Inventory is one of industrial or retail companies’ most significant and tangible investments. Smart inventory management techniques can distinguish between thriving and barely surviving businesses. They can also help increase revenues.

Many business owners are unaware of the actual cost of carrying extra inventory, which, when all carrying costs are taken into account, can be as high as 29% of the inventory’s worth (interest, storage, damage, obsolescence, etc.). These expenses are directly deducted from the net profit.

What is Inventory Costing?

The term “inventory costing” highlights the expense of acquiring and holding inventory and the time spent processing the documentation required to keep your stock organised. The inventory cost must be evaluated to determine how much stock to maintain on hand to fulfil client requests on schedule.

Inventory expenses come in many different forms, including ordering costs and spoiling costs, to name a few. Businesses can find their money-losing areas and learn how to reduce those losses for greater financial performance by categorising expenses.

Types of Inventory Costs

Given below are the various different types of inventory costs encountered by a business:

Ordering Costs

The costs associated with placing an order, including labour, payroll taxes, and benefits, are referred to as ordering costs. Costs are frequently incorporated into the overall budgetary allocation for these costs. Transport fees, reception fees, expedition costs, clerical costs, and EDI costs are additional order costs that may apply (electronic data interchange). Thanks to EDI systems, your company’s ordering costs can be processed more affordably.

Holding/Carrying Costs

The expenses paid by storing inventory before sales are referred to as holding costs (also known as inventory carrying costs). Depending on the type of business, the cost of financing inventory may be included in inventory holding expenses. Depending on how much a business pays to lease a space, storage costs may be substantial, and working capital interest may also be high. Inventory also entails risks because there is always a chance of suffering a loss due to theft, damage, or other problems.

Shortage Costs

Businesses miss out on the chance to make sales when their inventory runs out. Many other reasons for stock shortages include sluggish deliveries or interrupting production. Customers might easily decide to buy a comparable product from a rival if a company’s product is out of stock. Additionally, the company’s reputation is at risk since it can come out unprepared or unprofessional if supply runs out.

Spoilage Expenses

The environment where perishable goods are stored must be controlled if they are successful since they can spoil if they are not sold immediately. The industries of food and beverage production, medicine, cosmetics, and healthcare are all required to adhere to the expiration dates of their products.

What are the Different Types of Inventory Costing Methods?

Due to variations in business kinds, sizes, and complexity, several inventory costing methodologies are required. As a result, you should choose a strategy that considers your organisation’s unique requirements.

Here are some of the most common categories of inventory costing strategies and their applications.

First in, First Out (FIFO)

The inventory cost on hand at any given time should correspond to the cost of the most recently purchased goods, according to an operation that uses the First-in, First-out inventory costing strategy. This implies that the oldest prices (the cost of goods for the oldest inventory) are attached to the sale of inventory.

The strategy best suited to real buying cycles, where the oldest inventory is often the first to be sold, is first-in, first-out inventory costing. This is particularly crucial for products like food, medicines, and other perishable goods that quickly go out of date or expire.

Last in, First Out (LIFO)

The LIFO technique is the reverse of the FIFO inventory costing approach. According to LIFO, each sale is accompanied by the most recent inventory expenses.

Since LIFO is unrelated to the regular buying cycle, it may look strange to many operations as a technique of inventory costing. And in most situations, it is less valuable than FIFO. Procedures where LIFO does match the buying cycle are among the operations and product types where LIFO makes sense.

Weighted Average

By determining the average of all inventory acquisition costs, a business utilising the average cost inventory costing methodology would assign expenses to goods sold. Then, rather than costs associated with the date of purchase or the age of the commodity, this average cost is applied to each item of inventory.

The average cost/weighted average for the cost of goods sold must constantly be updated to remain correct, regardless of whether a product is sold or added to inventory. The inventory management system of an operation frequently performs this automatically.

Most businesses employing the average cost methodology sell or distribute non-perishable commodities, frequently in a non-sequential order. In these activities, new stock is mixed with older stock, making it challenging to distinguish between the two.

What is Standard Cost Inventory?

Companies may utilise standard cost inventory procedures, which assign a good with an expected or standard cost of labour or material rather than its actual cost, to assist in budget planning. The standard cost amount is determined by looking at past data and operations under typical conditions. The causes of major deviations must be found by leaders so that they can make necessary adjustments.

What is the Cost of Ending Inventory?

The value of items on the market at the end of an accounting period is known as ending inventory. It consists of the initial stock plus net purchases less the cost of goods sold. Inventory purchases considered “net purchases” have had any returns or discounts subtracted.

