Most business owners hold a high-level understanding of the importance of inventory management. They understand maintaining inventory stocks ties up cash until it can be recouped in the form of sales revenues from clients. And they also understand maintaining the proper amount of stocks is important—you don’t want your inventory so large all of your spare cash is tied up in product, but you want to maintain adequate inventory so that you don’t miss out on sales.
There are other costs of inventory that are more subtle, and tend to easily be overlooked—things like ‘holding cost’, ‘reorder cost’ or, the more nebulous estimation of cost as it relates to a customer’s experience, ‘shortage cost’.
Holding Cost relates to the costs incurred by a business related to maintaining inventory. This can be costs in the form of rent for storage space, utilities to maintain the inventory at certain temperatures or other climate considerations, and labor involved with inventory management.
Reorder Cost refers to costs related to placing a repeat order. These costs can be directly related costs like commissions, shipping fees, or packaging. But it can also include indirect costs such as labor related to placing orders, or quality control inspections.
And finally, the last cost to discuss today is Shortage Cost—the cost of missed sales due to being out of stock of an item when a customer wants to make a purchase. In this day and age of instant gratification, same day delivery, and other services that customers have come to expect, not having a part on hand, or long wait-times for delivery could result in customers seeking service elsewhere for their future purchases. And once those customers have found satisfaction elsewhere, it can be incredibly difficult to win them back. Business owners know this intuitively, and many, if asked, would say that the ‘cost’ of missed sales is high. Because of this, they often choose to overestimate the amount of inventory needed “just in case.”
This can be a reasonable position for business owners to take. But, what we at Sweeten CPA have found in working with our clients is there is often room for greater efficiency in inventory management. We work with our clients to analyze their inventory data and help minimize holding and reorder costs, while maintaining enough inventory to deliver a positive customer experience.
If you have questions about inventory management, please don’t hesitate to reach out. We’d be happy to schedule an advisory consultation.