When Does Slow Moving Inventory Become Dead Inventory?
What criteria are used to determine slow moving or dead inventory?
First one is gross profit. When looking to determine whether something is slow moving or obsolete, it’s best to first understand what the initial gross profit is of the product.
The gross profit calculation is simple. It’s the sale of the product minus the direct costs to make the sale, or COGS = Cost of Goods Sold. The Gross Profit Margin Calculation is (Sell Price – Costs)/Sell price. The “COGS” on a product would be the costs to buy (or make) the product, the freight to get that product into the warehouse (freight costs) and any additional surcharges relating to handling fees on freight. What’s not included in the Gross Profit calculation is the company’s salaries, taxes, and indirect costs of the business (electricity, rent, cost of office furniture). When thinking of gross profit, see it as what the company could make if it didn’t have to pay salaries, and other expenses. Net Profit is Gross Profit minus all those aforementioned salaries, taxes etc. So, keep it simple to the product’s current gross profit value.
When it comes to determining what reduces the product’s gross profit over time, the key word itself is “time”. Since most companies use business loans or credit lines to finance the purchase of their inventory, there is a daily cost of money that plays a role in the gradual decline in the product’s gross profit. That business loan or credit line has a yearly interest rate that the company must pay. That yearly rate can be broken down into a monthly and daily interest rate. It’s that daily interest rate that erodes the gross profit on a product every day it isn’t sold, but there’s more. Most companies apply a monthly inventory cost of 3% on their inventory’s value. This 3% is made up of a number of factors – including the aforementioned daily cost of money. This 3% is essentially the costs to manage inventory monthly.
It’s the last question of seasonality & margin percentage that often decides when a product moves from slow moving to dead stock. In some industries the margins are razor thin. This means the products must have a high inventory turn over rate – be sold as soon as it’s brought in.
Ever notice how the biggest and best sales for clothes are at the end of season? Why is that? It’s because if that inventory isn’t sold at the end of season, it quickly becomes so useless that it can only be sold until the following year – if and only if it’s held that long and most stores dump their dead inventory with as much incentive to get consumers to buy as possible.
When looking to determine whether your inventory is slow moving or on a path to becoming dead stock, be sure to understand your company’s inventory turnover rate on those products. If the inventory turnover rate (the rate at which inventory is purchased and sold) is about 2 weeks and then you suddenly find it staying in your inventory for 1 to 2 months, then it’s a sure bet it’s slow moving.
Understand your gross profit and gross profit margins, your inventory cost structure and the seasonality of your products (if there is one). Also, be sure to incentivize customer sales when that inventory becomes slow moving. It will reduce the costs of holding inventory for too long.