What are costs associated with inventory?

Question

Why is controlling turnover in the inventory important? How can improvements in inventory management impact profitability?

Answer 1

Inventory is comprised of stocks considered as temporary asset acquired by the company for the purpose selling at a profit from margin. Turnover rates (or the speed by which inventory is replaced) per inventory category or classification may vary. A slow turnover rate may be good if the inventory category is high end meaning its high priced and consumers seldom buy that category. However, a slow turnover rate for low end category suggests that company is losing/ For instance, grocery items. Your margin is normally 2-3% and your carrying cost (for salary, space, cost of borrowed money, utilities, etc.) is 5% per month, so you need to make sure that you replace inventory at least twice a month so you profit from having the inventory in your asset.

Some retailers do not profit from certain inventory but they still carry it for the reason that their inventory will appear incomplete without the so-called 'lost leaders'. Others, which can afford not to cater to all consumer segments, immediately streamline their inventory to retain only those so-called 'killer' inventory.

If you're a keen observer, you can see that today's successful companies have found the right formula in inventory management like the Just-in-Time (JIT) Ordering Technique, the Open-to-Buy Principle, the Economic Order Quantity (EOQ) and lately the Category Management Technique, etc. wherein retailers as well as manufacturers order just enough finished/raw goods for a specific period so that their capital is not spent holding the inventory of others.

Answer 2

The cost of replacing lost items. It is important to limit shortages and damages so that the company doesn't have to replace the items. If the company does have to replace the items, then that is additional money spent on labor and materials, not to mention the possibility of lost sales since they can't sell a product they don't have. By having an accurate inventory, the profitablity increases due to the reasons listed above. Also, if employees know where the inventory is, they don't have to waste time trying to find the part or investigate what happened to the part, and the part is shipped sooner (which means the customer is invoiced sooner, which means the company receives their money from the customer sooner).

Answer 3

If you store inventory for long periods of time, you necessarily incur costs for rent (for the warehouse), utilities (heating the warehouse), payroll (security for the warehouse) and interest (on the loan you took out to buy the inventory). By "turning" inventory, you increase the number of units across which you recover you costs.

For example, if the warehouse rent is $100/year and you store 1 unit there for the year, then you need to increase the price of your inventory by at least $100 to recover your warehouse rent. But if you turn the inventory 10 times (i.e., sell 10 units in a year), then the warehouse cost of $100 is spread over the 10 units and you only need to increase the price of your by $10 per unit to recover your cost.

And if my cost is $90/unit less than yours, I will sell a lot more units and make a lot more $$$ than you.

Answer 4

The absence of income on the money invested in inventory is a cost. The less inventory sits and the oftener it is turned over, the more profitable it is.

Answer 5

Missing inventory means loss of profit, because you can't sell an item you can't find. There is the money spent on lost production (the employees spent time going to a location which didn't have the part in it and then spent time looking for the part). There is also money spent on replacing the part.

Answer 6

When, you know what you, and what is the price of each item by itself, then you can sell by the price each item cost, because even if it may be red apples, probably the apples that you bough yesterday are cheaper than the apples you bought a month ago... and of course in that sense you get to know whats the real value of your inventory.

Answer 7

inventory control helps cash flow. because if things are sitting on the shelf for a long time, that is money that can be spent on other things such as better selling items, capital investment, etc.