Did you know 20-30% of a retailer’s complete inventory value is taken up by holding and managing inventory?
That might not be a big concern in boom times, but right now – when costs are rising, the economic outlook is uncertain and cash reserves might be running low – it’s enough to set alarm bells ringing.
Retailers need to take action to cut inventory carrying costs in order to maximize their profit and boost their cash flow. This blog will share three detailed strategies for doing so. But first…
What are inventory carrying costs?
Inventory carrying costs (also known as holding costs) are the expenses incurred by a merchant to store and maintain its inventory.
The costs are directly linked with how much cash a business has tied up in inventory and its potential for profitability.
As well as the capital cost of inventory (how much the inventory cost to buy in the first place), inventory carrying costs also include:
- Storage – the costs linked to physically storing the items
- Depreciation and shrinkage – the financial implications of holding excess stock which become obsolete or stale and has to be discounted or written off
- Transportation – moving inventory between warehouses or spaces can add up
- Labor – expenses associated with moving, handling, and managing inventory, including wages and equipment
- Insurance – premiums may increase to cover inventory against risks such as fire, theft and damage
How to work out inventory carrying costs
It’s essential that merchants understand their inventory carrying costs in order to gauge the scale of action required to reduce them. There are two ways to work out inventory carrying costs:
- Simply divide total annual inventory value by four. This provides a rough estimate of carrying costs.
- Add up all associated costs of carrying inventory (as outlined above) across 12 months and divide it by total inventory value, as show in this formula:
Associated costs (annual) / total inventory value (annual) x 100 = inventory carrying costs
3 ways to cut your inventory carrying costs
1. Utilize inventory planning technology
Inventory planning technology enables merchants to accurately forecast future demand. The best inventory planning tools factor in supplier timescales, seasonality and promotions alongside historical sales data to reveal which inventory to order, how much to order, and the perfect moment to order it.
Accurate demand forecasting helps businesses determine how much inventory they need to meet customer demand without risking excess stock or stockouts – which both have a clear impact on cash flow and inventory carrying costs.
Demand forecasting with dedicated software (and not unreliable spreadsheets) also enables businesses to optimize their order fulfillment processes. By having a clear understanding of anticipated demand, companies can plan for the future with confidence. This can have a direct impact on carrying costs, too.
Festival clothing brand Freedom Rave Wear is a shining example of a brand that has used inventory planning technology to cut its inventory carrying costs. Thanks to Inventory Planner’s detailed and accurate demand forecasting, the business was able to slim down its inventory and double its profits as a result.
Mike Hodgen, Co-Founder of Freedom Rave Wear, says: “Our business was holding around $300k in inventory and we used Inventory Planner forecasting to only make items in high demand.
“At its lowest, our inventory held around $100k – and at this stage our business doubled. This was because items were being made, then immediately sold – or perhaps sitting on the shelf for 7-14 days.”
2. Optimize order quantities
It can be tricky to strike the balance right when it comes to ordering the right quantities of inventory at the right time. However, it plays a critical role in minimizing carrying costs and keeping cash flow healthy, so it’s worth making every effort to optimize where possible.
Using inventory planning technology, such as Inventory Planner, is the easiest way to optimize order quantities because the software provides reliable buying recommendations that specify exactly how much to order and when to order it.
It even goes into detail on exactly which variants to order, and it can be used to easily tweak quantities to maximize the available space in shipping containers or warehouses to save costs. Inventory Planner lets you scale a PO to ensure you fill every square inch of your containers to avoid wasted space and unnecessary costs.
If you don’t have inventory planning technology at your disposal, there are manual ways to optimize order quantities, such as:
- Manual demand forecasting. By continually monitoring and manually analyzing sales data, inventory levels and demand, it’s possible to optimize order quantities by aligning them with expected future demand. However, this can be error-prone and very time consuming.
- Calculate Economic Order Quantity (EOQ). Using the EOQ formula, which factors in demand, ordering costs and holding costs, can help you determine optimal order quantities while minimizing total inventory costs. EOQ is typically used to determine a company’s inventory reorder point so that when inventory falls to a particular level, a reorder is triggered. However, EOQ is only reliable when demand is steady and predictable – which isn’t the case for most merchants right now.
- Use ‘safety’ stock. Safety stock acts as a buffer to cover unexpected variations in demand or supply disruptions. Most businesses use safety stock to some degree and it can help with reducing the risk of ordering the wrong quantity. However, safety stock should be kept to a minimum, especially in current times, because it ties up cash and takes up space.
Multichannel apparel brand Cycology, which sells across four global regions, has learned about the risks of manually optimizing order quantities the hard way.
“It resulted in huge overheads and multiple bad decisions for us,” says Founder and CEO Michael Tomchin, who made the decision to use Inventory Planner instead.
“Inventory Planner gives me the clarity I need to confidently make truly informed inventory decisions.
“Now I tell other merchants that they can’t afford not to have it. Say you hold $1 million in inventory and, at a very conservative estimate, Inventory Planner improves your inventory ordering and investments by 10% a year (for us, it’s actually higher than 10%). That would result in a saving of $100,000 a year!”
3. Improve supplier relationships
Merchants that have strong relationships with their suppliers typically enjoy better service, shorter lead times and more favorable pricing, which ultimately leads to lower carrying costs, happier customers and a healthier bottom line.
Some suppliers have minimum (or even maximum) order quantities which are important to factor into your buying decisions to reduce carrying costs. It’s easy to keep on top of each supplier’s policy within the dashboard of your inventory planning software, saving time and avoiding confusion.
It’s often worth sharing insights on sales and demand forecasts with your suppliers, as well as giving them a heads up about new product launches. By working collaboratively, you can ensure schedules are realistic, cash flow stays healthy and carrying costs are kept to a minimum.
Monitoring supplier performance based on key performance indicators (KPIs) can help you promptly identify areas for improvement, which can also help improve overall cash flow.
The bottom line
Adopting a holistic approach to inventory management that includes leveraging the best inventory planning technology, optimizing order quantities and maintaining effective supplier relationships is the key to optimizing your stock holding and improving cash flow, while maximizing profitability.
To learn how Inventory Planner can help, book a short demo now.