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Inventory Carrying Costs - The Hidden Costs of Independent Retail

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Published: 11Mar2012
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If you're like most independent retailers, inventory represents your single largest investment. Your customers know you in large part by your inventory, your merchandise, by those categories and items you choose to carry. And, if you're like many independent retailers, you feel naked if your store doesn't feel fully stocked with broad assortments and deep, impactful displays of core merchandise. When I work with my clients, I make sure they understand the full implications of their merchandising choices and inventory policies. The full cost of inventory extends far beyond the costs on vendor invoices or the cost of goods sold on a Profit and Loss Statement. Carrying inventory has its own costs, beyond invoice costs or cost of goods sold. To demonstrate this for my clients, I often ask a question - If you could make your sales without carrying any inventory, would you? The answer is always - Of course! They understand intuitively that carrying inventory not only ties up cash that could be held for other purposes, but also creates costs of its own. These retail inventory carrying costs are not always easy to quantify, but they are real nonetheless. In fact, these costs are often buried within a number of different expense lines. Here's a few places you'll find them:

Interest Expense: Are you financing your seasonal inventory needs from your cash flow, or are you having to rely on a line of credit. If you're relying on a line of credit, the interest on that line are part of your inventory carrying costs.

Insurance and taxes: Business insurance and inventory taxes on inventory are highly dependent on inventory value. The more inventory you carry, the more you're likely to spend on business insurance and inventory taxes.

Payroll: Think of all the times somebody has to touch the inventory. When it's received in, ticketed, when it's put out on the floor, when it's re-merchandised, when it's dusted, when it's marked down, when it's counted. All of those touches represents payroll. If you added it all up, how many man-hours would that represent?

Rent and Utilities: If you had twice the inventory, you might need twice the space - right? Well, what if you had half the inventory or three-quarters of the inventory? You probably wouldn't need as much space. Rent and utilities are often thought of as fixed expenses, but recognize how much of those expenses are a function of inventory levels - and how inventory levels are often a function of how much space there is to fill!

Cost of Goods Sold: COGS includes more than just the invoice cost of the merchandise you sold. It also includes all of your write-offs - for damages, obsolescence, shrink. The more inventory you carry, the more exposed you are to damages and shrink. The more inventory you carry, the more aged it will be, which makes you more exposed to markdown risks.

The important point to recognize is that carrying excess inventory - inventory in excess of what is needed to support the near-term sales forecast - not only ties up cash but also impacts profitability. Reducing inventory levels to eliminate excesses doesn't directly recapture those profits, but opens up the possibilities for specific expense reductions that will directly add to profitability and cash flow.

Ted Hurlbut is a retail consultant, coach and speaker who helps independent retailers increase sales, profitability and cash flow by leveraging his deep expertise in the core retail disciplines. To learn more about how you can benefit from Ted's proven retail know-how, visit his website at http://www.hurlbutassociates.com.

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