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How Poor Inventory Management Affects Profitability

How Poor Inventory Management Affects Profitability


Nov 09, 2016
Manufacturing and Distribution

Profitability and good inventory management are intertwined.

Think about it: There's a cost to carrying inventory that extends beyond an item's sticker price. If you purchase too much product, it just sits on shelves taking up space in a warehouse. If you lease that warehouse space on an as-used basis, you're throwing money away to store items that go unused for prolonged periods of time.

Also consider the personal property tax element that's at play. When storing inventory in a facility in a state that collects personal property taxes, you want to avoid paying taxes on items that are sitting around for no purpose.

Overbuying and carrying excess inventory could also lead to overstocked inventory reaching the end of its product lifecycle and becoming obsolete. If that happens, you might not be able to sell the product or return it to the supplier, meaning you're stuck with the cost.

On the flipside, underbuying also is a potentially costly mistake, as stockouts may result. This could require you to ask your supplier to expedite an order, which usually costs more and therefore lowers your profit margins.

Poor purchasing decisions that lead to excess or inadequate inventory have tax and overhead implications, which also impacts the margins on sellable products.

Take a moment to consider your in-house inventory management procedures. Do you stock any products with storage restraints (temperature, environment, etc.)? Are all of your employees properly trained on how to handle inventory?

To ensure your workers have good inventory management habits, regularly communicate with people who handle your inventory. Ask what changes could improve efficiency and effectiveness. Since these people are on the ground, they're a great resource to rely on.

Proper inventory management extends to the production process, too. Train shop floor workers on how to best use products and avoid wasting parts when items are broken, incorrectly assembled or otherwise mishandled.

Also consider how your research and development (R&D) process affects inventory management and profitability. It's likely that your R&D team requires access to products from your inventory to do their work. But it's unlikely that the R&D process is taken into account when placing purchase orders. While special orders for R&D are frequent, it's also inevitable that some parts for R&D projects will be taken out of common inventory stock, so make sure you're accounting for this.

Good inventory management boils down to accountability. You need to account for what's coming into and out of your inventory. Assess your inventory management methods regularly to make sure you're not sacrificing profitability due to poor procedures.

Author(s)

Suzanne Koss
Suzanne Koss, CPIM
Partner
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