Dispose of Excess InventoryĪ good way to minimize inventory holding costs is to promptly disposition any inventory items that are not selling well. This is a common approach for car dealerships, or any sellers of expensive consumer goods. A business that wants to reduce its inventory carrying costs could do so by purchasing from a cluster of suppliers that is located nearby.Ī variation on the concept is to sell off goods near the end of a tax reporting period, so that the firm pays fewer taxes on its inventory assets. Thus, changing suppliers can have an impact on reorder points and quantities. Reorder points can be influenced by how far suppliers are located from the company’s location, since closer suppliers have shorter delivery times. This analysis can result in differing inventory levels throughout the year, as customer order volumes vary inventory levels are especially likely to change for a seasonal business, where sales may spike for a very short span of months. Monitor Inventory LevelsĪnother option is to constantly monitor optimal inventory levels and reorder points, to keep from investing too much in inventory. Only an extremely well-organized production facility that uses just-in-time manufacturing principles can produce to order. Instead, the production process is geared towards very short production runs, so that it can process individual customer orders as they arrive. This means that the amount of finished goods inventory is kept to a minimum. Goods can also be produced only to match existing customer orders, so that obsolescence costs are eliminated.

Depending on the situation, this can mean that suppliers are taking on the cost of carrying the inventory. One way to reduce the cost of carrying inventory is to adopt just-in-time production principles, so that suppliers deliver raw materials directly to the company’s production lines, thereby greatly reducing the inventory investment. There are several ways to reduce the carrying cost of inventory, involving just-in-time production principles, constant monitoring of inventory levels, and promptly disposing of excess inventory. In short, poor systems, incorrect purchasing practices, and inaccurate sales forecasts can all result in high inventory carrying costs. The same outcome can arise when a customer backs out of a large purchase. The result is excess stocks that customers do not want. Yet another reason for excessive carrying costs is that the sales manager forecasts higher sales than are actually experienced. In these cases, the unit cost will be low, but the business is investing in too much inventory for a protracted period of time, which drives up its carrying costs. Another reason is that the purchasing department may be buying in excessive quantities in order to take advantage of volume discounts.

When the materials manager does not have a good inventory tracking system or warehouse layout, it is easy for inventory levels to become excessive. One possibility is poor inventory management. There are several reasons why a business may find itself with an overabundance of inventory, which triggers high carrying costs. Reasons for High Inventory Carrying Costs For them, tight management of carrying costs is an essential technique for earning a profit (or not). Retailers are more likely to separately store and present information about their inventory carrying cost, since this can represent a significant part of their cost structure. When a firm invests in a large amount of inventory, it can elect to present the associated costs of doing so within a separate line item on the income statement. Instead, inventory carrying cost is contained within a firm’s cost of goods sold line item. This expense does not directly appear on a company’s income statement, since the statement is not normally constructed to separately present such information. Operations Management Presentation of Inventory Carrying Cost If the cash had not been used to acquire inventory, it might have been more profitably invested elsewhere, or returned to investors in the form of a dividend or stock buyback. It is common for a business to experience an inventory carrying cost of about 20% of the cost of its inventory.Īn additional factor related to inventory carrying cost is the opportunity cost of the invested funds. Perishable goods have a higher carrying cost, since they must be written off after they reach a certain age. This expense is comprised of the costs of inventory shrinkage, obsolescence, insurance, interest, taxes, and depreciation on warehouse and rack space, as well as the compensation costs for the materials handling staff. Inventory carrying cost is the expense associated with keeping goods in stock.

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