Aging inventory: risks, solutions and tips to avoid them in the first place
Some things get better with age. Your inventory is not one of them.
What is aging inventory and why does it matter?
As a business owner, striking the balance when it comes to inventory is important. Place too little of an order for your products and you risk the chance of a stockout, resulting in lost momentum for your sales and disappointed customers moving to your competitors. However, if you order in excess, there’s a high chance you may find yourself struggling to sell all of them and dealing with a case of aging inventory.
Aging inventory, also called slow-moving inventory, includes all the items that have been sitting around in your warehouse for months.These items are not generating the profits you expected due to their slow or no movement.
Ideally, non-perishable inventory is distributed or sold somewhere between one week up to 90 days from the receiving date. Of course, if your business deals with perishable goods, their shelf life is even shorter. When an item reaches 180 days old in your warehouse, it is considered dead. Dead stock represents irrecoverable lost capital and refers to inventory that has become obsolete and is no longer sellable.
But what about the period in between?
That’s where the parameters of aging inventory comes in, which is 60 up to 180 days from its receiving date. Unlike dead stocks, it’s not too late to do something about these items. However, allowing your inventory to age does come with certain risks, as will be discussed in the section below.
The risks of carrying aging inventory
It takes up warehouse space
Having pallets of aging stock can easily clutter up your warehouse and limit your restocking capacity. Every aging product that is sitting on your shelf, no matter how big or small, takes up valuable space that could have been allocated towards new or better-selling items that generate revenue for your business.
It restrains your cash flow
Ideally, the life cycle of your stocks should move on a first in, first out (FIFO) basis, looking something like this: Acquire, store, distribute, and acquire again. The FIFO method operates on the reasoning that inventory has a shelf life and will either expire, especially if the products are consumable, or become obsolete due to loss of value. Thus, adapting a FIFO approach contributes to the reduction of aging inventory since the oldest goods get shipped out to customers first.
However, aging inventory can throw a wrench in this process by restraining your cash flow. Instead of your working capital going towards developing new products, increasing manpower or acquiring fast-moving goods, aging inventory can increase your holding costs and result in higher labor and insurance charges.
It depreciates in value
The longer your inventory sits around your warehouse, the more difficult it becomes to sell. In addition, the chances of it being sold at the full retail price grows slimmer and slimmer by the day.
The solutions
As previously mentioned, not all aging stock results in a complete loss. Here are a few strategies that may help your business free up space and recover what you spent to acquire them in the first place.
Sales, clearances, and bundles
Having aging inventory may be an indicator that you need to rethink your promotions.
Sales, clearances and bundles are great opportunities to clear out your aging stock. Take advantage of the holidays and occasions such as back to school, the start of summer or Christmas among others to highlight the relevance of your items.
Another route is to bundle your best sellers and slow moving items together or attach steep clearance price drops to stocks that are nearing the end of their lifetime. If your business has a rewards or cashback system in place, try attaching double the reward points to your slow moving goods to make them more appealing to your customers.
Switch up your marketing and promotions
Aside from in-store promotions, pursuing new marketing initiatives can also aid in getting rid of aging inventory. One common initiative is running competitions directed towards goals outside of sales.
For example, you can run a social media contest with a selection of your aging stocks as the prize. If you make following the page and liking and sharing the post a parameter of the game, then you have an opportunity to boost your online presence on top of getting rid of your aging stocks.
If you want to build your brand’s database of ambassadors and influencers, you can also add your aging stock into a press or PR kit together with some of your brand’s essentials and send them out to your leads.
Liquidation
Finally, if purchasing external space isn’t an option, the promotions and bundles aren’t working, and your marketing initiatives don’t seem to resonate with your customers, there’s always the option to liquidate.
Liquidation is the process of converting your assets into cash. In this case, those assets are your slow-moving goods. Selling your items to a liquidation company is one way of clearing up your space and recovering revenue from your stocks that would have otherwise gone obsolete.
Tips to avoid having aging inventory in the first place
Use your inventory’s average age data to improve your demand forecasting
Knowledge of your stock’s average age helps you anticipate your customers’ demands, improving demand forecasting and future purchasing decisions.
Get to the bottom of your low sales volume
Once you are able to identify the goods that are not selling as fast as you expected, you can move onto identifying the reasons why.
Are certain items seasonal, selling better during summer or rainy days? Perhaps your product is getting lost in all your SKUs and you need to improve their website or eCommerce placement? Trends caused by the media are also powerful swayers of customer demand.
Understanding why items aren’t moving as fast as you want them to allows you to align your current marketing initiatives and purchasing decisions so you can get better results.
Inventory audits
Routine inventory audits ensure that all your stock is accounted for and existing financial records match what is physically available in your warehouse.
Financial and physical warehouse alignment gives insight into your stock flow, allowing you to smooth out any bumps in the process and increase the visibility of your items that may not be experiencing any movement.
