Most small business owners understand that inventory is an asset, but few understand what role the daily cost of money plays in reducing the value of that asset over time. Small business owners need inventory to sell in order to meet customer demands, improve customer loyalty and capture sales. While it’s understood that inventory is an important part of business success, a number of small business owners often become too attached to their inventory. What does this mean? Simply put, a number of small business owners are reluctant to do what it takes to liquidate slow moving product. They retain original values to the inventory regardless of how long it’s held and rarely take the time to understand how the cost of money reduces the value of that inventory over time. Instead, they see the value of the inventory as constant and are therefore unable to reconcile selling the inventory for lower than its original cost. What they lack is an understanding of how the cost of money reduces that value. So, what is the cost of money and how does it reduce the value of inventory?
The Cost of Money Plays an Important Role in Inventory Value
Most businesses finance their inventory with loans or credit lines. Like any loan, business loans have a yearly interest rate that borrowers must pay for being able to draw upon cash reserves. When it comes to understanding the daily cost of money, it amounts to taking this yearly interest rate and dividing it by the 365 days in year. Doing this will provide businesses with their daily interest rate. Since inventory is financed through this daily interest rate, every day inventory is held and not sold is a direct cost of inventory. Hold onto inventory for too long and the costs simply add up. When looking at your inventory, ask yourself the following questions.
- What is my yearly interest rate on business loans and credit lines?
- What is my daily interest rate and cost of money?
- How much of my inventory is slow moving?
- What is the daily cost of not selling that slow moving inventory?
When looking at your inventory, understand that its value changes over time. It can never retain its original value. When thinking about slow moving inventory, think about how retailers immediately liquidate their inventory at the end of a given season. If they don’t, they’ll retain that inventory for too long and its value will eventually erode to an even bigger loss.