The inventory valuation technique impacts the final inventory value even when the number of inventory units is constant at the end of each accounting period. When there are rising prices or inflationary pressures, the FIFO (first in, first out) strategy is chosen since it produces a higher ending inventory valuation than LIFO (last in, first out). In light of various business situations, some companies purposefully use LIFO or FIFO strategies.

For instance, if you started the quarter with inventory valued at Rs.100,000, purchased Rs. 50,000 worth of goods throughout the quarter, and ended the quarter with Rs. 80,000 in cost of Gold sold (COGS), the value of your closing inventory should be Rs.70,000. A stocktake can be used to confirm this and check for inconsistencies and errors.

Ending inventory = (beginning inventory + purchase costs) – cost of goods sold

How do you Reduce the Cost of Inventory?

Inventory costs can rise quickly, leaving you with little profit and excessive spending. You may recoup your cash flow and increase your income by utilising just a few ways to reduce inventory costs.

Use an Inventory Management Software

When making purchase selections, inventory management software delivers in-depth Inventorying purchase selections.

Ordering in Bulk

Typically, buying in bulk will result in cost savings. Manufacturers might also be prepared to work with your company to make larger purchases on favourable terms.

Getting Rid of Deadstock

Maintaining inventory that you don’t require costs you time and money. Clearance sales can help you move merchandise faster when your inventory stock is more than what is required or can be sold. Find a way to offload that inventory even if you cannot sell it. Even the donation of commodities for tax deductions may be possible.

Employ Safety Stock

When your usual inventory is exhausted, safety stock, or additional products not included in your regular inventory, can help you swiftly fill orders.

Negotiate to Carry Expenses With Clients

You can establish a long-term revenue stream by negotiating to carry costs with clients and putting long-term contracts in place. Long-term agreements can help your financial situation because you’ll probably be able to receive lower prices on products.

Utilise Storage Space Wisely

Optimising your area and being aware of how much inventory you have will help you reduce expenditures. For efficient inward/outward inventory flow, perishable and high-turnover items should be kept in locations that are simple to reach. Additionally, storing items in clearly labelled locations makes stock-keeping simpler for warehouse staff.

Setting minimum inventory levels can help you maintain the proper supply on hand to satisfy client demand and reduce the danger of overstocking.

Setting Minimum Inventory Costs

Additionally, minimum inventory levels assist you in determining whether to order extra stock. The management must assess the sale rate of various commodities and adjust minimums as necessary.

Organise Your Product and Inventory Costing Methods

The nature of the supply chain and inventory must be considered while setting inventory stock levels. For instance, some products might be perishable, others might have high turnover rates, and others might have longer fulfilment times. Sometimes using a FIFO approach will produce superior outcomes.

Systems for inventory management can be useful for more complicated inventory products, like those that require assembly. Your company will be better able to manage complex inventory difficulties if you properly label, categorise, and store your goods.

Observe Lead Times Carefully

For the proper quantity of stock to be kept on hand, it can be essential to understand your lead times and how long it takes for things to move from the order placement stage to warehouse inventory to final delivery.

Shorter lead times are frequently requested, but your firm may generally benefit more in the long term from suppliers who offer superior customer service and dependability. Managers can be reminded to place new orders by receiving alerts from inventory management software about low inventory levels, supplier availability, and lead times.

Consider Inventory Management When Calculating Forecasts

Although adopting an advanced inventory management system can be helpful, historical data cannot always predict future sales. With the help of these effective tools, brands may boost sales, KPIs, and forecasts. Businesses can gain detailed insight from inventory management software into warehouse stock, lead times, restocking problems, and product sales, giving you a better understanding of the state of your firm.

Calculate Reorder Points

You can have precise safety stock levels and prevent stockouts or overstocking by setting reorder points.

Avoid Understocking

When you’re just starting, understocking could seem like a good idea. However, placing additional orders from vendors and paying for quick delivery would increase your costs. Additionally, by understocking, you incur the risk of stockouts and even client loss.

Conclusion 

Managing and reducing inventory cost is a crucial task for business to remain competitive and profitable. It involves optimising inventory levels, improving supply chain efficiency, and implementing inventory management techniques. Businesses should also use technology solutions like Busy inventory management software, and analytics tools to monitor inventory and make data-driven decisions. By implementing these strategies, businesses can reduce inventory cost while improving customer satisfaction and increasing revenue.