As a small business owner, passion for your business and doing right by your customers’ trumps most everything else related to your business. One area that seems to get overlooked and is probably one of the most challenging is a thorough understanding of inventory management.
For a small business owner, how they handle inventory management can make or break their business. Successful inventory management involves the balancing act of keeping inventory costs low with the benefits of having the inventory in stock.
How long a business holds and stores an item determines the carrying cost of inventory. A business’s carrying cost of inventory is the average dollar value of inventory over a fixed period of time. The longer the inventory is kept, the more costly its upkeep. This number is expressed as a percentage of a business’s average inventory investment.
Carrying costs include storage of inventory, inventory insurance, risk of inventory becoming obsolete, taxes on the inventory, possible damage to inventory and opportunity costs.
Storage of Inventory
One of the biggest costs associated with inventory is that of storing merchandise prior to selling it. Whether it is kept in a storage room or offsite at a warehouse, the more inventory you keep will increase your costs to rent, maintain and manage it.
This cost covers the cost to replace inventory in the event of a major loss. The premiums paid vary based on the inventory kept.
Risk of Being Obsolete
Unfortunately there is a possibility that some inventory may become unusable over time. This can occur due to a new model coming out, technology changes or the item being perishable. The probability of this affecting a small business increases with any increase in inventory.
Although many states have moved away from charging property taxes on business inventory there are still several that do so. According to a September 2012 report from the Tax Foundation, there are still thirteen states that either fully or partially charge property taxes on business inventory.
The longer inventory is held, the more likely it is to get damaged. Once a piece of inventory is damaged an attempt can be made to sell it at a lower price. If that can’t be done, it becomes a total write-off to the business.
This cost is based on what alternatives investments could be made for your business if the money was not tired up in inventory. The difference between the value of the inventory and an alternative investment is the opportunity cost.
Understanding the full costs of inventory is very important for any small business. By examining these costs, a business can determine where they can make changes that will result in cost savings for their business.
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