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The optimistic business owner will look at inventory on his shelf and see potential profit. While there is nothing wrong with seeing profit in inventory, it does not tell the whole story. The inventory that you carry on your shelf has a cost to your business that must be figured into your operating costs. It is a dynamic cost that can change frequently, but it is essential that you keep a close eye on inventory costs as you determine your cost of doing business.
Inventory turnover is how often you cycle inventory, and it becomes a major part of your business costs. According to the University of Michigan, keeping down the amount of inventory that you have on hand can reduce your overall costs. But why is that? what are the true costs of holding inventory?
The primary cost of holding inventory is the investment you have in the product itself. Every day that the product sits on your shelf, that is another day that you had to borrow money to meet payroll or pay your building lease. Over time, these borrowing costs can start to dig deep into your business and cause a great deal of problems.
The space that is used to house the inventory also costs you a lot of money. The more inventory you hold, the more space you have to pay for. Not only do you have leasing costs for the warehouse space, but there are also the utilities costs for heating and electricity as well as the extra cost for shelving to hold the product. The less inventory that you have, the less space you need to pay for in order to hold that inventory.
Obsolescence is another inventory cost that people often forget about. If you were to purchase a product for $100 and try to sell it at $120, then your investment is $100. What if that product becomes obsolete before you can sell it? If you are lucky, you may get a portion of that investment back, but you will never sell the product for the profit you intended.
Your suppliers often have inventory costs that directly affect your business. For example, if you have to pay a restocking fee to return a product that you did not sell, then you lose out on that fee. Instead of getting all your money back, you have to pay shipping to the vendor and you have to pay a percentage of the product costs back as well. If you have a hard time selling inventory, then restocking fees can really add up.
As the manager or owner of a business that holds inventory, you must be very conscious of all of the costs involved in holding onto that product. In some cases, it makes good business sense to sell the product at cost as opposed to taking a loss. As you play the delicate balancing game of inventory control, you will need to become more aware of the various costs that are taking a chunk out of your bottom line. A good line of credit can help to supplement your inventory costs, and a state of the art inventory control system could be a business investment that pays for itself several times over. When you want to keep your business costs down, you need to learn how to control your inventory.