Three inventory costs SMEs need to know and manage

As an SME that manages inventory, the costs you see are not nearly as “risky” as the costs you don’t.

Managing these three inventory costs well can impact almost every aspect of your business operations. When well executed, good inventory management practices lead to accurate stock levels, a healthier balance sheet, a productive team, and most importantly, happy customers.

Ordering costs – looking beyond the price tag

Ordering costs are the costs associated with buying inventory, regardless of the value of the goods purchased and are highly specific to the type of business you operate and inventory being purchased.

There’s no silver bullet solution that will help you determine ordering costs but can include: clerical costs; freight and handling; and labour costs of receiving, examining and storing shipments.

Managing your ordering costs

The key to controlling ordering costs is to develop efficient processes that reduce time spent on procurement tasks. For SMEs without a procurement manager on staff, a digital procurement strategy that includes cloud-based software is a practical start.

Reducing manual processing can improve both efficiency and reduce cost. With cloud-based tools, for example, you can automate ordering of quickest-selling products by using inventory levels as a trigger for staff notifications – freeing up time for value-add work.

Holding costs – the hidden risk of storing stock

Also known as carrying costs, “holding costs” is an umbrella term that covers costs incurred from storage. This can involve warehouse rent, inventory shrinkage, and depreciation. SMEs selling perishable good are most at risk.

Holding costs matter because they are one of the key metrics that show how viable and cost-effective your business is. If they are too high, it could be a sign your business is struggling to sell stock. On the other hand, not holding enough inventory can lead to loss of sales and dissatisfied customers.

Managing your holding costs

Optimising inventory turnover is a continuous process. The key challenge is being able to balance stock on hand to meet customer demand. One way to do this is to ensure your inventory management system is by producing accurate data, then analysing that data for key insights such as sales forecasts and cashflow.

Shortage costs – the true cost of “out-of-stock”

Shortage costs occur when a business actually runs out of stock. These costs can include: the price of losing customers; loss of margin on sales not fulfilled; and cost of under-utilised machinery.

For manufacturers, stockouts can deal a significant blow to production. In the worst case, it can bring production to a halt until inventory is replenished resulting in missed deadlines or customers lost to a competitor.

Research shows that shoppers too would rather buy from a competitor if an item is unavailable than wait for stock to be reordered. Placing ‘emergency’ orders also means heavier shortage costs, such as for expedited shipping.

While the tangible costs of stockouts can be calculated, intangible costs are more elusive and can be far more detrimental to the bottom line in the long run. How do you place a value on customer dissatisfaction, poor reviews, or eroded customer loyalty?

Managing your shortage costs

Reducing shortage costs essentially comes down to good inventory management — ensuring that the right products are in the right place, at the right time. Tracking your goods is imperative here. If you can track your inventory throughout the supply chain, you can benefit from advanced warning of inventory shortages and even automate ordering to prevent stockouts.

Gareth Berry, CEO, Unleashed Software

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