The impact of inventory carrying costs on the bottom line can be enormous, but all too often these costs are overlooked. Why is this?
Is it a belief that interest rates are low, so what’s the big deal?
Perhaps the fact inventory carrying costs are not as obvious in the P & L as say, salaries and benefits costs?
Maybe an ‘out of sight out of mind’ mentality?
Inventory carrying costs vary by business and industry, but generally if you add 25% to overall inventory value you’ll have a reasonable figure. You can see why carrying too much inventory is more costly than it may appear.
Are you a skeptic? The quickest way to convince one’s self that these costs are real, that they are present and that they can be reduced is to ask one very simple question.
“What costs would my business not be incurring if I didn’t have to carry inventory?”
Here are a few:
• Labor associated with product handling – shipping, receiving, put away, order picking
• Equipment (and repairs to same) to operate the warehouse(s)
• The warehouse facility, including racking, shelving, rent, utilities, taxes, insurance, etc.
• Product damage and theft
• Obsolescence (manifested in large annual write-downs of ‘dead stock’)
• Insuring the inventory
• Labor costs for periodic physical inventory verification
• Financial accounting costs associated with control and costing
• Financing the inventory – a combination of bank and ‘owner’ provided capital
Reducing Carrying Costs
Some of these costs are fixed, the result of earlier commitments (buildings, equipment), but most vary with the volume of inventory being carried.
So if one dollar less inventory will allow you to recover 25 cents off the bottom line, how much benefit would one dollar of new sales result in? The answer is 7 to 9 cents pre-tax bottom line growth.
The two approaches are mutually exclusive and both have merit. But which approach is quicker, far less expensive and a sure bet? What is holding you back?
Deal with this unnecessary inventory and see your cash flow improve, reduce costs, and increase your profitability.