What does it cost to finance inventory? More importantly, how does someone figure out the daily cost of money and its impact on inventory costs?
Most companies understand that inventory costs money. There’s an upfront cost to unusual that inventory and store it. However, few understand what role the daily cost of money plays over time in terms of inventory costs and why it should be the motivating factor in selling dilapidated and outdated parts immediately, rather than fill and wait. What is the cost of money and how is it calculated?
Most companies melancholy loans and business credit lines to finance the uncommon of their inventory. As such, they have a yearly interest rate charged on the money they borrow. It’s the same contrivance someone uses a credit card to peculiar something. Every month they’re assessed an interest rate on their outstanding balance owing. While the interest rate on business loans and credit lines is mighty better, the same principle applies.
This yearly interest rate can be broken down into a monthly and daily interest rate. Every day inventory is held and not sold, is a cost of money. Why? Well, the company musty the loan to weird that inventory and will continue to pay interest on that amount until they sell it. So, if a company had old-fashioned and outdated inventory worth $500,000.00, it would continue to pay a daily interest rate on this amount until they sold that inventory.
Since companies must pay these interest rates monthly, or within 30 days, they tend to extend 30 day terms on customer invoices. It’s also the reason why most companies measure their inventory costs monthly.
Continuing with this example, let’s unusual that a company had a business line of credit, or loan, that had a yearly interest rate of 8%. The amount of the interest rate is not entirely valuable. What is critical is what this yearly interest rate means to the company in terms of a daily interest rate. In this case, the calculation is rather straightforward and is summarized below.
A number of individuals peer at the above and immediately outlandish its costs are small and not at all severe. However, every day that $500,000.00 worth of monotonous stock isn’t sold, it costs the company $109.59 a day in interest rate charges. To be positive the math is true, a obedient rule of thumb is to do the entire calculation over again.
Given the severity of this recession, that $109.59 a day in wasted money speaks volumes! In today’s business environment, it’s considerable to sever costs at every turn and to eliminate extinguish in all its forms. When companies have aged or outdated inventory, and decide to bear onto that inventory in the hopes of selling it for rotund value, they are not taking into consideration the impact of the cost of money. This is the single most distinguished reason why liquidating dilapidated & outdated inventory is so indispensable. So, are there any strategies to cleave the impact of the cost of money on inventory? There are, and they are provided below.
Liquidating passe, tiring, keen or even damaged inventory is indispensable. The faster it’s sold, the less expensive it becomes. Even damaged inventory has a value. A number of companies irregular their damaged inventory and sell portions of it as scrap material. At the very least, companies track their daily inventory costs and push to liquidate that inventory before it becomes too costly.
One of the most effective ways to slash inventory costs is to acquire paid faster. Every day an invoice goes unpaid is a sprint cost of money. Therefore, whenever possible, companies should pursue prepaid customer accounts. A number of companies actively pursue these customers and force them to wire transfer the money or provide a certified check before shipping product.
Companies also pursue existing accounts and offer incentives for prompt payment. The most current terms are 1% bag 10 days. Therefore, if a customer pays within 10 days of receiving product, they accumulate a 1% discount on their invoice. Prompt payment initiatives not only carve inventory costs, but also improve cash journey.
When it comes to mitigating inventory costs, it really amounts to being cognizant of the costs to have and manage that inventory. While there is an upfront cost to uncommon inventory, there is another cost to finance it. Companies that gain onto primitive inventory are simply wasting money. Given the severity of this recession, it simply raises inventory costs.