You need inventory to capture opportunistic sales, but you can’t quite come to terms with your monthly inventory holding costs. It’s why most companies have a love-hate relationship with their inventory, and it's ultimately why all strive to reduce their costs to hold finished goods. It’s a constant reminder of the company’s cost of capital. When it comes to these costs, it’s important to remember that every dollar saved within your supply chain is one that goes directly to your company’s bottom line.
1. Inventory Damage: First to make the list is an inventory holding cost that should be relatively easy to eliminate - or at the very least, easy to mitigate. Inventory damage is one cost that often becomes a complete write-off. In most cases, the costs to rework are too high and a company has no choice but to liquidate the inventory for scrap. So, why does damage occur?
In most cases damage is the result of poor handling practices. However, a large part of this cost is due to inaccurate sales forecasting. After all, the longer a company holds inventory, the more likely damage will occur. This is why it's essential that companies concentrate on increasing their inventory turnover rates. Improved forecasting means your company will hold high counts of popular finished goods, while reducing your counts of less popular finished goods.
To read more about improving your company's sales forecasting methods, please read: How Do I Improve Our Sales Forecast Accuracy?
2. Cost of Freight: Your company’s costs of freight on incoming and outgoing shipments are extremely important inventory costs. The impetus must be on reducing the per-unit freight cost on incoming shipments of parts and raw materials, while mitigating the costs of shipping finished goods to customers.
Granted, with fuel costs continually on the upswing, it’s often difficult to reduce a company’s freight bill. However, one of the biggest reasons freight is so high is because companies are unable to decide between purchasing too much or too little inventory. Too much, and the company may reduce its freight costs, but it could get nailed with damage, obsolescence and a high cost of capital. Too little, and not only will the company’s per-unit freight costs on incoming shipments increase, but it will also encounter lost sales.
To learn more about measuring freight savings versus the burden of carrying additional inventory, please read: Inventory Carrying Costs Versus Higher Volume Purchases
3. Inventory Obsolescence: Another consequence of poor sales forecasting is the high costs associated with inventory obsolescence. Sales drivers inventory requirements. Unfortunately, a number of companies have instances where their sales department focuses solely on sales of faster moving finished goods to the detriment of the company’s slower moving inventory. In addition, because slower moving inventory has higher costs (due to the time it’s held) a number of sales people ignore the importance of selling inventory with low turnover rates.
4. Cost of Capital: One can’t discuss inventory holding costs that impact your bottom line without mentioning a company’s cost of capital or better put, the cost of money. The cost of money is your company’s cost to finance inventory. Most companies use business credit lines and bank loans to finance inventory. As such, these all include a yearly interest rate to borrow money. That yearly rate can be converted into a daily rate. Therefore, every day your company holds inventory it doesn’t sell is yet another cost to your company. The most aggressive companies track the impact of this cost within their supply chain. They understand that the longer they hold inventory, and the longer it takes their customers to pay their invoices, the higher the costs.
Learn more about your company's cost of capital.
Surprised to hear that losing sales and customers accounts is a direct cost of inventory. Don’t be! One of your company’s biggest inventory cost drivers is the costs of losing sales because of inaccurate inventory counts and low inventory levels. Not having inventory available due to stock-outs, and losing sales as a result, is an inventory cost that must be addressed by improved sales forecasting. One of the biggest reasons for this cost driver is the fact that a number of companies run inventory and supply chain strategies that are contrary to their business model.
Read more about tracking lost sales as a direct cost of inventory
When thinking of these five inventory holding costs that impact your bottom line, think of the $1.00 rule. How much in sales must your company make in order to secure $1.00 in profit? Let’s assume your company must generate $12.00 in order to derive a dollar in profit. If that’s the case, then every dollar saved or reduced in supply chain costs is akin to a 1200% return on investment. It's a savings that goes directly to your company’s bottom line.
Your company must focus on identifying its cost drivers and putting plans in motion to reduce their impact. Once you've defined your company's monthly carrying charges, you can then put together simple strategies to reduce these charges. To read more about a company’s inventory holding costs, please read: Sample Inventory Costing Excel Sheet: Graph & Pie-Chart of Expenditures