If you are purchasing and holding stock that exceeds your demand for the billing period, then you have excess stock. Holding more stock than you need to avoid running out and disappointing customers is a common pitfall for many businesses.
Holding excess stock in inventory directly affects your bottom line. Besides the actual cost you pay for the products, there are other less salient expenses to be aware of. The cost of the floor space in your warehouse being taken up by excess stock is one such example.
Holding excess stock directly affects your cash flow. You are instead holding cash in your warehouse that could be making you a profit if invested more appropriately. Being able to identify your excess inventory, and which processes have led to the over ordering, means you can minimise the risk of creating more.
Identifying excess stock
To quickly identify your excess stock, it is imperative that your inventory is correctly classified.
Ideally, you will have zero non-stocked items in your warehouse. These products are typically those that are ordered in on request, and so should be sold as soon as they are received. Any stock on hand of non-stocked items should be regarded as excess.
Being able to identify excess stock on your stocked items requires more information.
The stock on hand must not exceed its “maximum stock level.” The maximum stock level is determined by adding your safety stock and the stock in a natural replenishment cycle. Stock on hand that is greater than this quantity is considered to be excess inventory and should not be in the warehouse.
Note: The portion of this excess that can be disposed of without compromising customer fill rates requires a different calculation. Information about the impact of lead times can be found in the next section.
- Accurate forecasts
- Accurate lead times
- Correct replenishment cycle
- Safety stock must be correctly set.
The impact of lead times
Lead times have an impact in maintaining a good level of stock. If you dispose of excess stock, down to your maximum stock level, without any purchasing plan or orders placed, then your next reorder will not be delivered until after its lead time. This could cause an overbalance, and lead to a stock-out.
Tip: Before considering an inventory management system, confirm that the system handles the impact of the lead time when calculating the "disposable excess quantity" for stocked items.
What does excess inventory cost your business?
Not all the costs of carrying excess stock are apparent. Here are costs that you may not have thought about:
- The cost of the item.
- The cost of transportation and shipping to get your inventory to your warehouse.
- The cost of the space in your warehouse to store your inventory, including rent, utilities, property taxes, and insurance.
- The cost of safety equipment, such as fire suppression equipment.
- The cost of warehouse equipment, such as conveyor belts, trolleys, forklifts, and pallet jacks.
- The cost of labor and security in your warehouse.
- The cost of loss via obsolescence or depreciation.
- The cost of loss via deterioration, expiration, and breakage.
- The cost of a lost opportunity in having your cash tied up in unsold inventory.
The capital lying in the warehouse in the form of excess stock generates nothing of value. This must be sold off at a low price, written off, or scrapped. Ignoring the problem does not make it go away – it escalates it. Typically, management is reluctant to rectify the issues as it can impact the bottom line. But having a persistent excess stock problem will cost your business far more in the long term.
What are the causes of excess stock?
- Over-forecasting is one of the most obvious causes of over-ordering. The longer the lead time, the more dramatically over-forecasting will create excess.
- It is tempting to purchase a larger than normal quantity to get a ‘good deal,’ but this often ends up causing excess stock issues. Accurate information, a thorough understanding of how money is made by turning inventory as quickly as possible, and a sound inventory management system are all essential when considering these ‘good deals.’
- Calculating recommended order quantities using lead times longer than the supplier's actual lead time results in deliveries being received before they are required.
- Ordering without an effective inventory management system to calculate the recommended order poses a high risk. Without an objective system, the buyer’s opinion will influence the amount ordered. This opinion may well be unfounded.
- Supplier's minimum order quantities result in excess stock.
- Ordering non-standard products without a firm customer order often results in excess.
- Placing a poorly considered "initial purchase order" for a new product launch without thorough market research is a prevalent cause of excess.
- Products with a limited shelf life require extra care when ordering, as it is much more difficult to sell away the excess, even with a significant discount.
Excess inventory is a challenge for many companies. Your goal should be to lower your risk of generating excess.
Here are some suggestions to help you:
- Invest in an inventory management system, like NETSTOCK, that provides you with effective classification, forecasting, safety stock, and ordering features.
- Choose an inventory management system with a dashboard that will identify and display the excess items by descending excess value.
- Have the ability to identify and fix over-forecasted items as soon as possible.
- Periodically review lead times, especially for the suppliers from whom you purchase the most inventory.
- Since excess inventory will be generated from time to time, make sure you have a formal effective excess stock disposal process.
If excess inventory is one of your inventory challenges and you'd like more information about Inventory Management Software, excess stock or NETSTOCK, please email us.