Common Inventory Management Costs and Myths

By |2019-01-14T09:15:14-04:00January 2nd, 2019|eCommerce News|

Inventory management – it’s a breeze, isn’t it?

Not exactly.

“Inventory management is easy,” is one of the most common myths in business. The thing is, it isn’t the only myth that can affect your company’s bottom line negatively.

Taking the wrong approach to inventory management can land businesses in hot water. Costs spiral, stress adds up, there isn’t enough inventory to keep up with orders, a huge headache.

Unless you know what the common inventory costs and myths are, you could be at risk of mismanaging your inventory.

In this article, we give you the low-down on what to watch out for so you can effectively manage your inventory.

 

There are Three Types of Inventory Costs

You must be aware of the three main categories of inventory-related costs. They are:

1) Ordering Costs

2) Carrying costs

3) Stock-out costs  

Let’s take a look at what each one means to your business.

Ordering Costs

Each time you make an order with a supplier, you have to take into consideration ordering costs.

It doesn’t matter if an order is super small – there will always be an ordering costs involved.

To work out exactly how much an order is going to cost you, there are a few things to weigh up:

  •   Purchase requisition
  •   Purchase order
  •   When goods are received, you might need to spend on labour to inspect the goods
  •   Storage costs
  •   Invoice costs

Some of these costs will be small – such as preparing invoices and issuing payment to suppliers.

Others, such as the actual purchase order, will be bigger.

 

Stock-Out Costs

Stock-out costs represent any lost opportunities, typically caused by a depleted inventory that can’t keep up with consumer demand.

For example, if a customer orders an item that is no longer part of your inventory, both you and the customer lose out.

A stock-out is very bad for businesses, especially if the customer decides to cancel the order and doesn’t want to purchase a product from your company anymore.

 

Carrying Costs

Carrying costs include storage and space, taxes, insurance and more.

They are the costs your company incurs over the period of time that it stores and holds its inventory.

Having an accurate view of these costs is critical to knowing how much profit your current inventory can make.

Here are the common carrying costs of inventory your business needs to consider:

 

Space and Storage

Space and storage costs cover rent, security, lighting and heating, as well as upkeep and other utilities.

It also includes the wages of security workers and janitors. This type of labor is needed to maintain a clean, safe and organized inventory storage facility.

These costs soon build up, but it’s impossible to keep an inventory if you have nowhere to store it.

You may even need to purchase or rent an additional warehouse if you carry a high volume of inventory and the number is consistently increasing.

if your company uses a 3PL, though, these individual costs may not be relevant to your total inventory carrying costs.

 

Handling

The purpose of handling costs are to facilitate safe inventory handling.

Handling costs are the labor costs of employees who are involved in shifting stock from one place to elsewhere.

This includes material handling equipment drivers, fork-lift truck drivers, and people involved in the handling of damages.

Handling costs don’t just include wages but extend to any taxes applied by your government, employee benefits, extra duty hours and so on.

Technological investments can be made to reduce handling costs.

 

Working Capital and Capital Costs

Capital cost is typically the biggest of all the carrying costs.

It is the cost is that a business spends on carrying inventory. Manufacturing companies are generally between 7 – 12%.

It includes investment, any interests on the working capital, as well as the opportunity costs of all the money invested in your inventory.

Your company can determine its capital costs by calculating the weighted average cost of capital (WACC). The WACC is the minimum average rate of return your company must earn on the current assets that it holds. This can often be a subjective figure.

When calculating your capital costs, always remember to take into consideration all risk attached to your inventory.

It’s often higher than you might think, especially if you have lots of perishable goods.

 

Taxes and Insurance

Insurance and taxes are always complex, and anyone who goes into business doesn’t exactly look forward to organizing these aspects.

But if it’s true that the only certainties in life are death and taxes, it’s important that you take these costs seriously.

Indeed, there can be huge implications for your company if you don’t.

The amount of corporate tax your business pays is directly related to your inventory. The  FIFO method (see chapter 1) increases corporate tax liability.

In contrast, the LIFO method decreases corporate tax liability. Before you use LIFO, you must complete and file the Form 970, Application to Use LIFO Inventory Method.

