Why hold inventory at all?

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Anyone with inventory management experience will tell you that minimising stock costs is critical. They will remind you of the various types of these costs, including finance costs, obsolescence, storage rent, warehouse staff wages, light, heating, ventilation and security. This is good advice: such costs can quickly overwhelm your business if not managed, but it may lead you to ask, “Why hold inventory at all”? With practices such as “just-in-time” inventory commonly used in modern business, what is the value of holding stock on hand? To answer this, here are some common reasons why your business may need to hold some stock.

1. Preparing for the unexpected

Modern software and analysis techniques allow managers to make good demand forecasts, but ultimately these are just that: forecasts. No prediction can be fully accurate, and being caught without enough stock can mean big trouble. If there is a sudden spike in demand and you sell out of stock, then not only will you be missing out on potential sales, your customers will likely go elsewhere to buy their product, and they may never return. Sometimes you might be understocked because of a supply chain failure, but the end result is the same: unsatisfied customers. Holding excess inventory, known as safety stock, can mitigate the impact of such events.

2. Bulk buying

Many businesses hold excess stock not because they wish to, but as a side effect of bulk buying. Suppliers are often happy to give discounts for large, “bulk” sales, because the larger quantity sold in a single transaction allows them greater certainty. To take advantage of such discounts, your business will need to bear the burden of holding more stock as a result, and inventory minimisation strategies like “just in time” inventory are incompatible with this. These discounts will only be worthwhile if the amount of the discount is greater than the increased holding costs from the bulk purchase.

3. Keeping with the seasons

Seasonality is another reason for businesses to hold extra inventory. Some industries like tourism and recreation are particularly affected by seasonality, but most businesses will experience some degree of seasonal demand due to the seasonal nature of consumer spending. Due to this effect, businesses tend to increase their inventory levels ahead of busy periods, as their suppliers need time to meet the increased orders.

4. Buying when the time is right

Inventory is ultimately an investment. Any return on an investment will be greater if the initial price paid for that investment is lower, and therefore your business will be more profitable if you buy inventory at the lowest cost. This means that it may be best to buy (and consequently hold) more inventory now if the cost is low, rather than risk the price rising in future. As with bulk buying, this involves some risk: the benefit you receive from buying at the lower cost should exceed any increase in your holding costs.

Each of the above is an important consideration when determining your inventory needs. When taking these into account, be aware that different operations and industries have different needs. If your business operates in an industry with typically volatile or large seasonal change this must be factored into your purchasing decisions. If you keep the four above considerations in mind, while at the same time taking any specific factors into account, you will give yourself a solid base to plan a sensible level of inventory for your business.

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Jorge - Unleashed Software
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