Leveraging Inventory Cost Management to Improve Profitability | Bennett Thrasher Skip to main content

For many manufacturing firms, balancing inventory costs is vital to the company’s success. However, it can be a guessing game that is difficult to predict. Playing a vital role in successfully managing growth through the company’s business strategy, sustainable inventory cost management requires an effective system. With a high-quality inventory management system in place, it’s much easier to capture the appropriate costs and overhead expenses so that you’re able to implement sales and pricing strategies that improve profitability and growth.

Finding a Balance in Inventory and Sales

Much like checking an account balance, inventory is considered an asset on a company’s balance sheet. However, inventory can also become a liability because it doesn’t always have outstanding liquidity. With too much inventory on hand in the warehouse, purchasing flexibility will become reduced, including when the company wants to adapt to market demand shifts, keep ahead of competition, increase business profitability or purchase and use new or better products. On the opposite side, maintaining insufficient inventory can lead to supply chain issues, customer dissatisfaction, loss of customers and lowered profitability. For this reason, it’s of vital importance that manufacturers create a balance between what will sell and what’s on hand to create new products to replace sold units.

Inventory Data Collection

Collecting data from both current inventory on hand and inventory expenses as well as supply chain and market demand is vital if you want to leverage an inventory cost management process to the maximum. It’s for this reason that understanding what those insights mean will help you develop better business strategies and make improved company decisions.

Start by analyzing the data for inventory on hand. This prevents you from accumulating carrying costs that are associated with obsolescence, while making it easier for you to manage storage and materials handling expenses, which are usually tied to warehousing and moving of inventory. Understanding the details regarding what inventory you have on hand also helps you avoid fraud and theft issues. When you analyze sales data, you can better align inventory with the current demand in the market. This ensures that the company is able to meet customers’ demands by providing timely delivery of goods and services and avoiding overextending of costs.

By performing regular assessments of vendors, you’ll be able to gain insights to help you avoid potential supply chain issues and place orders in a timely manner. Additionally, in conjunction with inventory expense data, the information that you gather makes it easier to forecast future cost, produce more accurate revenue projections and track the company’s performance in these areas.

Inventory Data Analysis

There are several types of data analysis you can perform on inventory, but we will focus on the ones that are used by the vast majority of manufacturers:

  • Margin analysis allows manufacturers to determine each product’s margins by compiling all the associated product costs then subtracting those expenses from the revenue the product generates. By comparing actual supplies, labor and overhead expenses that take place against the budget estimates, variance analysis can be used by manufacturers to determine the cause behind any discrepancies.
  • ABC analysis makes it easier to reduce excess, prioritize items impacting inventory cost and manage shortages. The analysis is calculated by multiplying the cost per unit by the number sold annually to determine annual usage value. Next, calculate cumulative products sold percentage versus the annual consumption value. This allows you to categorize inventory based on data:
    • “A” represents the smallest category with the highest valued products accounting for the bulk of the company’s revenue – usually 80 percent.
    • “B” is the middle-of-the-road category, with products of moderate value and revenue generation – usually 15 percent.
    • “C” is the largest products by volume that generate the least total revenue – usually 5 percent.

Because each manufacturer is different, you may see shifts. Inventory needs may differ between locations. Analysis may need to be disaggregated by location or similar factor. The 80/20 rule is the primary principle in ABC Analysis, where 80 percent of total output will be generated by 20 percent of the input. Prioritizing products in group “A” will allow you to focus on the smallest number of products to generate the largest return. This is why ABC Analysis can help you keep the right products in stock to meet demand while eliminating excess inventory and managing expenses.

Considering Inventory Levels and Tax Strategy

As part of the company’s overall tax and accounting strategy, how you manage inventory can have a big impact on your company’s tax liability at the end of the fiscal year. With the global supply chain crisis, many manufacturing firms must weigh the option of having too much inventory on hand versus the potential tax impact of such inventory.

Learn More

At Bennett Thrasher, we have specialists in the manufacturing sector who can help you understand what your options are so that you can leverage any opportunities that come along, allowing you to avoid risk, increase profitability and improve operations. If you have questions or would like additional information, please contact Aaron Epp or David Kloess by emailing bennett-thrasher@btcpa.net.