What are the disadvantages of excess inventory?
Inventory is pivotal to business success. Without it, you can’t provide the items your customers need, and you’ll probably go out of business pretty quickly.
Understanding the right amounts of inventory to hold can be tricky. If you don’t have enough, you risk stockouts and missed sales, so holding large quantities of stock can be tempting to ensure you don’t run out. However, this can lead to excess inventory, which is also a problem.
This blog explores the disadvantages of excess inventory and how to avoid them.
What is excess inventory?
Excess inventory is what is left once you have met customer demand. If there is no demand for the items within a reasonable period, they become surplus to requirements and known as excess inventory. This leads to an unintentional stock build-up in the warehouse.
There are several reasons you might end up with excess inventory, for example:
- Inaccurate demand forecasts that overestimate what is needed.
- Poor purchasing decisions.
- Changes in trends or customer needs.
Holding too much of certain stock items can cause operational challenges and financial constraints.
Is excess stock the same as safety stock?
Some people believe that carrying excess inventory helps businesses respond quickly to customer orders and reduce the risk of stockouts. While carrying some additional stock to cover unexpected demand makes sense, there’s a balance between excess stock and extra or safety stock.
While excess stock is surplus to requirements, safety stock (buffer stock) is a calculated amount above forecasted demand that considers supply chain variables to cover instances such as unexpected peaks in sales or supplier delays. Calculating appropriate safety stock levels reduces the risk of filling warehouses with excess stock.
We explain more about how to improve stock availability without carrying excess stock and calculating safety stock in our blog posts.
What are the disadvantages of holding too much stock?
As we just discussed, holding excess inventory might seem like a good idea to help meet unexpected demand, but that comes at a cost. Let’s look at the four main disadvantages of excess inventory.
Excess inventory ties up much-needed working capital
Without good cash flow, businesses can struggle to pay employees, pay debts, and even stay in business. Excess stock is a major culprit for sucking up working capital and reducing available cash flow. Think of all the cash tied up in stock items sitting in your warehouse with very little or volatile demand. Your money is being wasted on stock that won’t generate a return in revenue. Even if they are sold, it’s likely to be at a heavy discount, or they could be written off completely, impacting revenue further.
If you tie up your cash in inventory, consider the opportunity costs you incur. Opportunity costs are other business activities you could have invested in instead of the excess stock. For example, by tying up most of your cash in inventory, you lose the opportunity to invest in other business areas, such as marketing activity, new machinery, or increasing your workforce.
Excess inventory increases carrying costs
As well as tying up cash, excess inventory also increases carrying costs. Carrying costs are costs associated with storing inventory in your warehouse and include these elements:
- Capital costs are the most significant cost, which includes everything related to your investment in buying the stock, e.g. the cost of the stock, interest on working capital, and opportunity cost.
- Storage costs combine warehouse rent or mortgage and maintenance costs, such as lighting, heating, and air conditioning.
- Service costs include insurance, security, IT hardware, and the cost of physically handling the goods.
- Inventory risk costs: the risk that items might fall in value over the period they are stored, shrinkage, and the risk that they become obsolete.
Many of these costs are not obvious or might seem insignificant, but if you have lots of excess stock, they can add up and chip away at your inventory’s profitability.
Excess inventory can lead to poor-quality goods and degradation
If you’ve got high levels of excess stock, the chances are you have low inventory turnover, which means you’re not turning all your stock regularly. This could begin to deteriorate or perish, making it unsellable. Businesses often sell off perishable or sub-standard stock at lower prices to prevent throwing it away and losing its value completely. Discounting or disposing of stock can significantly impact your business’s profitability.
Excess inventory can result in stock obsolescence
The reasons for excess inventory usually include poor forecasting and purchasing, i.e. you’ve over-projected your demand or bought too many of the wrong items. If demand for those items hits zero for a prolonged period, you could end up with obsolete inventory. This could be due to updated models or versions, new technology, or changing consumer trends and fashions.
As with sub-standard stock, obsolete stock is bad news for profitability. Trying to sell items with no demand will be challenging, even at a heavily discounted rate. It’s likely they will be written off altogether.
Overcoming excess inventory
If you have excess stock, you must act fast to prevent it from becoming obsolete.
Prevention is better than cure, so ensure you review your forecasting and inventory replenishment planning processes. Implementing effective and efficient demand forecasting techniques, setting reasonable safety stock levels, and having the correct reorder levels will help avoid excess inventory.
Using an enterprise resource planning (ERP) or warehouse management system (WMS) to manage your inventory is a good starting point. However, when you are tracking and managing lots of SKUs that could be affected by seasonality or erratic demand, their functionality may not be enough.
