Most business owners know that too much inventory on hand is a losing proposition, especially if that inventory has a low inventory turnover rate. And when a company’s inventory sits on shelves for too long, it can waste costly storage space and ties up cash that could’ve been better spent elsewhere.
What’s worse, the inventory could expire, become damaged, or even grow useless. In inventory management, this is known as inventory obsolescence. This article will define obsolete inventory and help you understand how to reduce your risk of obsolescence and handle inventory that’s grown too outdated to sell.
What is inventory obsolescence?
Inventory obsolescence occurs when a company determines that certain products can no longer be used or sold because demand is so low. Once an item reaches the end of its product lifecycle and a company feels certain that it will never be used or sold, a business will usually write down or write off that inventory as a loss.
Obsolete inventory can cause massive profit losses for businesses, but it’s a risk that can always be mitigated to some extent.
How does inventory obsolescence happen?
Businesses don’t set out to purchase inventory they know will become obsolete. Rather, purchasing decisions and market conditions are what typically, inadvertently causes goods to become obsolete.
In general, a business has a supply of inventory on hand that’s ready to be consumed or sold. What inventory and how much are key inventory decisions, informed by demand forecasting. But factors like suboptimal inventory control, supply chain snags, and unexpected demand fluctuations can cause more products to sit on the shelves with little or no chance of selling.
At some point, usually during an end-of-year inventory audit, a business will realize that some inventory on their shelves will only sell at a discount—or has no value at all.
Which businesses are at highest risk of obsolescence?
Unfortunately, some industries are more likely to experience obsolete inventory than others. Industries at the highest risk of inventory obsolescence include:
- Technology manufacturers
- Clothing manufacturers and retailers
- Merchandisers and merchandise manufacturers, especially those sellers time-sensitive items tied to specific dates, events, or phenomena
These industries are at high risk of obsolescence because demand for them is often seasonal and/or trend based. However, many businesses will experience some degree of inventory obsolescence. The important thing is having a plan for obsolescence inventory and factoring it in as you plan for the upcoming year.
How to handle obsolete inventory
First, start by assessing the potential overall value of your obsolete inventory. You’ll need to determine whether the inventory you have on hand has any value at all. If it’s not truly obsolete, you might be able to sell it—although not at full price. Here are some options for dealing with obsolete inventory:
Sell inventory at a discount
Have you ever shopped for Halloween candy on November 1st or red roses on February 15th? You probably got quite a deal. That’s because these items have become obsolete. Demand for them has plummeted, sending their value to a fraction of what it was. But candy still tastes good, and roses are still pretty—leaving sellers in a position to still move the products, even for less than they had hoped.
You can think of some outdated inventory on your shelves in the same way. If a product is no longer in high demand but still has some value, there’s a good chance you can sell it. Try to determine a sale price that mitigates your losses. Sometimes, it’s even possible to cover your costs.
Flash sales, buy-one-get-one offers, and other promotions can also help your company move obsolete inventory before losing its value.
Another option for obsolete inventory: excess inventory bundling. During this process, you’ll identify slow-moving inventory that’s at risk of becoming obsolete soon. You can then bundle these products with best-sellers to get them off your balance sheet before value tanks.
Here’s an example. A grocery store purchased cases and cases of champagne in November and Decemeber, anticipating high demand for the bubbly drink throughout the holiday season. Demand, of course, peaked for champagne in the days leading up to New Year’s Eve. But the business knew that demand for champagne would plummet on January 1st.
Still, champagne retains some value, even in January. But to move the product faster and get more cash for it, the company decided to bundle the product with two best-selling wines, a red and a white. The store is able to charge more for the set once they add champagne—and customers continue to purchase the bundle. Best of all, the company is now covering its costs and has avoided a write-off altogether.
If you’ve determined there’s simply not enough demand to run a sale or bundle inventory, you might need to consider liquidation. Inventory liquidation is the process of selling off undesirable inventory at a significant discount in exchange for cash.
Unlike running a sale on bundling inventory, liquidation will not aim to cover costs. Instead, the goal of liquidation is to make a tiny dent in the losses.
While businesses will often liquidate all of their inventory before closing shop, a company can always consider liquidating a certain segment of their inventory that’s fallen into obsolescence. To liquidate inventory, you’ll want to work with a surplus reseller specializing in moving “unwanted” inventory.
Write off inventory
Ultimately, your inventory may have become so obsolete that there’s no demand for it whatsoever. If even a highly-experienced liquidator refuses your inventory, writing off the obsolete products may be your best bet.
How to write off obsolete inventory
Writing off inventory is a complicated accounting process with tax implications that should be performed with the help of an experienced accountant. That said, the general process of calculating a potential write-off is simple enough to understand.
To “write off” the cost of zero-value stock, you’ll need to do some math. While it would be great to write off the entire cost of purchasing the inventory, this is not always the amount you may deduct. Instead, you’ll want to determine:
- The “cost” of the inventory (COGS—even though you never sold it)
- The amount of cash you could sell this inventory for (it’s possible this amount is zero)
Now, subtract the “cash value” of the inventory from the COGS. It should approximately equal your write-off amount. Note that the true write-off occurs only when you dispose of the inventory.
How to prevent obsolescence
While you can always try to recoup some of your obsolete inventory costs, it’s still a losing proposition. And while some inventory obsolescence is simply the cost of doing business, there’s plenty your company can do to reduce that risk.
Here are a few ways to reduce inventory obsolescence:
Improve demand forecasting
The simplest way to avoid obsolete inventory? Optimize how you forecast demand. By choosing a more accurate way to predict demand, you could save your business time, stress, and money.
You can learn more about the different ways to forecast demand in our easy guide.
Audit inventory more frequently
You can also reduce inventory obsolescence by physically auditing your inventory more frequently. A year-end inventory count will help you discover obsolescence, but by reviewing inventory monthly or quarterly, you can identify stock at risk of becoming obsolete before it’s too late. Then, you can minimize profit loss by running a sale, bundling products, or even reaching out to a liquidator while the inventory has some value.
Frequent physical audits are also an excellent opportunity to adjust upcoming orders.
If your company cannot audit everything more than once a year, perform inventory cycle counts on items at highest risk of obsolescence.
Switch to inventory management software
Finally, another way to prevent inventory obsolescence is to optimize your entire inventory management strategy. By switching to inventory management software, your business can automate every aspect of tracking inventory.
This means you’ll always know what you’ve got in stock and where it is, even if you stock inventory across multiple locations. This should help your team order confidently, practice tighter inventory control, and quickly estimate the value of inventory you have on hand.
Plus, visual inventory systems like Sortly allow you to see what you have on hand—an extra helpful tool when determining whether certain items are at risk of becoming obsolete.
Experience the simplest inventory management software.
Sortly is a top-rated inventory management software system designed to help your business avoid inventory obsolescence. With Sortly, it’s easy to keep track of every single item you have on hand, so you’ll never be surprised by what you find during an end-of-year inventory count.
Plus, Sortly’s data-rich, customized reporting can help you improve your demand forecasting—a key factor in reducing obsolescence.
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