There are multiple ways of going about your inventory auditing procedures such as physical inventory counting, high-value item inventory analysis, direct labor analysis, and more. However, there are a few key steps you may consider taking in order to produce a comprehensive report:
- Prioritize which items need auditing. Experts recommend that high-risk inventory items be audited more frequently.
- Create an inventory auditing schedule since it can potentially disrupt your day-to-day operations.
- Prepare the necessary documents such as inventory lists and financial statements ahead of time.
- Conduct, report, and condense the findings into a comprehensive and understandable report
By the end of your audit, you will have valuable data that can guide your budgeting and purchasing decisions, identify any inefficiencies in your stock keeping process, and account for the items that may be damaged, forgotten, or lost.
Inventory aging report
Also called an aged stock report or stock aging report, this is a financial report that provides insight into the average number of days your inventory has been sitting in your warehouse. Essentially, it reveals information about your business’ financial health. In addition, it allows you to pinpoint which items are slower-moving in comparison to others.
This report will guide your strategy moving forward through the following:
- Allows for a more accurate forecasting of your customers’ demand
- Results in better purchasing decisions
- Reduces your financial risk
- Minimizes your risk not only aging inventory but also dead stock
- Gives insight into your inventory turnover ratio
- Maximizes knowledge on storage costs and inventory control strategies through quantitative data
The inventory aging report can greatly benefit you and your business. However, there are a few key metrics and formulas you need to know.
The inventory formula cheat sheet
Average Inventory Cost
The average inventory cost formula is your business’ annual cost of goods divided by the total number of inventory you have on hand.
The formula looks something like this:
- Average Inventory Cost = Annual cost of goods/Total inventory on hand
Calculating for this metric gives you better insight into whether the amount of inventory your business is carrying is beneficial or detrimental to your net income. Furthermore, comparing average inventory costs between two different periods also helps you identify spikes and dips in your sales which may have been caused by shifts in the market, shipping costs, seasonal changes, and more.
Cost of Goods Sold (COGS)
The cost of goods sold tells you how much your products take to produce, taking into account direct expenses such as raw materials, supplies, and labor.
The formula is as follows:
- Cost of Goods Sold = (Beginning Inventory + Stock Purchases ) – Ending Inventory
The beginning inventory is what you already had at the start of the accounting period. Purchases account for the cost of additional stock you had to buy. Finally, the ending inventory is defined as whatever is left unsold.
Carrying Cost
Carrying cost is the total sum your business pays to keep products in stock. This covers everything from the rent of the warehouse and the labor of its employees, insurance of the inventory, and any losses or damages that might happen.
Carrying costs can be anywhere from 15% to 30% of the value of your company’s inventory. For the sake of your business’ profits, this metric shouldn’t exceed 30%.
The formula is as follows:
- Carrying Cost = Inventory holding sum / Stock value x 100
What this figure tells you is how long you can keep certain items in stock before they start being unsellable and lead you to losses. In addition, understanding the cost of the inventory you have helps you make more data-driven decisions regarding ideal inventory levels and while also informing your long-term inventory planning.
Days to Sell Inventory (DSI)
The days to sell inventory also called the days sales of inventory (DSI) is a straightforward financial metric that tells you how much time it takes your business to convert inventory to sales. It helps you keep track of the speed in which your stock moves through your business.
The formula is as follows:
- Days Sales of Inventory = (Average Inventory/Cost of Goods Sold) x 365
The general principle is the lower the average number of days, the better. This means that your inventory generally does not sit around in your warehouse for an extended period of time. Businesses can use this metric to set the necessary changes that will increase liquidity and decrease holding costs.
Sell-through Rate
The sell-through rate is the total amount of inventory that has been sold to your customers over a certain period of time. It is a strong indicator of your inventory management, giving you insight into the profitability of your goods.
The formula is as follows:
- Sell-through Rate = (Number of Units Sold/Number of Units Received) x 100
The average sell-through rate is anywhere upwards of 40%, with 80% being the desired percentage. Understanding the importance of this metric is key to accurately planning and predicting how much stock your business will need and how you can go about improving your sales performance.
Inventory Turnover Ratio
The inventory turnover ratio is the amount of stock that your business has sold, used, and replaced during a specific time period. It can also help you forecast the number of days it will take for your remaining inventory to sell.
The formula is as follows:
- Inventory Turnover Ratio = Cost of Goods Sold/Average Inventory Cost
The general rule of thumb is the higher the ratio, the better. A low ratio may be an indicator of overstocking or weak sales.
Tracking this metric helps you evaluate whether your business is effectively managing your assets. This will also guide you in making better decisions, ranging from purchasing to pricing.
Managing your aging inventory
Keeping track of your business’ aging inventory helps you minimize your chances of having piles of obsolete stock and permanently losing your investment. To better manage your aging inventory, we encourage you to use the formulas we shared above so you can make data-driven decisions moving forward. You may also try applying the solutions we mentioned to help you generate sales from your aging inventory.
With the proper planning, more accurate forecasting of customer demand and a lot of creativity, avoiding having aging inventory and managing them is easier said and done.