Inventory Costs Explained and Mistakes to Avoid
Inventory costs are one of the assets and liabilities a company has on its balance sheet. Managing inventory costs is crucial for success. Managing inventory is a complex process that involves multiple vendors, suppliers, fees, and reports. Striking the delicate balance of ordering and storing the right amount of inventory is tricky. Companies don’t want to under-order but they don’t want to over-order. Establishing what to track and when to make adjustments can be confusing. This article will explain the main inventory costs and common mistakes to avoid when creating an inventory management process.
Inventory Costs Explained – Categories
What are the main costs associated with inventory? There are four primary categories of expenses related to inventory management.
Purchasing Costs
Purchasing costs are the price paid to a supplier or vendor for a product. If you purchase 100 vintage-style handbags at $15 per item, your purchase cost is $1500. This line item does not include shipping, handling, taxes, or insurance. Some companies calculate the purchase cost within the ordering cost category. It depends on personal preference and the desired level of detail.
Ordering Costs
Typically, ordering costs include labor, fees, and transportation associated with getting your product shipped from the manufacturer to your storage facility. The expenses in this category tend to be small compared to the purchase costs but can add up quickly if not measured accurately.
Carrying Costs
Carrying costs, also known as “holding costs,” are fees associated with keeping inventory in stock. Anything from employee wages to warehouse rents is included in this category. Carrying costs vary significantly according to the type of product that is being sold and managed. Higher costs are associated with products with a limited shelf-life or requiring consistent handling, movement, and restocking.
Stockout Costs
Stockout costs are any costs related to the loss of revenue from inventory shortages. These costs can add up for various reasons, like; running out of a product before your in-store or online inventory management system is updated. A customer purchases a product that is no longer available, which triggers a refund process. The sale is potentially lost when a suitable alternative cannot be offered. Sales are also lost due to stockouts. How many consumers go to a competitor when a product is listed as “out-of-stock”? It is a missed opportunity cost. Fortunately, many of these costs can be avoided or minimized. Companies can increase their supply chain resilience by partnering with a competent 3PL.
Inventory Costs Explained – What to Track
Storage Costs
Storage costs include repetitive payments related to inventory storage management. These include warehouse rents, heating and cooling costs, lighting, security, and employee wages. Any fee for maintaining a clean, organized, and pest-free space would be considered a storage cost. Holding onto inventory that is slow-moving or considered deadstock increases storage costs quickly.
Capital Costs
Capital costs are typically the largest upfront investment regarding inventory costs. They are a one-time fee required to physically store and carry inventory to the designated storage facility. Capital costs can include land purchases, building or buying a warehouse, and sourcing inventory equipment (e.g., forklifts, pallets, storage racks/shelves, etc.).
Damage & Obsolescence
Things get banged, bruised, and battered in the shipping and receiving process. It is essential to track this inventory cost closely. If a pattern of damage is noticed, it can be corrected; otherwise, it is like flushing money down the toilet. Similarly, items that become obsolete are like leaving money on the shelf. Businesses still carry the costs of unsold and outdated products in the balance sheet.
Theft and Fraud
Theft and fraud associated with managing inventory costs can only be solved through careful tracking and utilizing accurate inventory management systems. While it won’t catch every criminal that threatens the bottom line, it will undoubtedly show where items are going missing.
Taxes and Insurance
“There is nothing certain in life but death and taxes.” (Paraphrase Ben Franklin) Inventory costs of taxes and insurance are determined by many factors, including but not limited to; types of product, location, and local ordinances related to product distribution. It is best to consult a lawyer regarding the nuances and costs associated with this category. Alternatively, partnering with a 3PL with extensive experience in your industry can typically provide introductions to legal counsel and help ballpark costings where appropriate.
Inventory Costs Explained – Mistake to Avoid
Understocking
There is nothing worse than missing out on a sale because of stockouts. Proper inventory management systems and tracking can help forecast accurately and avoid losing sales. It is more important to overstock than understock. For one, you miss a sale. Second, you can lose a customer permanently. Third, you have to issue refunds which costs you additional money in employee wages and customer service strain. Include inventory management in product forecasting to help avoid understocking whenever possible.
Failing to Include Inventory Management in Forecasting Sales
The entire process of managing inventory is complicated. Including inventory management in forecasting will improve accuracy and minimize overstock or understock situations. Inventory management data will include product levels, cycles and highlight stock value categories. This helps businesses forecast not based on sales numbers alone but the overall health and movement of products through the inventory management process.
Launching a Product and Retroactively Managing Inventory
Launching the business and then getting around to managing inventory can be tempting. This is a significant mistake because by the time inventory management is a need; it has become a problem. Implementing inventory management before a product launch can help with forecasting, restocking timelines, and reducing stockouts. Accurate sales data, stock levels, and performance are readily available by preparing to track inventory management from the beginning.
Always Buying in Bulk
It is important to buy what you need when you need it. Sometimes bulk purchasing is ideal. Other times, it is a gamble. It might be tempting to buy 1000 units of your most popular product, but it could cost you if that item trends out or becomes obsolete before you can sell them.
There is a lot of information involved when explaining or managing inventory costs. It can be an area of business that causes many owners sleepless nights. Falcon Fulfillment utilizes a proprietary inventory management system that touts a 99.9% accuracy rating. We pride ourselves on helping our clients have accurate data so they can make the best decisions for their businesses. If you would like to learn more about how Falcon can help streamline your inventory costs, get in touch with one of our agents today.
