Increasing Profitability through Inventory and Financial Reports Analysis: A case for SAP Business One

Although inventory report and cash flow report are seen as independent reports to some extent, they are however interwoven. The perception of most SAP Business One users is that the cash flow report is a product of just "current cash transactions". Yea, to some extent this assertion is true; however, there is another leg to it.

The cash flow report gives the balances of cash accounts and accounts that are subject to cash flow in the future. Inventory (Stock) itself can be perceived as money that is tied down because asset increases when stock is procured. The purchased stock can be raw materials for a finished good(s) that will yield revenue in the future. At production stage, it is classified as work-in-progress (WIP). A number of journal entries are created during the production process in SAP Business One. When components are issued for production, the WIP account is debited and the stock account of the component is credited. When the production order is completed, receipt from production is created. The stock account of the product is debited by the actual value of the finished product and the WIP account is credited. In case variance occurs, the system debits the WIP account with a negative value and credits the WIP variance account.

From the foregoing, it can be deduced that the stock value increases by the cost of production tied to the production process. On receipt from production, it becomes a sales item that is expected to generate revenue. Inventory is also updated accordingly. However, the costs incurred during production represent payables. These payables need to be settled somehow, hence the need for cash flow report, which is a critical analysis of "money - in and money - out".

The Chief Financial Officer (CFO) is not interested in high inventory (over stocking) based on the premise that it is "money tied down". Keeping high inventory is not cost effective. This is because additional costs (such as carrying costs) are incurred especially while these stocks last in the warehouse. This is not to say that inventory should be kept so low as not to meet demands or orders.

Although, the amount of inventory to be kept at any point in time is ambiguous, the inventory turn ratio is a metric for determining inventory usage. Inventory usage is calculated as a ratio of the annual cost of goods sold to the average inventory.

For the purpose of illustration, let $1,000,000 be the annual cost of goods sold and $500,000 be the average inventory; obtained from profit and loss statement and balance sheet report.
Inventory Turn = Annual cost of goods sold/Average Inventory
= $1,000,000/$500,000
= 2

If through better inventory management and financial analysis, the inventory turn is increased to 10.
Average Inventory = Annual cost of goods sold/Inventory Turn
= $1,000,000/10
= $100,000

Reduction in inventory = $500,000 - $100,000
= $400,000
The implication therefore is that you can generate same sales with only $100,000 of average inventory.

Furthermore, if the carrying cost (which is based on weight/volume carried) is 20% of the average inventory, the savings will be
Savings = Reduction in Inventory x 0.20
=$ 400,000 x 0.20
= $80,000

Cross analysis of Inventory report and Financial reports such as Cash Flow, Balance Sheet and Profit and Loss Statement can lead to cost saving and ultimately, profitability. Hence, it would be nice to have a detailed and generic business intelligence report (that makes this analysis and more) like this by default in SAP Business One. What do you think?