Running an efficient inventory is never easy. Having too much is too costly and not having enough means lost sales. In fact, lost sales is one of the biggest costs of inventory and one often ignored by enterprises. Companies try and stay one step ahead by improving their sales forecasting. Regardless, at some point a company will encounter issues of slow moving inventory. However, what does it take for this inventory to become obsolete & dead? What are the criteria a company should use to determine when its slow moving stock should be liquidated? We’ll include some of the most common variables of slow moving inventory and what the process is for moving it to dead inventory.
To make this post as simple as possible, we’ll define the criteria used to determine the product’s current gross profit, what reduces that gross profit over time and when the product has ultimately moved from slow moving to dead. Each of these plays a role in deciding whether a product has ultimately decreased so much in value that it must now be determined to be obsolete.
1. Determine the Product’s Current Gross Profit
The gross profit calculation is simple. It’s the sale of the product minus the direct costs to make the sale, or COGS = Cost of Goods Sold. The “COGS” on a product would be the costs to buy the product, the freight to get that product into the warehouse (freight costs) and any additional surcharges relating to handling fees on freight. What’s not included in the Gross Profit calculation is the company’s salaries, taxes, and indirect costs of the business (electricity, rent, cost of office furniture). When thinking of gross profit, see it as what the company could make if it didn’t have to pay salaries, and other expenses. Net Profit is Gross Profit minus all those aforementioned salaries, taxes etc. So, keep it simple to the product’s current gross profit value. Here’s an example.
Price of Product $130.00
Cost of Goods Sold = $80.00
(Cost to purchase product: $55.00, Cost of freight into warehouse: $15.00, Surcharge on freight: $10)
Gross Profit = $50.00
The Gross Profit Margin Calculation is (Sell Price – Costs)/Sell price ($130.00 - $80)/ $130.0 = 38%
When looking to determine whether something is slow moving or obsolete, it’s best to first understand what the initial gross profit is of the product.
2. Determine What Reduces the Product’s Gross Profit Over Time
When it comes to determining what reduces the product’s gross profit over time, the key word itself is “time”. Since most companies use business loans or credit lines to finance the purchase of their inventory, there is a daily cost of money that plays a role in the gradual decline in the product’s gross profit. That business loan or credit line has a yearly interest rate that the company must pay. That yearly rate can be broken down into a monthly and daily interest rate. It’s that daily interest rate that erodes the gross profit on a product every day it isn’t sold, but there’s more. Most companies apply a monthly inventory cost of 3% on their inventory’s value. This 3% is made up of a number of factors – including the aforementioned daily cost of money. This 3% is essentially the costs to manage inventory monthly.
For every month the inventory isn’t sold, it can be assumed that it costs the company approximately 3% of the value on the product. In the above gross profit example of $50 GP & 38% GP Margin, this 3% monthly cost doesn’t really have a huge impact. If inventory remains unsold for 3 months, then perhaps the impacts aren’t as severe. However, what if it the product’s gross profit margins weren’t as high? What if the product was seasonal in terms of customer purchase patterns?
3. How Does Product Move from Slow Moving to Dead Inventory?
It’s the last question of seasonality & margin percentage that often decides when a product moves from slow moving to dead stock. In our example, the margins are very healthy, but in some industries the margins are razor thin. This means the products must have a high inventory turn over rate – be sold as soon as it’s brought in. In the above example where our GP margin starts at 38%, it’s reasonable to expect that it would take a while before the monthly costs of inventory had a true impact. However, what if the margins were 10 – 15%? What if the product was a seasonal product like winter, spring, summer or fall clothes?
Ever notice how the biggest & best sales for clothes are at the end of season? Why is that? It’s because if that inventory isn’t sold at the end of season, it quickly becomes so useless that it can only be sold until the following year – if and only if it’s held that long and most stores dump their dead inventory with as much incentive to get consumers to buy as possible.
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