Andrew Seay provides an article that identifies five ways your inventory costs are hurting your bottom line.
For its status as the arch-enemy of “lean manufacturing,” excess inventory can actually feel pretty good in a company: It prevents lost sales due to stock-outs. It provides peace of mind when a critical piece of equipment breaks. Ordering in bulk often reduces piece price, providing a benefit to cost-of-goods-sold (COGS). If anything, inventory can often feel like it’s saving a company money.
So, why not go ahead and make the big order with that supplier to get a break on material cost? Or do a large production run to amortize “make ready” expenses? Or build up a big queue on the production floor to bump up OEE of your equipment?
The problem with inventory is that benefits are often easier to observe than the costs. When the costs are added up, inventory can be surprisingly expensive: Our clients typically calculate a cost of inventory in the 14-20% range over the course of a year. This can add up to big dollars that ultimately cost your company money.
This article will detail 5 ways that inventory is costing your company money, potentially without your knowledge. It will review the approach to calculating the annual cost of inventory and provide some tools that may be helpful in sizing annual impact.
- It’s tying up cash that could be used to fund growth
The opportunity cost of using cash to fund inventory is often a significant expense. We often hear clients reference the cost of their warehouse credit facility to estimate the opportunity cost of tying up cash in inventory. While this is a great, start, it really doesn’t tell the full story for two reasons:
The true cost of capital should be measured based on the weighted average cost of capital, which includes the cost of equity, which is generally higher than the cost of debt. This can lead to underestimation of the true cost of holding inventory, resulting in increased willingness to hold excess inventory on the balance sheet.
Short falls in cash can limit the business’s ability to invest in high-return projects. This is a value much more difficult to measure until an opportunity is presented. A “slam-dunk” project may present an opportunity to produce high returns, but may not be accessible due to a shortfall of cash. As a result, we often see management teams become distracted with closing new credit facilities or, worse, dreaded and energy-draining equity raises.
Key points include:
- Damaged, lost, aged and obsolete, inventory directly impact earnings
- Your inventory doesn’t pay rent (but someone else’s might)
- It obscures operational issues that should grab your attention
Read the full article, 5 Ways Your Inventory Costs are Hurting your Bottom line, on SeayAssociates.com.