Profits Lost

WHILE I’VE yet to see a profit-and-loss statement with an expense category called “hidden costs” at any company that is carrying more inventory than it should, hidden costs surely exist.

Also known as carrying costs, they represent expenses related to paying for and then maintaining inventory. The bottom line? Your extra inventory may be gathering more than just dust. It’s also picking up hidden costs that can put a severe ding in your profits.

Learning just how high these hidden costs can be is a real incentive to trimming the excess. Leading logistics and accounting experts place the cost of carrying inventory between 25 percent and 55 percent a year depending on the products and business.

What makes up inventory-carrying costs? The most common include:

• Storage space (2%-5%) — Whether it’s your safe, cases, drawers or whatever, you’ve got to put it somewhere, right? A certain jeweler we know gained more than 1,000 square feet just by winnowing down the gift lines he carried (along with all the accompanying gift boxes) to the top three.
• Insurance (1%-3%) — Got stuff? Must insure.
• Taxes (2%-6%) — Have assets? The government wants its share.

The value of carrying the right inventory — products that turn quickly and at a good margin? Priceless.

• Physical handling/clerical/inventory control (4%-10%) — Inventory must be counted, cleaned, accounted for, put in cases, taken out of cases. Someone’s got to do it, someone’s got to pay them.
• Obsolescence (6%-12%) — It looked so good in the buying room. Your jeweler buddies told it was a sure sell. You had to carry it in all colors and sizes. And it’s still with you three years later. Because of the emphasis on fashion in the jewelry industry, I’m guessing you’re at the high end of the range.
• Waste, theft, spoilage (3%-6%) — OK, you’re not in the food business, so your old dogs don’t actually smell. But they do get damaged, and they certainly get lifted occasionally despite your best efforts. As inventory is handled and moved, it gets damaged and scraped. Shipments come in short but the error isn’t caught until weeks or months later. Pricing errors occur, or the wrong inventory is taken out of display or put into storage. The more stuff you have the more likely all this is to happen.
• Financing (6%-12%) — This is the biggie. Also known as the cost of money, it includes financing the acquisition of the inventory. Don’t forget the lost opportunity cost of what you could have used that money for instead of buying inventory that just sits around.

The grand total? 25 percent to 55 percent. Let’s say that you’re carrying $100,000 too much inventory. Take even the low end of the hidden-cost range times that excess inventory and you’ve got $25,000 less in profits per year.

Here’s another way of looking at it. Remember that piece you bought four years ago that you finally sent home with a customer last month? Four years times 25 percent means no profit at all.

The value of carrying the right inventory — products that turn quickly and at a good margin? Priceless.

• MONEY MATH
• Is Excess Inventory Costing You Too Much?

Here’s a formula to find out the hidden costs.

Take the amount of excess inventory and multiply it by the carrying costs of inventory. Accounting and inventory experts peg it as low as 25 percent and as high as 55 percent. Let’s say you’ve got $150,000 too much inventory. $150,000 x 25% = $37,500 in hidden costs per year.

• MONEY MATH
• The Perfect Figure: 1.72

What is it? Sales to Assets. It’s the amount of sales generated for every dollar invested in total assets (cash, inventory, accounts receivable, and other current and long term assets) by the top 25 percent in the 2005 FIT Jewelers Financial Benchmarking Study. The top 25 percent represents those companies earning the highest owners’ discretionary profit percentage.

This story is from the February 2007 edition of INSTORE.