When reviewing the balance sheet of any company—be it a startup or a large corporation—inventory usually takes up one of the biggest asset balances. As you gain more experience in operating your business, you’ll find that all assets need additional spending. These include storing, repairing, and ensuring your assets. In business terms, the costs related to holding inventory are called carrying costs. Keeping inventory carrying costs under control is crucial. Otherwise, you might be wasting money without even noticing.
Top 3 carrying costs
- Storage – You need to shell out money for storing inventory in a warehouse or your store.
- Insurance – Inventory is one of the most valuable assets of your business, so you need to insure it against damage or theft.
- Interest – Borrowing money to purchase inventory means paying interest costs.
Any business owner knows that carrying costs increase as inventory grows larger. Because of this, it’s best to avoid inventory buildup whenever possible. The problem lies in finding the perfect balance between meeting customer demand and holding the right amount of inventory. Mastering how to manage inventory takes time, but it can create a massive impact on your bottom line.
Easing up cash flow
In most cases, excess inventory eats up profits because of the higher carrying costs. This means less cash to use for other aspects of your business such as payroll, product development, and advertising. Planning your operating cycle is the best way to ease up cash flow, ensuring that you have enough money to cover inventory and other operating expenses.
Your cash flow, inventory, and sales are all connected. Analyze your sales since it tells you how many products to produce and thus, the amount of inventory to meet sales. This is precisely why the biggest corporations invest heavily in an accurate sales projection. It helps you produce just as much product as your business sells, minimizing the inventory you must carry. Projecting sales also allows you to schedule production more strategically to ensure that it’s closer to the time the products are shipped, meaning you don’t have to hold inventory for an extended period.
Knowing when to keep excess inventory
There are cases in which carrying excess inventory proves to be a strategic business decision. This applies in particular to wholesalers such as aluminum producers. They may decide to keep excess inventory even when the current market supply is high.
The aluminum industry, however, is unique in that producers have the luxury of charging hefty fees to give access to their excess inventory in short notice. In case they get approached by a can manufacturer, for example, the producer can cover the carrying costs of holding excess inventory by asking for higher fees.
Again, sales and cash flow need to be accounted for. Storing excess inventory can easily hurt cash flow, especially if sales projections aren’t met. This scenario often results in the producer borrowing money to ease up cash flow and pay for different operating costs. Since borrowing entails paying interest, the producer needs to figure out whether the potential revenue from higher fees is greater than the interest costs of borrowing funds.