Excess Inventory: What it is & How to Profit
If you run a small business, you may be able to meet your inventory needs with QuickBooks’ Excel Inventory Template. By using this template, you can track products and raw materials by quantity and unit price. For a cupcake-making business, this would be the baked and iced cupcakes on display for sale. For a business that buys products from a supplier, finished goods are all items that have been quality-checked and are available for sale.
Lack of supply chain data
Obsolete inventory refers to a product that has reached the end of its lifecycle. It happens when a business considers it to be no longer sellable or usable and most likely will not sell in the future due to a lack of market value and demand. Usually, inventory items become obsolete stock after a certain time period has passed and after they reach the end of their lifecycle. Obsolete inventory is any excess products or stock a small business has and doesn’t expect will sell, usually due to lack of demand. Also known as dead inventory, obsolete inventory is at the end of its product life cycle—often because it has been replaced in the market by newer, updated versions of the product. A small business that has a great deal of obsolete inventory should reevaluate their inventory management systems, forecasting, and the quality of their products.
Demand planning
Your best bet for reducing excess inventory is removing the possibility of human error in your ordering and planning process through inventory optimization. The best thing you can do is avoid what is bad inventory called excess inventory in the first place (you can do this with an ops optimization tool like Cogsy). After all, the more stock you have on hand, the harder it is to sell or give it away.
WMS = Warehouse management system
Once a sale is made, the item is shipped to the customer directly from the source, and the profit is split between you and the product owner. In this method, you would record a journal entry with a credit to a contra-asset account, such as an allowance for obsolete inventory. The company would then make an offsetting debit to an inventory write-off expense account. One way is to use an inventory management system that helps track inventory throughout its lifecycle. This way, you have data to calculate inventory days on hand and inventory turnover rate, which are key inventory metrics to track. Examples of expense accounts include cost of goods sold, inventory obsolescence accounts, and loss on inventory write-down.
Depreciation and obsolescence
As I mentioned earlier, when excess inventory finally sells, it’s at a loss (or, at minimum, much lower profit margins). With excess inventory, you run a better chance of getting a product into your customers’ hands faster, leading to higher customer satisfaction. If you don’t know your turnover rate, you’ll likely only discover an excess inventory problem after diving deep into your inventory data. Because of the untidy data issues outlined above and without the right tools to help, conducting inventory audits is so time-consuming that it doesn’t seem worth it.
- Having robust inventory management softwarecan help you track inventory, predict future selling trends, and identify slow-moving items before you put in your next repurchasing order.
- However, if you’re writing off large dollar amounts of inventory, it has to be disclosed on your income statement.
- Ideally, you want to keep enough inventory on hand to meet customer demand.
- In order to comply with generally accepted accounting principles (GAAP), businesses must follow the inventory write-down process in their bookkeeping when their inventory’s value is reduced.
- You need as much capital available as possible at any given time because that’s actual business security — not a full warehouse.
- This is useful in preserving the historical cost in the original inventory account.
This reduction in assets can affect various financial ratios such as the current ratio and inventory turnover ratio. This can be really important to companies that must meet debt covenants or other reporting metrics for obligations. The decline in inventory value also reduces the overall book value of the company.
Understanding Obsolete Inventory
Raw materials, work in progress and finished goods are the three main types of inventory that are factored into a business’s financial accounts. That’s why tracking metrics like your inventory turnover is important for finding the right balance. Limited visibility into real-time stock levels, making it challenging to respond quickly to demand fluctuations or stockouts.
- Obsolete inventory doesn’t just collect dust in a forgotten corner of the warehouse—it also has a negative impact on a company’s bottom line.
- This indicates that your shipment is smaller than an ocean freight container.
- But it’s also very expensive since you have to invest in (and maintain) machines that can access every part of your warehouse.
- Debit your Raw Materials Inventory account to show an increase in inventory.
One common challenge in inventory management is dealing with the fluctuation of customer demand. Businesses often face the dilemma of unpredictable shifts in the market, leading to overstocking or stockouts. A business will record a credit to the inventory asset account and a debit to the expense account using the direct write-off method.