Study the balance sheet of most retail or manufacturing businesses, and you’ll find inventory near the top of the asset list. Accountants define inventory as raw materials, supplies, work in progress, and finished goods. It’s the stuff sitting on shelves, parked in the lot, or being produced in the factory — merchandise that managers expect to sell in the normal course of business. Buying, storing, handling, and insuring that stuff is expensive. As a high-value asset, inventory often represents a significant risk, and mitigating that risk is crucial to maintaining profitability.
To reduce inventory risk in your business, consider the following:
- Too many or too few goods. Nothing beats a comprehensive and consistently applied inventory tracking system for making sure you don’t overbuy from vendors or underestimate the needs of your customers. The best information systems will capture detailed sales histories and forecast demand with reasonable precision. In addition, regular contact with customers may help to identify emerging demand or dissatisfaction with existing products. These conversations, in turn, can influence your inventory purchase decisions.
- Obsolescence. Most inventory declines in value over time. To mitigate this risk, a manager should track revenue data and regularly move inventory via special promotions, discounting, and sales. Paying to hold and insure obsolete merchandise drains profits. Make room for fresh inventory by creatively moving the inventory that’s already on your shelves.
- Damage. Managers should identify the causes behind frequent damage. Perhaps employees need better training in handling goods; perhaps more stringent policies need to be set. Some clothing retailers, for example, limit the number of boxes that can be stacked on pallets. Maybe the company’s packaging is not sturdy enough, or a change of suppliers is warranted. Knowing why your inventory is being broken is the first step to reducing that risk.
- Theft. Establishing physical safeguards — locks, lighting, fences, cameras, and the like — can help protect merchandise, whether it’s housed in the store or warehouse. Taking time to perform thorough background checks on employees may also reduce fraud risk. Hiring an independent auditor to review inventory levels is often a good preventive control, a control that sometimes ferrets out theft. If employees know that management routinely checks the company books and counts inventory, they may be less likely to shuffle goods from the warehouse to their homes or engage in “creative” accounting.