How To Calculate Excess Inventory?
Updated: Aug 13
A crucial part of calculating excess inventory is finding the inventory turnover ratio. The inventory turnover ratio shows which items harm cash flow and profits by incurring unnecessary costs.
This procedure always tabs old inventory in a whole stock. It can also find which slow-moving products are causing losses.
To do this, find the total amount sold in the old inventory. Then, divide it by the average inventory of the specific product or products in the store. You can always use this basic idea to determine the inventory turnover ratio first. Opt for inventory software over manual item counting at this stage.
Quantify the total product sales from inventory program records and receipts. After that, divide the amount by the initial cost of the product in question. The tool generates the Ratio, freeing us from time-consuming. The performance will improve once the Ratio is higher, and we don't have to worry about it.
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What Is Excess Inventory?
The definition of excess inventory varies based on industry and product type. High-volume, low-margin businesses, like discount stores, can't hold excess inventory. It's costly if it's held too long. Luxury retailers may afford to keep expensive items in stock for a long time.
Seasonality also plays a role. A sports store might carry skis all summer without selling any. But, if those skis remain unsold during the winter, they become excess inventory.
Calculating Excess Inventory
Accurate calculation of excess inventory is essential for effective inventory management. It involves evaluating the excess stock's monetary value and understanding its impact on business operations. Here's a detailed approach to determining excess inventory:
Key Factors to Consider
1. Monetary Value: Determine the net value of excess inventory. Here are two methods:
Option 1: Using Inventory Management Software:
Set a Threshold: Establish a time frame, such as three months, to determine which items are considered excess. This threshold helps identify inventory that has not moved within this period.
Sort Inventory: Utilize inventory management software to categorize and analyze your stock based on the set threshold. The software will help you sort through your inventory records to identify items in your warehouse or store for a specified duration.
Calculate Value: After you've specified the excess inventory, total its value. This figure represents the amount of capital invested in a stock that is not generating sales, helping you understand the financial implications of your excess inventory.
Option 2: Using Accounting Software:
Compile Purchase Data: Create a detailed list of products purchased for resale over the last three months. This list should include quantities and costs associated with each item.
Subtract Sales: Determine the value of products sold during the same period. Subtract this value from the total purchased inventory value. The resulting figure represents your excess inventory. This approach is helpful if you still need specialized inventory management software but need a clear picture of your excess stock.
2. Lost Sales: Excess inventory can lead to understocking issues. When certain items remain unsold for too long, it can result in stockouts of other products, causing missed sales opportunities and unfulfilled customer orders. This not only affects revenue but can also damage customer satisfaction and loyalty.
3. Costs: Maintaining excess inventory incurs additional costs. These include storage fees, insurance, and potential obsolescence. Moreover, capital tied up in unsold inventory could be better invested in other business areas. Managing excess inventory effectively can minimize these costs and improve financial efficiency.
Formula to Calculate Excess Inventory:
Inventory Turnover Ratio = (Cost of Goods Sold) / (Average Inventory Value)
Example:
In the first 6 months of 2018, I sold different brands of diapers in my store. Each diaper cost me an average of 8 USD (regardless of the brand) while purchasing from my vendor. Total diapers sold totalled 48000 USD. At the beginning of the year, my inventory totalled 18,500 USD for the entire store. By the end of the six months, my inventory totalled 11,300 USD. Therefore, to calculate my excess inventory turnover ratio, simply added the opening and closing inventory for the diapers and divided them by two
[18,500+11,300]/2= $14,900.
Inventory turnover ratio= $48,000/$14,900=3.22
This means that during the six months, I sold the diapers on average three times. This means that I have a lot of excess inventory that I would have to sell at a low price to avoid incurring losses.
Measuring Excess Inventory's Impact
Utilizing specific metrics is essential to effectively managing excess inventory and understanding its impact on your business. One of the most insightful metrics for this purpose is the Inventory Turnover Ratio. This Ratio helps evaluate how efficiently inventory is being sold and replaced over a certain period. A higher Inventory Turnover Ratio indicates that inventory moves more quickly, suggesting less excess stock.
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Seasonal Consideration For Calculating Overstock
Make sure to distinguish seasonal items from products that sell well year-round. Consider adding to your holiday marketing/promotion strategy points to monitor sales velocity and if discounts are appropriate. You can also add to your plan an extensive promotion immediately following a holiday or peak season to connect with bargain hunters looking to help you liquidate inventory.
When looking at how many units of seasonal products to liquidate, look at when peak season is and how far away that is. If you are on overstock for the first time or the first time in a while, be careful not to liquidate too close to when you'll have those products again. If you are only four to six weeks away from the beginning of holiday sales, consider holding onto that overstock to promote during peak times.
Conclusion
Mastering inventory control ensures strong cash flow and profitability. Businesses can identify slow-moving products by calculating the inventory turnover ratio, which can hurt their finances. This process involves using inventory management software to streamline calculations and cut labor. Also, excess inventory has different definitions based on industry and product type. It is key for accurate assessment. High-volume, low-margin businesses must refrain from excess inventory. High-end retailers may adopt a distinct approach.
When calculating excess inventory, consider its value and business impact. Inventory or accounting software can find the net value of excess inventory. We must know the costs and lost sales from understocking to assess the impact on business. A higher inventory turnover ratio signifies better inventory management and fewer excess goods. For businesses looking to optimize their inventory, Dynamic Distributors offers solutions to buy or sell excess inventory, ensuring you keep your operations efficient and profitable.
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