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Inventory Costs and How to Reduce Them

by Vera Lim

2 min read

As you start branching into multichannel sales, you’ll start spending more on your inventory to ensure that you have enough supply to match customer demand. Most businesses already have the bulk of their capital tied up in their inventory, and you’ll find yourself spending even more on inventory costs as you increase your order quantities.

Before we discuss tips on how to keep these costs low, it is important to understand what they consist of:

  1. Order costs: The amount you have to spend to procure stock, covering approval processes, inspection, and so on. These are fixed costs that you’ll have to pay when you place an order
  2. Carrying costs: How much are you spending on maintaining your inventory? This covers everything from the opportunity costs of investing in inventory, to storage and inventory service costs, and even inventory risk costs
  3. Shortage costs: These are costs that arise from being out of stock, like paying for expedited shipping from your vendors or losing customer loyalty

If you’re looking to put a stop to ever-increasing inventory costs, we have some tips to help you out.

Know Your Optimal Order Quantities

A few weeks ago, we wrote about the need to determine your optimal order quantities.

When you’re looking to cut down on your inventory costs, you need to calculate your reorder point. Your reorder point tells you when’s the right time to place a new order to top up your inventory levels, ensuring that you have enough stock on hand to match your customers’ demand.

Setting a reorder point and sticking to it means that you won’t have to spend more on storing excess items, or risk incurring shortage costs when you’re running out of stock.

Don’t Overstock

As a small business owner, you’ll be going up against wholesalers that may be really strict about sticking to their minimum order quantities (MOQ). On top of setting MOQs, wholesalers can offer you price quantity breaks.

You may think you’re saving money by purchasing an extra 20% to enjoy a 10% discount — after all, if you’re going to reorder at some point, you might as well enjoy a better rate. But the increase in inventory also means an increase in carrying costs, as you’ll need to upkeep these products.

In addition, overstocking increases your risk of dead stock. If you’re unable to sell all the products you’ve purchased, these unsold items will be taking up valuable space in your storage facility.

Get an Inventory Management Software Solution

As we’ve said before, one of the best ways to improve your inventory management game is to get a cloud-based inventory management software solution.

Inventory management software helps you to keep an eye on your stock movement across all channels, which will help you avoid incurring shortage costs.

You’ll be able to enter your reorder points for your products into the system, which will alert you when it’s time to place a new order. It can even generate a new purchase order for you, so all you have to do is to give it the once-over and approve it.

One useful metric for measuring your inventory management success is to keep track of how much you’re spending on carrying costs (approximately 25%).

Next week, we’ll be back with more metrics to help you put a number on your inventory management success.

Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.

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