The Teetering Relationship Between Inventory Control and Profit

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The control of inventory and the effect it has on a company’s profit is inextricable and should be duly noticed by anyone attempting to manage sales and inventory. What many companies fail to fully appreciate is that inventory and cash can often be thought of as one and the same. If too much cash is invested in purchasing inventory in the hopes of future sales, it comes directly off the bottom line until it is recuperated through sales. If insufficient inventory is supplied for the demand, sales are essentially ‘left on the table’, resulting in less profit and dissatisfied customers.

Not investing enough time into understanding inventory control and how it can work for you from a financial perspective is a sure way to negatively impact your bottom line. Let us delve into how inventory control and profit are intricately associated with one another.

Cost of Goods Sold and profit

A company’s profit is the remainder once the cost of goods sold (COGS) is subtracted from the net sales. Now, the COGS is comprised of every cost the inventory incurs along the way, not simply the cost of purchasing it in the first place. For example, if the inventory order was not placed soon enough resulting in expedited shipping to ensure demand is met, then this adds to the COGS and decreases the profit.

Likewise, if inventory is left languishing in excess in the warehouse not being sold, it incurs storage and insurance costs which also add to the COGS and decrease profits. Therefore, the idea is to ensure inventory management (including predicting future demand, timely ordering and managing the entire supply chain) is as efficient as possible. Having this goal in mind will help to reduce the COGS and maximise a company’s take-home profits.

Storage control

A great deal of thought should be given to this as the needless travel throughout the warehouse to pick products for orders can account for a significant amount of wasted labour hours; it need not be said that these wasted hours are the equivalent to wasted money and reduced profit at the end of the day.

To avoid this scenario, it is important to analyse what products are used or sold most often and to house these products close the warehouse entry so they can be picked with ease. It is also important to consider how to store like items in terms of their expiratory dates. The goal is to always use items well before their expiratory dates so that the quality of all manufactured products is optimised (therefore enhancing the company’s reputation and subsequent sales) and so that no items become expired or obsolete prior to being sold.

Relying on an inventory classification system like ABC, FSN, or SDE analysis can help you organise and prioritise inventory in your warehouse.

Data control

Inventory control is reliant upon stellar record keeping and data entry. When this goes awry, incorrect quantities of products could be ordered resulting in unnecessary expenditure and over or under-stocking the warehouse. It has been found that even the most detailed human will average one error in 300 keystrokes, so those are odds you cannot afford to play with.

Incorrect data entry can also have ripple effects over the entire supply chain which could affect efficiency significantly. The result of this is adding to the cost of the product which, as previously mentioned, decreases the company’s eventual profits. Inventory management software is vital for a growing, inventory-based business to ensure nothing goes unnoticed and human errors do not creep in which cost the bottom line dearly.

Inventory representing lost opportunity costs

When inventory accumulates in excess, it represents cash that is tied up and cannot be used elsewhere. This is called lost opportunity costs, and simply means that a company loses other, possibly better opportunities, because their cash is not usable. If that money could be better spent on marketing or development initiatives that could generate more profit rather than hoping a product will eventually sell, the company is forgoing an important opportunity to spend wisely to invest and see a return in the form of profit.

It is exceedingly important to understand the relationship between inventory control and profit and how changes in inventory can impact a company’s profit both positively and negatively. To gain this understanding without learning it the hard way, it requires implementing systems that will facilitate your dream of an efficient supply chain and inventory management.

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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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