We are pleased to welcome Kevin Wilson one of our expert G.A Wright Consultants as our guest blogger for this week’s post on The Hidden Costs of Inventory.
Entry Written by Kevin Wilson 6.18.12
Recently I was conducting a Quitting Business sale for a G.A. Wright client to close out part of their retail operation. Like most small business owners they were very focused on their Gross Profit Margin – the Revenue or Selling Price minus the direct Cost of Goods Sold (COGS). They were looking only at the profit they were making on their goods before overhead expenses were paid. So even though this was a liquidation sale, designed to clear out their merchandise, they were very concerned about selling merchandise below cost and “losing money.” What they didn’t realize is that they were probably already selling some of their inventory at a much lower profit than they expected because of costs and expenses they weren’t accounting for.
Their feeling was that an item which they’ve had in inventory at the same price for 10 years is worth more than the ticketed price because costs have increased and their competitors are selling the item for more. They didn’t recognize that an item that hasn’t sold at full retail in 10 years is not worth the price it’s marked – it’s actually worth no more than whatever someone is willing to pay. If a $230 food processor has an inch of dust on it, your customer is telling you it’s not worth $230.*
A good merchant should understand that excess or dead inventory in their stockroom, warehouse or on the sales floor is costing them money. They should be familiar with the concept of turnover, and how many times they need to turn their inventory in a year in order to be profitable. A Promotional Sale can help address these concerns by reducing that inventory and freeing up cash to put into more productive merchandise.
It’s important to be aware that inventory costs include more than just the cost paid to the vendor or distributor of the goods. Most retailers also acknowledge that the cost of getting the merchandise shipped to the store is part of the Cost of Goods Sold, even though it probably isn’t reflected in the dealer cost shown in a catalog or on a price list.
But there are other costs that need to be covered by the sale of merchandise. A business has a number of expenses, such as rent and utilities, which are fixed. They aren’t tied to the amount of volume the store does from month to month. If you generate $50,000 in revenue in August, and $100,000 in September, the rent stays the same. Any change in utilities will likely be because of the weather, not the sales. But other expenses are tied directly to revenue and do fluctuate based on the amount of business the store does. If you sell twice as much in one month as in another then in most cases you’ve spent twice as much to buy the merchandise that was sold.
But beyond that there is a time factor that comes into play. The longer you hold onto your goods the more those goods end up costing. These Holding Costs include some of the following:
Cost of Money – If you rely on a Line of Credit from the bank to keep merchandise in stock, you’re paying interest on whatever amount you’ve borrowed that’s tied up in non-productive inventory.
Lost Earnings – Money that’s invested in dead inventory could be earning money in a savings or an interest bearing checking account, a sweep account, or a CD.
Turnover Cost –Dead inventory ties up funds that could be generating sales and profit if it were converted into merchandise that will turn more quickly.
Storage Cost – Those excess goods have to be kept somewhere. There may be a cost associated with that storage if it requires renting additional space.
Insurance – Insurance premiums may go up to provide coverage for the excess goods.
Property Tax – Many businesses have to pay property tax based in part on the amount of inventory that’s on the books.
Handling Cost – Moving the extra goods around to store or display the better selling items requires extra man-hours in the stockroom and on the sales floor. Working around surplus goods carries with it a cost.
Devaluation – The assumption among many retailers is that goods hold their value indefinitely or perhaps even increase in value over time as their replacement cost rises. In most cases the opposite is true. Last year’s fashions aren’t worth nearly as much as this season’s, last year’s model of appliance or mower isn’t as desirable as the new model year’s, and last year’s laptop or smartphone is outdated clearly doesn’t measure up to the new ones.
Some retailers feel that they have to stock EVERYTHING. “If we don’t carry the hard to find items we’ll lose our customer to the competition.” Of course, if it’s truly a “hard to find item” then by definition the competition doesn’t stock it either.** Like hoarders, some retailers feel it’s essential to their bottom line to keep the mis-measured chain and rope or yard goods, mis-mixed paint and other rejects because someone will buy it some day. They figure that they paid too much for something to throw it out or feel that it’s been written off so it doesn’t hurt to keep it.
The fact is that those goods are still sitting on the shelf taking up space, clogging the system, and restricting cash flow. The only thing that appreciates over time is gold. ***Old merchandise needs to be sold as quickly as is profitably possible to generate cash, regardless of how little, for the sake of the business.
*There are other factors that can affect how an item sells, such as where it’s displayed or how it’s featured. There are also other factors that affect how much dust is on the box, such as why the heck don’t you clean your store more often?
**There’s also the theory that if the small business owner carries difficult to find items, he’ll build loyalty. He’ll be able to sell the more competitive items at a reasonable profit margin to the customer who comes in for the Holy Grail, the Loch Ness Monster, or the Honest Politician. Guess what? The customer will buy the hard to find item where he can find it, and go to the big box store to save money on everything else. There are loyal customers, but they’re usually found hanging out with the Loch Ness Monster and the Honest Politician.
***There was a time before the bubble burst that you could say that about real estate too. Sadly, that’s no longer the case.
For More Information on How to conduct an HUGE Inventory Liquidation Sale with G.a wright Please call our office at 303-333-4453 to receive your FREE Packet of information.* offer is for retail business owners only*