How does inventory affect costs? Why is reducing inventory beneficial for retail businesses?

Question

please explain the significance in detail

Answer 1

Inevntory is a depreciable asset that impacts the balance sheet. Any asset needs to be working, meaning making money somehow for its owner. By having excess inventory, owners bear the buying costs for stuff that literally sits there and just depreciates with time- meaning its a bad investment.

In the retail business, this problem is especially stark because consumer demand is so fickle that hot inventory now can be garbage tomorrow. Imagine you had a clothing store that stocked up on the latest leather handbags, only to find out that there's a new movement toward environmentally conscious products (common issue), all the bags u bought are toast overnight. You'll have to eat that cost as a tax write-off.

This is why its important for retailers, not necessarily to reduce inventory, but streamline wholesale purchasing in a way that can be shifted quickly.

Answer 2

Think of inventory in terms of the money invested. Then think of what else you could be doing with that money and if the money for the inventory is borrowed, think of the interest invested. A smaller inventory cost less to maintain directly in investment and indirectly from the size of the storage facility and the number of employees required to maintain it.

Remember, inventory reduced beyond the point of good customer service is not a benefit, it is customers going to another business, usually never to return.