COST ASSOCIATED WITH HOLDING MUCH INVENTORIES

Inventory can be defined as an idle of physical goods that containing of economic value and are hold in various form by an organization in it casted are weight packing, processing, transportation or sale in future point of turn.

If the level of holding inventories turns out to be excessive it a loss to the management. Management of inventory is a powerful driver of financial performance. In response to slowing growth and pressures on profitability, many companies today are exploring new ways to manage inventory better. Improved inventory management frees up cash to be invested elsewhere, allows products to be sold at lower prices, facilitates entrance into new markets, and delivers other benefits that improve financial performance and create competitive advantage. Yet despite the importance of inventory management, there appears to be various consensuses on how to estimate the real cost of holding inventory the total cost.

The following are the costs which are associated with holding inventories in excess level;

Capital Cost

The capital cost is the cost that a business expends on carrying inventory. It is the largest component of the total costs of carrying inventory. A company will express the capital cost as a percentage of the shs value of the total inventory it is holding. For example, if a company says that the capital cost is 35 percent of its total inventory costs, and the total inventory held is 6000shs, then the capital cost is 2100shs. Although companies will give a percentage for their capital cost, this figure may be an objective figure, derived from a calculation, or a subjective figure, derived from experience or industry standards.

Storage Space Cost

The storage space cost is a combination of the warehouse rent or mortgage, lighting, heating, air conditioning, plus the handling costs of moving the materials in and out of the warehouse. Some of the costs are fixed, such as rent or mortgage, but there are variable costs, such as the handling of the materials that will vary with the level of inventory.

Inventory Service Cost

The cost of carrying inventory will include inventory service costs. These costs include insurance paid on the inventory and taxes to local government. The insurance that a company pays is dependent on the type of goods in the warehouse as well as the level of inventory. The higher the level of inventory in the warehouse, the higher the insurance premium will be. Many local authorities tax the level of inventory in the warehouse, so higher levels of inventory will lead to higher taxes paid and a higher inventory service cost.

Inventory Risk Cost

Carrying inventory comes with a certain degree of risk. This risk is a component of the cost of carrying inventory. When a company stocks items in the warehouse there is always the risk that the items may fall in real value during the period they are stored. For example, an item could become obsolete or superseded by a new model or version. If a company stored parts for their work centers or equipment, but those parts were replaced with a new version, the parts in the warehouse could be worth far less than the price that was originally paid. In the retail industry the risk is much higher as finished items may be seasonally specific. If the items remain in the warehouse too long, the value may be a fraction of the original worth. Other aspects of inventory risk includes the possibility that the stored items may expire, especially with items that have a sell-by date or use-by date. If the items expire then they can become worthless and have to be scraped. Items in the warehouse can also degrade, by water damage, heat damage, or by incorrect storage. Pilferage and theft should also be included in the inventory risk cost.

Deterioration and Obsolescence

Some businesses sell goods that tend to deteriorate or perish over time, such as food products. Keeping a large amount of perishable inventory on hand risks the possibility that you will be unable to sell some of the inventory in time before it goes bad, which can force you to throw away product. Similarly, certain types of products, such as computers and other electronic devices tend to become obsolete quickly. Keeping a large inventory of such products is risky because consumers might not be willing to buy old versions of products at a price that is profitable when new or updated versions become available.

Shifts in Demand

Another disadvantage of keeping a large amount inventory on hand is that certain goods might not sell due to shifts in market demand. For example, a clothing store that stocks too many tank tops during the summer may find itself unable to get rid of the tank tops before fall. During the fall, consumers might demand different types of clothing, like T-shirts or sweatshirts, leaving the company with a large quantity of goods on hand that simply take up space.

conclusion

When companies are looking to reduce costs, a great many times they ignore the inventory sitting in their warehouses and the cost of carrying that inventory. It is important for businesses to carefully examine all the costs of carrying inventory and determine where they can make changes to reduce that cost and help with the company’s bottom line

Considerations

While high levels of inventory can be a disadvantage, carrying too few goods on hand can also be harmful to a business. If you run out of a certain product, you could miss out on potentially profitable sales, and this could cause customers to give their business to your competitors. Managers must decide on an inventory level that balances the risk of running out of products with storage costs and the other negative aspects of holding too much inventory.

REFERENCE:

• The Free Dictionary: Inventory
• UK Business Link: How Much Stock Should you Keep?

"Entrepreneur"; Inventory Control; April 2006