What are The Disadvantages of Excess Inventory?
- Why is excess inventory bad? What are the effects of excess inventory?
- Excess inventory ties-up much-needed working capital
- Excess inventory increases carrying costs
- Excess inventory can lead to poor quality goods and degradation
- Excess inventory can result in stock obsolescence
- Don’t be disadvantaged by excess stock!
Excess inventory is when a business carries more stock than they need to meet their forecasted demand. This can cause a wealth of operational challenges and financial constraints. In this blog post we will look at the most problematic. But before we do, lets clear up a few myths:
Some people believe that there are advantages to carrying excess inventory because it helps businesses respond quicker to customer orders and ensure a lower risk of stockouts. At EazyStock we argue you can do this without holding excessive amounts of stock – read more about how here.
Often excess inventory gets confused with buffer stock (safety stock). Buffer stock is when inventory teams deliberately carry a controlled amount of additional stock (above forecasted demand), to cover instances such as unexpected peaks in sales or supplier delays. Excess stock on the other hand is when stock builds up in a warehouse unintentionally, often caused by poor forecasting and purchasing decisions.
But no matter the reason for excess stock, one thing is sure, it often bring with it many disadvantages. Let’s take a closer look:
Why is excess inventory bad? What are the effects of excess inventory?
Excess inventory ties-up much-needed working capital
Cashflow is the lifeblood of many businesses. Without good cashflow, businesses can struggle to pay employees, to pay debts and even to stay trading. Unfortunately, excess stock is a major culprit for sucking up working capital. If cash is invested in stock items sat in a warehouse that have very little, or volatile demand, then it’s being wasted on assets that are not going to generate revenue soon.
Excess inventory increases carrying costs
Excess inventory also increases carrying costs. Carrying costs are costs associated with storing inventory in your warehouse and are made up of these different elements:
- Capital costs: The largest cost and includes everything related to your investment in buying the stock, e.g the cost of the stock, the interest on working capital and the opportunity cost.
Opportunity costs are the difference between investing in stock or investing in other business activities. For example, if most of your cash is tied up in inventory, you lose the opportunity to invest in other areas of the business, such as marketing activity, new machinery, or taking on more employees.
- Storage space costs: a combination of the 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, but, if you’ve lots of excess stock, each one will rise and chip away at the profitability of your inventory.
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 on a regular basis. Unfortunately, excess stock that sits on warehouse shelves can begin to deteriorate and perish. So, businesses often sell off perishable or sub-standard stock at lower prices to prevent having to throw it away and lose its value altogether. Discounting stock or disposing of it altogether can have a significant impact on your business’s profitability.
Excess inventory can result in stock obsolescence
The reasons for excess inventory usually include poor forecasting and purchasing e.g you’ve over-projected your demand and/or bought too much of the wrong items. If demand for those items then hits zero for a prolonged period of time, the result is obsolete stock.
Again, obsolete stock is bad news for profitability. Items with no demand often have to be sold off at a discounted rate or even worse, end up being written off altogether.
Don’t be disadvantaged by excess stock!
If you have excess stock, you need to act fast to prevent it becoming obsolete. Read our blog on how to reduce excess inventory for some easy-fix solutions. Prevention is obviously better than cure! Excess inventory can be easily avoided if you follow good forecasting and inventory replenishment planning processes. Using an enterprise resource planning (ERP) or warehouse management system (WMS) to manage your inventory is a good starting point, but when you have lots of SKUs, products affected by seasonality, or erratic demand, their functionality may not be enough.
EazyStock inventory optimisation software will enhance the capabilities of your current inventory management system. EazyStock uses statistical demand forecasting to automatically calculate your reordering requirements. 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 min/max order quantities. With EazyStock you can easily check which items are healthy (you have enough to cover demand), which are ‘excess’ (so you need to adjust your purchasing parameters to lower their levels) and which are 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. Alternatively you can arrange a demo here.