How Low Inventory Can Actually Cost You Money

Posted by on Oct 17, 2016 9:45:07 PM

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Everyone who works in inventory management is well aware of the need to keep inventory levels manageable. There are a number of costs that go into managing your inventory. It is never as simple as just paying for the materials or parts on the shelf. Inventory costs are made up of a number of different factors. The freight you pay to get materials and parts into your warehouse is one cost.

Other costs include obsolete inventory and dead stock. There is also the added cost of moving inventory from one location to another to make room for faster moving inventory. Costs of electricity and heating also play a role. Any cost that is directly related to managing your inventory, can be considered a cost of inventory.

Knowing that there are so many aspects to analyzing inventory costs, what are the drawbacks of keeping inventory levels low? Are there any issues with this approach, or is it ideal to always keep inventory at a minimal level? While it might surprise you, low inventory can cost a company a lot of money in many different ways.

We need the parts immediately, get them here now!

  • When parts aren’t available, you pay higher freight bills and expedite fees.
  • You also pay overtime to receive, repackage, and ship out to your customers.

 When you’ve kept your inventory levels low, and managed to avoid the added cost of carrying too much inventory, there are always those situations that suddenly catch you off guard. These tend to be the super urgent customer calls you get when the opportunity to pursue new business presents itself, and you have no way of capturing the sale because the inventory is not available. Sometimes it’s the urgent request to replace parts for an important account. Whatever the case may be, the urgency is there.

Without the inventory you are suddenly in catch up mode. While you have managed to keep inventory levels low, and been satisfied with the effort, you must now do everything possible to rectify the situation and service your customer. So what does that involve? Well, you’ll typically get on the phone with your supplier and request they do everything within their power to get you product.

If you’re lucky, you may be able to avoid paying a rush or expedite fee from your supplier. However, you’ll most likely have to pay a high freight bill to rush the shipment to your facility. Once it’s there, you’ll likely have to pay someone overtime to wait for the shipment, and repackage it if necessary. If you’ve got an upset customer that demands you pay for freight, you’ll now get hit with another high freight bill.

All this time, you were extremely pleased that you managed to keep your inventory levels low, and felt a sense of accomplishment for a job well done. Does this whole situation give you another perspective now? For some companies, it can be rather obvious what the cost was of having too low an inventory level.

However, other companies will not attribute these extra costs to having a low inventory. Instead, they will ignore the costs or simply refer to them as the cost of doing business. It simply isn’t. It is a direct cost to your inventory.

Not using your purchasing power to your advantage.

  • You now have the burden of paying more invoices and cutting more checks.
  • You are not getting the best pricing for your volume.

Inventory managers tend to concentrate on keeping inventory levels low. They do this in order to avoid the month to month carrying charges. However, they may actually be doing more harm than good. They may not be using their economies of scale to negotiate the best possible pricing. In addition, they may also not be maximizing their per unit freight cost for incoming parts and materials.

There are further complications about how the internal company system will process the invoices for the materials and parts that were ordered. For instance, if purchasing were to order parts too infrequently, how would each of these invoices be paid? Would they be paid individually with separate checks, or would the company be proactive and pay a larger amount for a group of invoices?

Most companies are intelligent enough to work out a single payment for multiple invoices, but some don’t. The hidden cost of time and money can play an important role here. For most businesses, it’s extremely difficult to estimate the cost of writing a check. However, it is much less expensive to pay all at once, instead of multiple payments for the same item.

There are several references that estimate the actual cost of writing a check can be well over $25.00. This takes into consideration the time needed for approvals. You also have to deal with higher freight costs as the parts were ordered in multiple shipments.

You now have to deal with a larger volume of invoices, more frequent freight bills, and you’ve likely not secured stronger pricing because your orders themselves are always small volume ones. Unless there is an agreement in place on pricing with your suppliers, you are simply wasting money with these practices. 

To summarize, what are the direct costs of maintaining too low an inventory?

Companies are often completely unaware of the high cost of inventory. A number of these costs are directly attributed to maintaining too low an inventory level. These are summarized below in point form. 

  • Lost business because inventory was not available.
  • High Freight costs for incoming and outgoing shipments because inventory levels were too low.
  • Higher prices for parts and materials because a company is not using its economies of scale.
  • Higher per unit freight cost for parts and materials because shipments are too infrequent.
  • Overtime for shipping and receiving to stay and receive urgent parts from suppliers, and stay and ship out parts to customers.

When it comes to managing inventory, it can easily be viewed as a constant juggling act. There is no guaranteed way to avoid any of these issues. When these situations come up, it’s best to simply take a step back and analyze the frequency with which they occur.

If they continue to occur without any corrective action taken, then the costs can easily add up. Take the time to analyze the costs associated with being caught with too low an inventory level.

One of the easiest and most efficient ways to control inventory and reduce out of stocks is to implement RFID. Make sure to download our whitepaper on the key factors to consider before implementing RFID.

20 questions to ask yourself before implementing RFID

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Topics: Retail

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