EazyStock cloud-based inventory optimization software will enhance the capabilities of your current inventory management system. EazyStock uses statistical demand forecasting to calculate your reordering requirements automatically. It also dynamically adjusts reorder points and reorder quantities based on any changes in demand or to account for supply variables, such as longer lead times or minimum and maximum order quantities.
With EazyStock, you can easily check the status of your items to see which are healthy (you have enough inventory on hand to cover demand), excess (you need to adjust purchasing parameters to lower their stock levels), and at risk of run out (so you can place recommended orders as soon as possible).
If you’d like an insight into the current health of your stock, contact us for a Stock Health Analysis. We’ll segment your inventory into healthy, excess, and obsolete stock and provide a list of actions for improvement. You can also arrange a demo here.
FAQs about disadvantages of excess inventory
Excess inventory is what’s left after you have met customer demand. If items have no demand within a specific period, they become surplus to requirements and take up space that could be used by items with demand.
Excess inventory can build up due to inaccurate demand forecasts that overestimate customer needs, poor purchasing decisions to meet supplier MOQs, or being swayed by bulk-buy discounts, or changes in trends or customer needs.
Holding excess inventory ties up working capital, limiting cash flow. Money is tied up in items that won’t sell and won’t generate a return in revenue. It increases holding costs and risks become dead or obsolete stock. If excess stock is sold, it’s likely to be sold at a discount or written off if it becomes obsolete.
To calculate the carrying costs of excess stock, first, identify the value of excess stock. You can do this using the inventory turnover ratio and highlighting items with turnovers of 4 or under.
- Calculate component costs for these items – capital costs (related to investment in stock), storage space costs (warehouse, mortgage, maintenance), inventory service costs (insurance, security, hardware, physical costs), and inventory risk costs (insurance to cover shrinkage, wastage, obsolescence).
- Add all of the component costs together for excess stock to get total carrying costs.
- Divide the total costs by the total value of excess inventory and multiply by 100. This will give you the percentage of the inventory’s value that it costs just to keep it in stock.
Safety stock is a calculated amount above forecasted demand that accounts for supply chain variables, covering unexpected demand peaks or supplier delays to maintain product availability. Safety stock is recalculated based on demand trends and market variables to prevent excess stock from building up. As safety stock is planned, the capital invested is recoverable.
Excess stock builds up due to inaccurate forecasting and isn’t aligned with demand. It isn’t planned and can go unnoticed in manual forecasting and inventory management processes, incurring unexpected and potentially unrecoverable costs.
Holding too much inventory ties up working capital that could be used to invest in necessary stock, marketing, new machinery, or other operational areas. It also increases carrying costs, including capital costs (related to investment in stock), storage space costs (warehouse, mortgage, maintenance), inventory service costs (insurance, security, hardware, physical costs), and inventory risk costs (insurance to cover shrinkage, wastage, obsolescence).
While some of these costs might seem insignificant, if you have lots of excess stock, they can add up and chip away at your bottom line.
The older the stock gets, the greater the chance it deteriorates, perishes, or becomes obsolete, making it unsellable. Selling items at lower costs or having to throw them away reduces or eliminates return on investment.
Overstocking increases carrying costs, including capital costs (related to investment in stock), storage space costs (warehouse, mortgage, maintenance), inventory service costs (insurance, security, hardware, physical costs), and inventory risk costs (insurance to cover shrinkage, wastage, obsolescence).
As excess stock becomes obsolete, it becomes harder to sell profitably, if at all. This diminishes return on investment, impacting the bottom line and shrinking profit margins.
Preventing excess stock is easier than reducing it:
- Start by reviewing your forecasting and inventory replenishment processes. Ensure you have effective and efficient demand forecasting techniques to set reasonable safety stock levels and have the right reorder levels to avoid excess inventory.
- Review your supplier contracts and highlight any MOQs or MOVs that don’t fit with your inventory profiles.
- Consider inventory optimization software to automate inventory management. Specialist software will calculate your reordering requirement and dynamically adjust reorder points, reorder quantities and safety stock levels based on demand changes or supply variables. You will be able to track items through their lifecycle and demand profiles, and check their status to see if levels are healthy excess or at risk of running out.
Once you have excess inventory, work quickly to stop it from becoming obsolete. Some ways to reduce excess stock include:
- Run sales promotions and offer discounts. See if you can bundle items together to make them more attractive to customers.
- Investigate new markets and see if there are new audiences for your items. This could be a different industry or country – if you’re B2B, can you sell B2C? You could also investigate new sales channels, such as third-party websites.
- Sell your stock to a surplus specialist who will take your items off your hands, but this could be a heavy discount.
- The final option is to write off the goods and dispose of them. While this won’t bring in any money, you won’t continue to incur holding costs.