How much tax you pay on your inventory will also depend on your location and industry.

In terms of insurance, most business insurance policies cover insurance. But if your inventory is high value, you might need separate cover.

Your insurance policy can cover theft, damage that occurred during the transport of your goods, as well as damage incurred by a natural disaster.

 

Obsolescence

Obsolescence is an inventory risk cost that refers to items in your inventory you simply can’t shift, or which might perish before they sell, such as flowers or food.

Obsolescence can be costly because you’re effectively leaving cash on the shelf.

Products could literally be sat in your inventory for months.

Many small businesses encounter obsolescence costs, but there are ways to reduce them.

Consider selling your stock on eBay or Amazon for a cut price fee, or offer a number of related products to customers as a bundle.

And with Amazon projected to sell over $23 billion in groceries by 2021, there is no reason you shouldn’t get a slice of the pie.

 

Investment

What is an inventory? It’s an investment.

For small businesses who haven’t worked out an effective inventory management strategy yet, it’s a pretty costly investment.

We all have a finite amount of money at our disposal, and we need to be careful with how we spend it.

It’s important that you see your inventory as an investment. This will help your company strike the right balance with your resources so that you don’t overspend.

Work out how much of your budget needs to be spent on your inventory and how much should be dedicated to other core aspects of your business.

 

Criminal Activity

If you fail to implement the proper controls, you’re leaving your inventory open to criminal activity. This can be costly.

Shrinkage – which includes all kinds of criminal activity, is hugely damaging.

It cost UK retailers as a collective over £3,000,000,000 in 2015, which equates to almost 1% of total sales.

Criminal activity can include theft from your warehouses, but it can also include fraud and dishonest employee activity.

It’s important that you use data to understand when, where and how losses occur so you can protect your inventory better in the future.

 

How to Bring Your Carrying Costs Down

When you bring your inventory costs down, you free up capital.

You can then use this money in other areas of your business to grow and scale.

At the moment, there’s a big chance your inventory is where a lot of your cash is going – too much perhaps.

Here’s how to bring carrying costs down:

 

Know When To Reorder

Unless you know when to reorder, there’s every chance that you’ll end up with a stockout – or an overstock.

An overstock is very costly, as it means you’re carrying stock that you don’t even need.

Working out your reorder point doesn’t require a sixth sense and it shouldn’t be a guessing game.

Skubana is an inventory management software that can predict likely sales and product demand by providing you with accurate forecasts of the future.

This prevents a stock out from hurting your sales dramatically.

 

Clear Out The Dead Stock

For some businesses, dead stock is what can really bring them down.

Remember, all stock in your inventory is costing you something while you hold it. This includes stock that analytics shows isn’t going to sell.

With dead stock, it’s time to give up the ghost and get rid of it.

If you’re set on making some money from it, offer it as part of a bundle. Otherwise, return it to the supplier or donate.

Either way, you need to get rid of it in order to loosen up your carrying costs.

 

Don’t Overstock

Some suppliers like to offer discounts that are essentially similar to a “buy one, get one free deal.”

This is great for them, as it helps them to ship unwanted stock. At the time, it sounds like a great idea for you, too.

The problem is that it can easily lead to overstock.

Remember, the more you order, the higher your carrying costs will rise. Don’t give into temptation.

Stick to your inventory management strategy and decide if it’s worth taking advantage of an offer.

 

Common Myths Associated With Inventory Management

Inventory is such a crucial part of any retailer’s success, but so many small businesses keep getting it wrong.

They think it’s easy. An afterthought after their business has launched.

However, going into inventory management blind is a huge mistake that can set you back.

Here are some of the most common myths to be aware of:

 

Inventory Management Is Easy

Let’s start with the aforementioned myth we mentioned at the beginning of this chapter: “Inventory management is easy”.

What’s so easy about managing numerous locations, reordering new stock, as well as staff and technologies?

Or how about generating reports, cutting out fraud, identifying why things are going missing?

Even with the help of software, inventory management is still challenging. It’s never been easy and never will be. And because it can literally bring a business down or make it successful, there’s absolutely no reason to subscribe to this myth.

