Answer to Question #203088 in Management for nhlaphu

Question

1. why should retailers such as fruit and veg not keep too much inventory? (20 marks)

Answer 1

Excess inventory can lead to poor quality goods and degradation. If you’ve got high levels of excess stock, the chances are you have low inventory turnover, which means you’re not turning all your stock on a regular basis. Unfortunately, excess stock that sits on warehouse shelves can begin to deteriorate and perish. So, businesses often sell off perishable or sub-standard stock at lower prices to prevent having to throw it away and lose its value altogether. Discounting stock or disposing of it altogether can have a significant impact on your business’s profitability.

Excess inventory can result in stock obsolescence. The reasons for excess inventory usually include poor forecasting and purchasing e.g. you’ve over-projected your demand and/or bought too much of the wrong items. If demand for those items then hits zero for a prolonged period of time, the result is obsolete stock. Again, obsolete stock is bad news for profitability. Items with no demand often have to be sold off at a discounted rate or even worse, end up being written off altogether.

Excess inventory ties-up much-needed working capital. Cash flow is the lifeblood of many businesses. Without good cash flow, businesses can struggle to pay employees, to pay debts and even to stay trading. Unfortunately, excess stock is a major culprit for sucking up working capital. If cash is invested in stock items sat in a warehouse that have very little, or volatile demand, then it’s being wasted on assets that are not going to generate revenue soon.

Excess inventory increases carrying costs. Excess inventory also increases carrying costs. Carrying costs are costs associated with storing inventory in your warehouse and are made up of these different elements:

Capital costs: The largest cost and includes everything related to your investment in buying the stock, e.g the cost of the stock, the interest on working capital and the opportunity cost.

Opportunity costs are the difference between investing in stock or investing in other business activities. For example, if most of your cash is tied up in inventory, you lose the opportunity to invest in other areas of the business, such as marketing activity, new machinery, or taking on more employees.

Storage space costs: a combination of the warehouse rent or mortgage and maintenance costs, such as lighting, heating and air conditioning.

Service costs: include insurance, security, IT hardware and the cost of physically handling the goods.

Inventory risk costs: the risk that items might fall in value over the period they are stored, shrinkage and the risk that they become obsolete.

Many of these costs are not obvious, but, if you’ve lots of excess stock, each one will rise and chip away at the profitability of your inventory.