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Hidden Costs of Inventory

Congratulations. You finally dusted off and sold that fine piece of giftware you fell in love with at the buying show four years ago. Since you sold it at full price, you made a pretty nice profit, too. Or did you? Probably not, if you factor in all that you spent the last couple of years in carrying that particular piece of inventory.

We try not to throw too many statistics at our workshop attendees, but one of the key factoids we always share with people is the average cost of carrying inventory. Inventory experts calculate that it starts at 20% of your total inventory dollar and can go as high at 55% depending on your industry. These costs are known as "hidden costs" because typically you won’t see them listed as a separate line item on your P&L.

Just because they’re hidden, though, doesn’t mean that they don’t erode your bottom line! These hidden costs include:

  • Cost of handling and moving inventory within your warehouse, shop and/or showroom. How much of your employees' time is spent in these activities? 2-5%

  • Rent and utilities for the portion of your warehouse, shop and/or showcases. 2-5%

  • Insurance and taxes on inventory. If it's on your property, you have to insure it. Depending upon your location, it may also be subject to tax. 3-9%

  • Physical inventory. The more material in your warehouse or shop, the longer it takes to count. 2-5%

  • Inventory shrinkage and obsolescence. The more stuff you carry, the higher the possibility of shrinkage and obsolescence. 3-6%

  • The biggest cost is the opportunity cost of the money invested in inventory. How much could you make if you were to take the money you're investing in inventory and invest it in a more traditional investment? Or, if you are financing your inventory, how much interest are you currently paying the bank? Most importantly, how much are you losing by not having the cash to buy more productive inventory? 6-12%.

For you more visual types, picture your company’s cash flow as akin to your body’s blood. You need good circulation to keep it healthy and flowing. Excess inventory is like plaque buildup on artery walls. You can survive with some, but it gradually slows everything down. Eventually, it puts a stop to the flow completely. In a business, excess inventory gradually siphons off profits in the short term, and in the long term, kills it by cutting off cash flow.

What to do?

Picture your inventory as dollar bills that turn to dust after one year (or less depending on your industry). You wouldn’t keep a bunch of those dollars just sitting around, would you?

Figure out what your inventory turns are now and what they should be, by comparing yourself to industry benchmarks.

Put a dollar to the problem to make it more real. Figure out "how much too much" inventory you’re carrying and multiply it by the hidden cost factor of 20%.

Get an inventory aging report on a regular basis. Too old? Mark it down or melt it down.

Buy better in the future by looking at your inventory by department and tracking: sales, gross margin and turns.

Review your price points that sell and buy (or re-price) into those.

Want to know more? Join us at a 2006 BRS Profit Mastery Workshop. Jewelers are here all others visit here.

 

Business Resource Services, Inc. | 200 First Avenue West | Suite 301 | Seattle WA 98119
Phone 206.284.5102 | Toll Free 800.488.3520 | Fax 206.282.4092 | E-mail brs@brs-seattle.com

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