If the merchandise must be assembled or otherwise prepared for sale, then the cost of getting the product ready for sale is considered part of the cost of inventory. Technically, inventory costs include warehousing and insurance expenses associated with storing unsold merchandise. However, the cost of tracking this information often outweighs the benefits of allocating these costs to each unit of inventory, so many companies simply apply these costs directly to the cost of goods sold as the expenses are incurred.
Previous Determining Inventory Levels. These groupings broadly separate the many different inventory costs that exist, and below we will identify and describe some examples of the different types of cost in each category.
The other requires a certain amount of calculation to understand the impact it has on your Gross Profit. Let's look at types of costs :. Ordering costs include payroll taxes, benefits and the wages of the procurement department, labor costs etc. These costs are typically included in an overhead cost pool and allocated to the number of units produced in each period.
This is simply the amount of rent a business pays for the storage area where they hold the inventory. This can be either the direct rent the company pays for all the warehouses put together or a percentage of the total rent of the office area utilized for storing inventory. Shortage costs, also known as stock-out costs, occurs when businesses become out of stock for various reasons. Some of the reasons might be as below :. Perishable inventory stock can rot or spoil if not sold in time, so controlling inventory to prevent spoilage is essential.
Products that expire are a concern for many industries. Industries such as the food and beverage, pharmaceutical, healthcare and cosmetic industries, are affected by the expiration and use-by dates of their products. This is the lesser-known aspect of inventory cost.
Inventory carrying costs refers to the amount of interest a business loses out on the unsold stock value lying in the warehouses. Business owners often miss out on understanding the impact of the above factors while calculating the impact inventory has on their business.
While the inventory carrying cost is seldom considered while calculating the gross profit, we usually take into account only the principle cost of the goods held in the warehouses. To understand the inventory carrying costs better, let's take an example of an importer of goods. When he imports goods into his country, they are first received at a dock.
Multiple customs department clearances are required before they can be transported to the company warehouse. Now let's say, due to some deficiency in the documentation, the goods get held up in the customs clearance department.
As everyone is aware, until the goods get cleared, there are charges that the customs department levies to hold these goods, and these charges rise exponentially. We can compare this by considering these additional charges that a business owner has to bear on the goods similar to the interest charges the business owner bears, which is a normal scenario that is invisible.
The dock is the warehouse, while the customs department's charges can be compared to the interest income the business loses out on the principle value of the goods. While these custom department penalties are still visible, the only difference is the interest a business loses out on the stock is never taken into account. A crucial question that arises is - What should a small business owner do to keep both the types of costs in check?
The answer is pretty simple - Use an efficient inventory management system, which gives you real-time reports for all your stock items.
Let's understand some aspects of an efficient accounting system that can help you keep these costs under control. An example of a good accounting and inventory management system is Deskera. It is essential to understand that you need to follow multiple steps to ensure that these costs are kept in check as a small business owner. A single report cannot highlight all these costs. As an example, an organization that does not maintain re-order levels and minimum order quantity levels for its stock items will always end up ordering stocks at the wrong time and with the incorrect quantity.
This will thus result in higher inventory carrying costs. If a business keeps stocks for a more extended amount of time, the higher is the interest lost out on them. Another essential element is stock ageing reports, which gives a good insight into which inventory has been lying with for the longest time.
Regular analysis of this report can provide us with a good understanding of which inventory to keep in our warehouses and the quantum of these stocks. Another essential tool that a sound inventory management system offers, is analyzing the fast-moving and slow-moving products.
Furthermore, when we attach the stock valuation of these slow-moving products, we understand its impact on the financial statements. The right actionable item would be to keep a check on the slow-moving items and order them only when required rather than hold them in the warehouses. Along with this comes another critical concept of "Lead Time". The lead time is the amount of time taken for a particular stock item to reach the warehouses from the date of ordering. This crucial piece of information can help you plan your high value - slow moving products very efficiently.
Longer lead times often result in inefficiencies and wastage of resources, and companies should review their processing times against benchmarks to identify ways of improving their lead times.
Regularly look at every area of the business to find where you can implement and action continuous improvement: are your sales, production, inventory control and customer service activities fully optimised and running as effectively as they can be? When looking to eliminate potential bottlenecks, a vital area to investigate is your capacity to deal with any new business.
