Calculating and reducing the real cost of inventory

Inventory management plays a crucial role in the success or failure of any business. This article unearths the real cost of inventory and helps you cut costs.

Inventory management plays a crucial role in the success or failure of any business, and the consequences of ineffective inventory management are seismic. Inventory distortion results in an estimated $1.1 trillion loss worldwide, so it’s crucial to identify the related costs that constitute the real cost of inventory. 

Typically, there’s a direct correlation between inventory turns and company success – this makes sense: you sell more, you turn more. However, even successful companies overlook the financial impact caused by ineffective inventorying – human error accounts for 46% of leading warehouse problems while 34% of businesses ship late due to inadequate stock levels.   

Monumental financial loss, warehouse inefficiency, and late shipments are primary considerations, but other factors contribute to the real cost of inventory, such as: 

• Transporting inventory to your warehouse
• Inventory storage costs, including rent, utilities, property taxes, and insurance
• Warehouse equipment – trolleys, conveyor belts, forklifts, etc.
• Safety equipment (e.g., fire suppression equipment)
• Warehouse labor and security 
• Loss via obsolescence, deterioration, expiration, and breakage
• Lost opportunity in having cash tied up in unsold inventory

How to reduce inventory

Some holding costs vary more than others. For example, the cost to store 100 cubic feet of inventory is the same whether the inventory is brand-new or obsolete. Moreover, keeping outdated stock creates several problems, including space issues, insurance costs, and reduced employee efficiency. Therefore, the importance of inventory costs and their associated expenses cannot be overstated – they’re key determinants of any business’s profitability and productivity.

Once a business identifies the elements that constitute their real cost of inventory, it can reduce these costs. Let’s take a look at how businesses can do this in practical terms: 

Avoid supplier minimum orders

Suppliers initiate minimum order costs to offload stock onto their retailers, reducing their costs while raising yours. If these restraints are unavoidable, consider forming alliances with other companies that require the same stock, as splitting orders can drastically reduce inventory expenses. Alternatively, you could offer your supplier a future order forecast, which may persuade them to allow smaller quantity orders. 

Organize your warehouse

To ensure staff efficiency, you need a warehouse that runs effectively. Consider placing fast-moving items at the front of your warehouse to optimize your pick, pack, and ship process, and follow other warehouse organization best practices.

Remove dead inventory

Dead inventory costs the US retail industry around $50bn per annum, so it’s imperative to eliminate obsolete stock. You can do this with special offers or bundling the product with a fast-moving item; however, ensure you don’t record them as ‘normal’ sales that will trigger the reorder cycle.

Offload consignment inventory

Consider offloading consignment stock to your retailers to utilize their shelf space instead of your warehouse. There’s one caveat here – your retailer won’t pay for this upfront, so calculate your floor space expenses relative to your consignment stock costs. 

Reduce lead times

Shorter lead times are preferable as they reduce the need for safety stock and excess inventory. In some cases, shorter lead times can facilitate warehouse downsizing, too, effectively decreasing your total inventory.  

Use cash forecasting

It is little wonder that cash forecasting is the primary inventory management priority, as data-driven predictions enable businesses to order sufficient stock, reducing excess. Remember, there’s a fine line between ordering excess (risking obsolescence) and too little inventory (risking stock-outs). Equipped with historical data, you can ascertain optimal inventory reorder points, superseding gut instinct with precise insights.

Monitor KPIs

Inventory visibility metrics are essential to running a successful business. For example, Auburn University research found companies using RFID reported 95% greater inventory accuracy, improved sales, and fewer out-of-stock items, highlighting the importance of clear visibility.

You can determine your warehouse’s health and optimization by measuring KPIs and monitoring your inventory turnover, cycle times, and fill rates. Once calculated, compare your numbers with industry averages to assess your business and warehouse management – these crucial insights will help you reduce your inventory and other related costs.

Summarizing the real cost of inventory

Effectively managing your inventory costs depends on accurate metrics – the optimal programs being integrated inventory management software. A sophisticated demand planning tool that leverages your ERP data will enable you to address the points above and optimize your warehouse, approach to inventory replenishment, and more.

Today, too many businesses take profit hits by using outdated tools and management tactics to run their warehouses. By following the above advice, you can implement smarter, better inventory policies that cut your costs – and it all starts with accurately measuring your inventory.