 

Start Managing the Inventory After Your Business Has Launched

This one is a common myth.

A team launches their small business, gets really excited … and then decides to prepare an inventory management system.

The problem is at this point, your inventory has already become disorganized and could be having a negative impact on your bottom line.

For many eCommerce newbies, inventory management isn’t a priority. They want to get the ball rolling with their business before they even think about something like managing inventory.

But before your business is up and running, your inventory needs to be managed.

Otherwise it will quickly get out of hand. Costs will spiral and you might be left in the embarrassing situation whereby a customer tries to buy an item that isn’t in stock.

For all fledgling companies, this is the last thing you need. Always prioritize an inventory management system and implement it before you launch your business.

 

Change Is Hard And Time Consuming

If anyone who’s leading a business doesn’t embrace change, they may need to adjust their mindset if they want to succeed.

The essence of business is change and innovation.

In a recent survey, 54% said that system integration was a significant challenge. Some eCommerce retailers feel that changing their current systems simply isn’t worth it.

Even though implementing an effective inventory management system will take some time, but over the long run it will improve efficiency and contribute hugely to the success of any business.

 

Inventory Management Isn’t Needed For Forecasting

Some businesses believe they can precisely predict future sales using past data only.

This is untrue and it can cost small businesses a lot of money.

To forecast future sales with precision is by implementing a precise inventory management system.

It will help you to follow the right trends, maintain the right amount of stock, gauge what isn’t selling, and calculate lead time for restocking.

 

Only Inventory Specialists should Place Orders and Track Inventory

As long as you’ve put software in place and are using barcode scanners, there’s no reason why your employees can’t take care of receiving, ordering and shipping your products.

All they need is some training, the correct equipment and they should be good to go.

 

Buying Stock In Bulk Is a Money Saver

Bulk buying is what some shoppers do at the weekends to save time and a bit of cash. It sometimes works and there are discounts to be had at the time of purchase.

It isn’t, however, what small businesses should be doing for their store.

Why not?

True, when you buy in bulk you usually get a better price. But that doesn’t automatically mean that you’re saving money.

For example, just like the shopper who bulk buys pizzas might not have the time to eat all the pizza before it goes past its expiry date, the stock you’ve bulk bought for your store might sell – but it might not.

Bulk buying saves you cash at the time of purchase, but what if the majority of the bulk is left on your shelves because no one is interested?

If you insist on bulk buying, use forecasting data to help you gauge what’s going to sell and what isn’t.

 

Inventory Software Is Too Expensive

Software and tools are essential for businesses who want to scale in 2018. Software automates your inventory so that the hard work is done for you.

But what if your company can’t afford it?

If you take a look at the technology that the biggest companies in the world are using to manage their inventory, then, yes, we’d have to agree with the myth that some inventory software is too expensive.

Take a look at Skubana, a piece of inventory software that’s affordable, and which offers functions and features that you’ll find on a lot of higher priced management software.

 

Have as Few Products as Possible On Hand To Save Money

It’s risky to have too much as well as too little inventory. The aim is always to meet customer demand, and as long as you have enough stock to do that, you’re okay.

If you decide to purchase less stock to save resources, there’s a chance your shelves will be understocked.

This is costly.

The buyer leaves unhappy, and you lose a sale and a potential loyal customer.

Of course, it’s a balancing act, and small businesses need to manage their budget effectively so that they don’t run out of resources. This is another reason why implementing an effective inventory management system is essential.

 

You Don’t Need An Inventory Management Software Solution

Got a spreadsheet?

Got checklists?

Ready to manually keep tabs on your inventory?

Your rivals have implemented automated inventory management systems and you need to keep up with them. Spreadsheets and checklists can work, but they take up so much time and they’re also subject to inevitable human error.

Software solutions make business operations run smoother.

 

Conclusion

These are some of the common costs and myths associated with inventory management.

Remember, inventory management isn’t easy.

Work out the costs, unfold the myths, download software and stick to your strategy.

In the next chapter we discuss exactly how you can create an effective inventory management strategy.

One that will improve your overall operations in this aspect of your supply chain.

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