The Cost of Too Much Inventory

by Jackie Biallas

The Cost of Too Much Inventory

Feel like you’re carrying too much inventory?  The cost of carrying excess inventory can have a great effect on your company’s bottom line. It can negatively impact the profit, take up excess space and significantly reduce the cashflow needed to run the business.

SAFIO Solutions helps companies identify their unproductive inventory, determine optimal inventory levels and increase their turnover rates.  One SAFIO Solutions client company was able to increase their turn from 6.0 to 8.2, by acting on the indicators that the application highlights. This turn improvement represents an estimated 27% reduction in actual inventory resulting in better cash flow and a savings on the interest of carrying that excess inventory plus other costs.

Carrying costs of inventory are the total costs of purchasing, housing, handling and accounting for depreciation of inventory.  It is commonly accepted that inventory carrying costs represent about 25-30% of the inventory value on hand.

Carrying costs can be divided into three different types of costs:

  • Capital costs
  • Non-capital costs
  • Inventory risk costs

Capital costs

Capital costs are typically the largest portion of total carrying costs.  Capital costs represent the cash that is being tied up in the inventory.  These costs include the money spent on the inventory, interest paid on the purchase, and the opportunity cost of the money invested in the inventory rather than other investments like mutual funds, etc.  Another capital cost that is incurred, although it may be more difficult to measure, is the cost of investing in inventory rather than other areas of the company.  The Weighted Average Cost of Capital (WACC) formula can be used to determine capital costs.

Another one of SAFIO Solutions clients was able to save $1 million by reducing the number of SKUs they carried.  Through use of SAFIO Solutions forecasting application, this company gained visibility to their inventory and were able to determine which SKUs were unproductive and needed to be discontinued, reducing their SKU base by 64% and inventory value by 50%.

Non-capital costs

Non-capital costs consist of the costs associated with inventory storage space and inventory services.  Theses costs include the mortgage or lease of the warehouse, depreciation of the warehouse, insurance, utilities, security, staff, equipment, and maintenance.  There are also costs related to inventory control, including handling and technology, such as an inventory management system.

Inventory risk costs

Inventory risk costs vary depending on the type of product that is being held.  Some products are perishable (e.g. food), some become obsolete quickly (e.g. technology).  These products will have higher costs than other products.  Accounting must be done for depreciation.  A write-down of inventory occurs when the stock has not sold, but the market value has fallen below purchase price.  A write-off occurs when the inventory is no longer sellable.  Inventory risk costs also include insurance of the inventory, taxes, and shrinkage.  Shrinkage can be a result of administrative errors, theft, or damage.

SAFIO Solutions Sales Analysis and Forecasting Tool© enables companies to better forecast sales, allowing companies to carry just enough inventory to cover vendor lead times and customer demand, thus minimizing these inventory risk costs.

If you would like to evaluate your inventory costs and the savings you could realize by reducing your inventory, check out our interactive calculator

The inventory carrying cost savings a company can realize by using inventory optimization software can offset the cost of these tools in a short amount of time.  Let SAFIO Solutions be your solution!