forecast demand.

Coordinate stock availability

Calculate optimal order points, safety stock, and order quantities automatically so the right amount of the desired materials are available at the right time.

Optimize calculations

Eliminate reorder guesswork by calculating past inventory turnovers and allowing for sales hikes/movements based on seasonal/cyclic trends or unusual demands. Maintain optimal stock levels, reduce inventory carrying costs, and help eliminate special or urgent reorder charges.

Automate the replenishment cycle

Save time and money by reducing the expense of last minute reorders and lost sales opportunities when stock is unavailable. With Microsoft Dynamics SL Inventory Replenishment you can automatically generate purchase orders.

Meet product needs

Satisfy your customers by maintaining sufficient quantities of products to meet expected demand. Balance inventory carrying costs with customer service levels, and cut expenses, including write-offs and mark-downs, associated with keeping excess stock on hand.

ERP/MIS support

In one of my earlier posts I mentioned an example, where in an outlet from a chain of retail stores in the US sells a product off its shelf and the half way across the globe, its Chinese suppliers are already packing it; that’s an ERP for you.

It ERP combines all your accounting, purchases, distribution and inventory management aspects of business in to one efficient database driven by a powerful software. Many ERP providers have even developed its character from an ERP into a supply chain management tool, which means that once a product is marked sold at a POS point, it automatically updates the sales figure, the inventory is affected by the same units, suppliers notified at the warehouse and even a purchase order is generated to be sent to the suppliers at source.

If you have a product, a mobile phone, a Nokia E5 and another product, another Nokia E90. The ERP should be able to tell you at what rack, in which warehouse is it lying and at what time (not just the date) did it arrive in the specific warehouse and of all the outlets which outlet has it been assigned to. Your ERP should also be able to tell you that if there are requests from other outlets for the same product and in case those have exhausted their inventory can this be sent to them if there is no demand for the products at the outlet they were originally marked for.

Inventory Analysis

The proper tool to analyze the inventory is the Inventory Turnover Ratio. The inventory turnover ratio is one of the most important financial ratios. The inventory turnover ratio measures the efficiency of the business in managing and selling its inventory. This ratio gauges the liquidity of the firm's inventory. It also helps the business owner determine how they can increase their sales through inventory control.

In order to calculate the ratio, you take net sales off the company's income statement and inventory off the balance sheet and dividing the net sales for the period over its average inventory:

Net Sales/Inventory = number of times the inventory moves




What does it mean?

A high inventory ratio means that the company is efficiently selling its inventory. The higher the resultant number off the ratio above faster the company is in selling its inventory and fewer funds the company has tied up.

Companies have to be careful thought that if they have a high inventory turnover as a high turnover and a high lead time can subject them to a stock-out.

Where companies have a low inventory turnover ratio, then there is a likelihood that they are holding obsolete inventory which is difficult to sell. This may eat in to a company's profit. However, the company may be holding a lot of inventory for legitimate reasons. They may be preparing for a holiday season in the case of the retail industry or preparing for a seasonal cycle, among other reasons.

It is important for a business owner to understand why the inventory turnover ratio is high or low. In order to do that, the owner needs to look at the company's inventory and determine what inventory is being most productive.

It is also important to use comparative data such as time series (trend) or industry data with which to compare a company's inventory ratio in order to analyze whether it is too high or too low.