What Effect Will Inventory Increase Have on a Company?
A company’s inventory is the stock it keeps on hand to fill customer orders. A grocery store, for example, keeps a large amount of inventory on its shelves. Two basic inventory-related costs exist: carrying costs and ordering costs. Increasing inventory affects both types of costs, but it also might affect sales and profitability.
When inventory increases, carrying costs increase. Carrying costs include all the expenses associated with storing the inventory. Depending on the type of company, these might include rent, insurance, security expenses, utility bills, refrigeration and any other maintenance- or storage-related expenses. Essentially, the more items a company must store, the greater the carrying costs.
Ordering costs might decrease when inventory increases, depending on the situation. Ordering costs relate to the tasks involved with buying new inventory, for example, making phone calls, filling out order forms and other clerical processes. Ordering a large amount of inventory at once minimizes ordering costs because fewer ordering events means less money is spent. Decreasing inventory, on the other hand, increases ordering costs because a company must pay for multiple ordering processes.
Buying in bulk might increase inventory-related costs, but if a bulk discount lowers the cost-per-unit of the product, each sale will have a higher profit margin. For example, if a bulk discount allows a company to pay a dollar less for each product, but the price to customers remains the same, the company will earn a dollar more per sale than before. Or the company could lower its prices to become more competitive without sacrificing profitability.
Increasing a company’s inventory might also increase sales, according to the book “Financial Management: Principles and Practice,” by Timothy J. Gallagher and Joseph D. Andrew. For example, a stock-out occurs whenever a customer places an order, but due to lack of inventory, the company can’t fill the order. A popular size or model, for instance, might sell out quickly if inventory is kept low. Increasing inventory allows the company to fill more customer orders on the spot, so it decreases stock-outs and increases sales. Another way an increased inventory can increase sales is to make the items more visible to customers. For example, the product packaging itself might be attractive to customers, so stocking shelves might be an effective way to generate more sales.
There’s no simple recipe to finding the right inventory level. Every company has to manage its inventory carefully to find the perfect balance between maximizing sales and minimizing expenses. Typically, companies aim to lower carrying costs by decreasing inventory to the minimum level necessary to meet customer orders. But that approach maximizes ordering costs and might cause the company to miss out on increased sales due to increased inventory. Every situation is different, but by carefully comparing the various inventory-related costs to sales, a company can find a workable balance.