Here are the top 7 dangers of holding too much inventory
- Cash flow restrictions
- Storage and holding costs
- Lost sales
- Dissatisfied customers
- Product degradation or waste
- Product obsolescence
- Lower Profits
You usually end up with too much inventory when you’ve ordered or manufactured more stock than you can sell.
Both overstocking and understocking are usually a reflection of insufficient inventory management. But the root cause could lie elsewhere in your business.
For instance, if your sales and marketing teams have done a poor job with customer demand forecasting, you could end up with too much or too little inventory.
Similarly, if you experience a surprise rise or fall in the sales of a product, even if this was out of your control, you will still end up either with insufficient stock or with surplus stock.
Another common reason for having too much inventory is FOMO – Fear Of Missing Out. You overstock to avoid missing sales. But this too is a reflection of poor sales forecasting.
Regardless of the reasons, it is bad to have too much inventory and you need to make a plan to get rid of your excess inventory.
Let’s find out why.
Why is it bad to have too much inventory?
1. Cash Flow restrictions
A key objective of inventory management is to keep only the optimal amount of inventory on hand and to convert it to customer cash as quickly as possible.
That’s because Inventory is money “stuck” in the business.
Inventory restricts free cash flow as it consumes working capital that could otherwise have been used in other parts of the business, like for marketing, promotion, salaries, bonuses, etc.
If you calculate the value of excess inventory, you can know exactly how much you could have freed up with sound inventory management techniques.
2. Storage and holding costs
Inventory takes space. Space costs money.
This will be space in a warehouse or prime retail real-estate on a store shelf. Either way, it is a cost.
And the longer you hold on to aging inventory, the more it is going to cost you.
Apart from the cost of purchase or manufacture and the storage fees, you may have inventory with other holding costs like service costs, transportation costs and insurance costs. The longer you hold on to surplus inventory the more these costs are going to pile up.
3. Lost sales
Ironically, having surplus stock could result in lost sales.
This can happen when you have excess inventory of a product that isn’t selling as much and insufficient stock of your best-selling products.
To make matters worse, money invested in your slow moving inventory is blocked and cannot be used to purchase more stock of better-selling products.
So, it’s a double whammy – you’re wasting money on unsellable inventory and are not earning enough from products which are selling well.
4. Dissatisfied customers
Customers who come to you looking for a certain product but instead find some other product that they do not want will eventually be dissatisfied and go to a competitor. If this happens too often, you could lose your customers permanently to someone else.
5. Product degradation or waste
If you have excess inventory of products that are perishable or which degrade quickly over time, you’ll have no choice but to throw the products out after their expiration date.
Not only will this be a complete loss, but you may even need to pay for the proper disposal of your products.
6. Product obsolescence
A product that’s trendy or fashionable one day could very quickly become unfashionable the next.
So, if your business sells such products then you may find yourself with surplus merchandise that suddenly nobody wants to buy anymore.
Obsolescence is just as possible (and sometimes planned) with consumer high-tech products. If you are still carrying products with yesterday’s technology, you may soon have no one left to buy them.
7. Lower Profits
For all the reasons stated above, too much inventory can result in lower profits.
If holding excess inventory creates cash flow problems for you, you may need a larger line of credit. This will mean increased interest payments.
Extra storage and inventory holding costs means more expenses than anticipated, thus lowering profits.
Lower sales of products that are doing well also means lower profits.
And if you end up throwing away your excess products, either because they have degraded to the point that they cannot be used or because they are so obsolete that no one will buy them, then you will need to absorb a complete loss on these products with a significant negative impact on your profits.
Summary
A small quantity of surplus inventory can be a good buffer in case of higher-than-expected sales volume. It can also give you some peace of mind.
But too much inventory can be bad for your business.
It’ll restrict your free cash flow, eat up your working capital, increase your storage costs, make you lose sales, lower your profits and leave a trail of disappointed customers.
So, keep an eye on your inventory levels and take immediate corrective action the moment you discover that your inventory levels are higher than they should be.