The disadvantages of holding excess inventory

Written by kathy adams mcintosh
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For many companies, inventory represents one of the largest assets held by the company. Companies need inventory to sell to customers or to manufacture finished products to sell to customers. The advantages of holding excess inventory include eliminating the risk of stockouts and dissatisfied customers. These companies also need to consider the disadvantages of holding excess inventory.

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Storage Capacity

One disadvantage of holding excess inventory pertains to the reduced storage capacity available. Any inventory maintained on the warehouse shelves reduces the company's ability to purchase additional inventory or store additional finished products. If a vendor offers a deep discount for an immediate purchase, the company might have to pass on the opportunity due to the limited space available. If the company continues manufacturing finished goods or receiving new inventory shipments, it might have to lease additional storage space in order to warehouse the inventory.

Carrying Costs

Holding inventory requires the company to pay carrying costs. Carrying costs refer to the additional costs incurred when a company holds inventory; they include storage costs, insurance on the inventory items and interest charges incurred while holding the items. Carrying costs also include the additional labour costs incurred for the employees working to manage the additional inventory. The additional carrying costs incurred from holding excessive inventory represent another disadvantage for the company.

Obsolescence Risk

Excessive inventory tends to turn over less and remain in inventory longer than lower inventory levels. The longer the inventory remains in the warehouse, the more the company runs the risk of the inventory becoming obsolete. Inventory becomes obsolete when other products hit the market that fill the same need more efficiently or at less cost. Inventory items that become obsolete become unsalable at their current pricing and require the company to sell the item at a deep discount.

Cost of Capital

Companies incur capital costs when they finance their business through borrowed funds. The financing includes the purchase of inventory. The inventory sitting in the warehouse incurs the financing costs, such as interest, until it sells. The longer the items sit in inventory, the more financing costs the inventory incurs. The company also needs to forgo other investment opportunities while holding the excess inventory. In these cases, the money the company could have used to finance the investment opportunity was used to purchase inventory.

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