You need reliable technology to run your day-to-day business operations and the technology to provide the product the business is offering. If you land any new business, do you have the resources available to keep up with the work? Plan for every possibility to help anticipate and eliminate potential threats to organisational growth. This involves having the right tools in place to support business functions, documented processes and the well-trained, qualified staff to undertake the necessary activities.
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. Do you have enough to keep up with a spike in demand? Contact us Careers About us. Check our help guide for more info.
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September 23, Ordering costs Ordering costs, also known as setup costs, are essentially costs incurred every time you place an order from your supplier. Examples include: Clerical costs of preparing purchase orders — there are many kinds of clerical costs, such as invoice processing, accounting, and communication costs Cost of finding suppliers and expediting orders — costs spent on these will likely be inconsistent, but they are important expenses for the business Transportation costs — the costs of moving the goods to the warehouse or store.
These costs are highly variable across different industries and items Receiving costs — these include costs of unloading goods at the warehouse and inspecting them to make sure they are the correct items and free of defects Cost of electronic data interchange EDI — These are systems used by large businesses and especially retailers, which allow ordering process costs to be significantly reduced.
There will be an ordering cost of some amount, no matter how small your order might be. The more orders placed, the greater the ordering costs. This ordering cost can be spread out if you placed a bulk order to use goods over a long period of time. However, if your business orders raw materials only as needed so that it keeps little stock on hand, you might be able to tolerate high ordering costs as this is balanced by an overall lower holding cost Holding costs Also known as carrying costs, these are costs involved with storing inventory before it is sold.
Inventory financing costs — this includes everything related to the investment made in inventory, including costs like interest on working capital. Financing costs can be complex depending on the business Opportunity cost of the money invested in inventory — this is found by factoring in the lost alternatives of tying money up in inventory, such as investing in term deposits or mutual funds Storage space costs — these are costs related to the place where the inventory is stored and will vary by location.
There will be the cost of the storage facility itself, or lease payments if it is not owned. Then there are facility maintenance costs like lighting, heating, and ventilation.
Depreciation and property taxes are also included in this Inventory services costs — this includes the cost of the physical handling of the goods, as well as insurance, security, and IT hardware, and applications if these are used. Expenses related to inventory control and cycle counting are further examples Inventory risk costs — a major cost is shrinkage , which is the loss of products between purchasing from the supplier and final sale due to any number of reasons: theft, vendor fraud, shipping errors, damage in transit or storage.
The other main example is dead stock Shortage costs These costs, also called stock-out costs, occur when businesses become out of stock for whatever reason. Disrupted production — when the business involves producing goods as well as selling them, a shortage will mean the business will have to pay for things like idle workers and factory overhead, even when nothing is being produced Emergency shipments — for retailers, stock-outs could mean paying extra to get a shipment on time, or changing suppliers Customer loyalty and reputation — aside from the loss of business from customers who go elsewhere to make purchases, the company takes a hit to customer loyalty and reputation when their customers are unhappy Spoilage costs Perishable inventory stock can rot or spoil if not sold in time, so controlling inventory to prevent spoilage is essential.
Part 1. Data entry errors The larger your inventory grows, the more likely you are to experience data entry errors. Confusion in the office Unlike a lot of online inventory management solutions that use the cloud to sync across a range of different devices, Excel spreadsheets have to be saved locally and distributed.
Confusion across offices Take all of these problems, and imagine how much bigger those problems would become if you were using one Excel file to manage inventories across two or more warehouses — the stress would get unbearable!
Employ Intelligent Demand Forecasts How dependable is your data? Best practices for demand forecasting: Create repeatable monthly processes.
Improved demand forecasting accuracy requires a consistent, timely process that systematically analyses previous forecasts to compare with actual market results. The data will identify when your predictions were right or not, and what the market demand was. By following a monthly process and evaluating results, you can minimise future errors Decide what to measure and how often you will measure it. To accurately forecast demand, you should focus on the most relevant data.
Points to consider include POS data, frequency of stockouts, any amounts of obsolete stock, shipping and dispatch and even competitor sales information Be sure to integrate data from all sales channel and combine the data from each individual product for all channels. Use your space efficiently Is it easy to access high turnover or perishable goods?
Rethink order cycles and quantities Can you reduce the size and frequency of stock orders?
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