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Five measures you need to reduce the impact of inventory costs on your business

by , 31 August 2015
Do you know that there is a cost associated with inventory? And that inventory carrying costs are one of the major components in any inventory management.

But inventory carrying costs is something businesses often neglect. This will lead to wasted, lost or damaged inventory which turns into a loss through a write-off for your business.

So to avoid this you need to effectively monitor the costs of holding and managing inventory.

Read on what measure you can implement to reduce the impact of inventory costs on your business.

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What is the actual cost of holding inventory?

The cost of acquiring inventory (also known as stock) is just the beginning of investments and expenses in inventory. A unit of inventory on hand or in transit continues to incur costs until a customer pays for it and takes it off your hands.

A number of related costs impact the total cost of your inventory such as:

  • Storage space;
  • Interest on capital borrowed to acquire the inventory;
  • Shrinkage due to obsolescence;
  • Damage;
  • Insurance;
  • Pilferage; and
  • Theft.

The total cost of holding inventory is business specific. It's usually largest asset and expense in businesses.

The rule of thumb for inventory carrying cost is between 20% and 30% of your total inventory.

You need to monitor closely the costs of holding and managing inventory as well as related risks.

Your inventory management and control systems should be efficient, use the best tools available and coordinated seamlessly with the accounting function.

Click here to read what inventory controls you can implement.

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Warning: Incorrectly costing your inventory could end in a financial disaster for your business

The whole point of your business is to make a profit. This means you must ensure your selling price covers all of your production costs.
If it doesn't, your business is in danger. This is where valuating your inventory by working out the costs comes in.

You may be tempted to just take a rough guess at your inventory costs. This is a big mistake! If you incorrectly cost your inventory, it could lead to financial disaster...

Don't let this happen!

Find out how you can correctly cost your inventory so your business can avoid a financial disaster

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To reduce the impact of inventory costs on cash flow and profits, you can implement the following five measures:

1.    You need to restrict access to inventory to designated personnel;
2.    Carry out periodic inventory counts and compare the inventory count to the value of the general ledger (i.e. count x the cost) and reconcile;
3.    Carry out a physical count on the last day of your business' financial year and compare the inventory count to the value on the ledger and reconcile. This stock count is not negotiable;
4.    Investigate any differences between physical stock count and the ledger which is more than 5% in quantity or value; and
5.    Adjust the reconciliation differences in the ledger

As James Sinegal said 'We want to turn our inventory faster than our people.' so by implementing effective inventory measures, you'll reduce the impact of your inventory costs on your cash flow.

P.S. Manage your inventory accounts payable and receivables, analyse your financial statements, identify errors with checklists, and get step-by-step instructions & examples. Click here to find out more


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