Controlling Inventory Costs: Ordering, Holding and Shortage

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Inventory is likely to be one of your biggest assets. Given the size of inventory on a typical business’ balance sheet, significant inventory costs are to be expected. Although the cost of procuring stock is the most obvious component, a range of other inventory costs (such as ordering costs, holding costs and shortage costs) can have a real impact on your business’ bottom line. Let’s take a look at some of the ways your business can reduce the overall cost of inventory.

Ordering costs

Procurement can involve a significant amount of work and cost. Researching and negotiating with suppliers, and creating purchase orders can take a surprisingly long time. Larger businesses typically employ a procurement manager or even an entire procurement team, the principal cost being salaries and wages. Smaller businesses may not have the scale to employ a procurement specialist, so the cost is primarily lost time that could be better spent growing the business. Either way, the key is to develop efficient processes to reduce the amount of time that is spent on procurement tasks. For smaller businesses, simplifying your product offering can reduce the amount of time that is required to deal with a range of different suppliers. As the business grows, its ability to absorb this overhead is likely to increase.

No matter the size of your business, reducing manual processing is likely to improve efficiency and reduce cost. For example, efficient businesses often automate ordering for their quickest selling products by using inventory levels as a trigger; when the stock count drops below a given threshold, inventory management software automatically generates a purchase order which is transmitted to the supplier.

Holding costs

Holding costs, or inventory carrying costs, include the cost of processing inbound and outbound inventory as well as the cost of keeping inventory in the warehouse. Building rent, electricity, insurance and staff costs are all included. Strategies to reduce these costs include reducing the warehouse footprint and using efficient handling processes (barcode and RFID scanning rather than manual tracking, for example).

Although there may be some low-hanging improvements, significantly reducing holding costs ultimately requires a business to reduce the amount of stock that it carries. Holding large reserves of stock increases the need for warehouse space, increases handling and also increases the risk of shrinkage and obsolescence.

Shortage costs

Running out of inventory is expensive. Aside from missing sales, stock outs erode customer loyalty and damage your business’ hard earned reputation. In manufacturing, stock outs can shut down an entire production line if a critical ingredient or component is missing. Reducing shortage costs essentially comes down to good inventory management; ensuring that reasonable levels of safety stock are maintained and that inventory data accurately reflects the business’ current position. A specialized inventory management system is particularly useful when combined with barcode or RFID tracking – businesses with this setup enjoy advanced warning of inventory shortages and can automate ordering to prevent stock outs.

IT expenses

Inventory management software was initially targeted at large companies and so, for over a decade, smaller businesses were unable to access a cost effective inventory management system. With the growth of cloud computing, inventory management software is now highly affordable. Investing in a comprehensive inventory management system is well worth the minimal cost, even for very small businesses.

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Melanie - Unleashed Software

Article by Melanie Chan in collaboration with our team of Unleashed Software inventory and business specialists. Melanie has been writing about inventory management for the past three years. When not writing about inventory management, you can find her eating her way through Auckland.

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