NFIB

Overcoming Hidden Costs by Managing Inventory
02/ 11/ 2003

by Jeffrey Moses

When reviewing budgets and expenses, small business owners quickly realize that there are a number of hidden but significant costs associated with inventory storage, including insurance; warehouse or storage facility costs such as personnel, utilities and equipment; interest on debt financing for inventory; damage to inventory during storage; and expense of returning damaged items.

After reviewing these costs, which can often be surprisingly high, an automatic reaction may be to trim inventory immediately. But that's not always the optimal solution. For example, when inventory is too trimmed back, orders for certain products that are no longer stocked may be delayed, potentially irritating customers. A better solution is to use a total approach that integrates purchasing, marketing and cash flow, thereby optimizing inventory costs.

Step One

Place all inventory into the following categories: Rarely ordered items, slow-selling items, average-selling items, rapidly-selling items and bestselling items.

Step Two

In almost all cases, inventory can be selectively reduced in the first two categories. Consider only purchasing these items when you receive a customer order.

Step Three

It's best to plan purchasing not in a vacuum but in coordination with the company's overall marketing plans and total projected cash flow. First work with your business adviser to determine as accurately as possible your marketing objectives. From this, you'll have a fairly accurate determination of which items are likely to be most in demand.

Then work with your accountant to determine cash flow projections. By analyzing prior percentages of total cash flow that was allotted to purchasing, future cash flow projections will help determine your overall projected capacity for purchasing. This projected capacity can be distributed among the items you project to be most in demand.

From the combination of marketing objectives and cash flow projections, you will be able to assign a general but accurate dollar amount that you could spend on the purchase of each specific item.

Also consult with suppliers to determine how quickly the products can be delivered. There's always a feeling of safety when stocking large quantities of a bestselling item, as well as a tendency to be lured by vendor incentives when purchasing in quantity. But there's no need to stock a month's worth of an item when it can be ordered and received in two days.

Final Steps

Once your excess inventory has been reduced, don't neglect to respond by reducing warehouse space, personnel and insurance coverage as needed. Normally, costs such as interest on lines of credit and other debt will automatically be reduced as loan amounts are lowered through reduced purchasing. Keep an eye on this, however, to make sure that draws on lines of credit are coordinated with your trimmed back purchasing.

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