Mar 28, 2019
The real cost of your inventory (and tips on how to reduce it)
Even though your company's expenses, liabilities, assets, mark-ups, and margin calculations are mostly the responsibility of your finance department, it's also important that your warehouse team and inventory planner understand the inputs involved in calculating the real cost of your stock.
You may think that it’s merely the cost of the goods, but many other factors should be taken into consideration. Knowing these will help you in your inventory planning and enable you to provide some valuable cost-saving insights to management.
Beyond the cost of purchasing inventory, other costs to consider are:
- The cost of transportation to get your inventory to your warehouse
- The cost of the space in your warehouse to store your inventory, including rent, utilities, property taxes and insurance
- The cost of safety equipment, such as fire suppression equipment
- The cost of warehouse equipment, such as conveyor belts, trolleys, forklifts and pallet jacks
- The cost of labor and security in your warehouse
- The cost of loss via obsolescence
- The cost of loss via deterioration, expiration, and breakage
- The cost of a lost opportunity in having your cash tied up in unsold inventory
Some holding costs may vary more than others. For example, the cost to store 100 cubic feet of inventory is the same whether the inventory is new or old. At the same time, if you’re hanging on to old and outdated stock, you could be creating a variety of problems including space issues, insurance costs, and reduced employee efficiency.
Hopefully you can see just how important it is to understand the costs that go into your inventory so you can improve your profitability and productivity.
Once a business understands the elements that make up the real cost of inventory only then can you start to see how you can reduce these costs. It’s not just a matter of bargaining with suppliers for better prices on finished goods or raw materials. Most companies end up stocking too much inventory, which increases storage costs, decreases margins, and ties up working capital.
Here are some tips to consider when you're looking to reduce inventory costs:
Avoid minimum order quantities from suppliers
This is a supplier’s way to offload stock onto their retailers and wholesalers, reducing their costs while increasing yours. If there is no way to directly avoid this, see if you can form alliances with other companies that require the same stock as you. Splitting the orders can go a long way to reducing your inventory costs. Alternatively, you could offer to provide a forecast of future orders as a commitment to your supplier who may agree to allow for smaller quantities.
Know your reorder point
There is a fine line between ordering too much (risking obsolescence) and ordering too little (risking stock-outs). Once you have historical data, finding optimal reorder points for your items should be less of a gut instinct and more about data-driven insights.
Organize your warehouse
To ensure staff efficiency when it comes to picking stock, you need a warehouse that runs effectively. For example, place your fast moving items in the front of your warehouse – this optimizes your pick, pack, and ship process.
Get rid of obsolete stock
Keeping stock that isn't selling probably costs more than what you paid for the items in the first place. Try a special offer or bundle the product with a fast moving item. However, be sure to not record this as a ‘normal’ sale that will trigger the reorder cycle. If none of these suggestions work, donate the items or write them off.
Order your inventory Just in Time
JIT ordering does not suit all companies. It’s a process that requires you to have a strong relationship with your suppliers and a good relationship with a reliable transport company. If JIT ordering doesn't work for you, you'll want to examine your demand planning process to make sure it's helping you run a optimized warehouse.
Use consignment inventory
In a wholesale situation, you could offload consignment stock to your retailers and utilize their shelf space instead of your warehouse space. The only catch to this is that your retailer won’t pay for this upfront, so weigh up the cost of your floor space relative to the cost of managing consignment levels.
Reduce lead times
Shorter is better when it comes to lead times, because that allows you to keep less safety stock and helps you cut down on excess stock. Shorter lead times can make it possible to reduce the size of your warehouse and your inventory value overall.
To understand you business, you have to utilize measurements that give you visibility into your inventory. You can discover how healthy your warehouse is by measuring KPIs (Key Performance Indicators) and by monitoring your inventory turnover, cycle times, and fill rates. Compare your numbers with industry averages to assess how well you are managing your business and warehouse. These insights will assist you in reducing your inventory and other related costs.
Use accurate forecasts
Forecasting demand through accurate and intelligent reports allows you to order just enough to meet your demand throughout the year, for every season. You can accurately determine what products you need to discard and what you need to reorder. Your forecasts should use historical data to produce more useful purchase orders.
You can only manage your inventory costs if you can measure your inventory – and the only way to measure your inventory is to have an automated and integrated system in place.
Using a demand planning tool that leverages your ERP data will allow you to focus on the above areas and tighten up your warehouse. Too many businesses hurt their profits by using outdated tools and management tactics to run their warehouses. You can implement smarter, better inventory policies that cut your costs – and it all starts with accurately measuring your inventory.
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Written by Tony Sinton
Tony studied BCom, Finance degree at the University of Witwatersrand but soon realised his passion lay in the operational side of business and commenced his career in Inventory optimization and management. Tony began his journey as Managing Director of EXECUuLINK Inventory Optimization to later taking the role of President for Barloworld Optimus USA. Today, Tony is the group CEO of NETSTOCK and co-founder of NETSTOCK, the first fully cloud-based inventory management solution. Tony provides strategy on supply chain management and has spent the last 27 years enabling thousands of companies across the world to better manage their inventories.