Unfortunately, inventory write-offs are an inevitable part – and cost – of doing business. When, for various reasons, inventory doesn’t sell as well as expected and loses market value, a business must report the loss as an “inventory write-off” which goes onto the balance sheet and income statement.
In the current economic climate, with the rising cost of doing business, you’ll want to reduce your costs as much as possible. We look at the main causes of inventory write-offs, how your business can write them off and some strategies for keeping inventory write-offs to an absolute minimum.
What is an inventory write-off?
An inventory write-off happens when products that were intended to sell have lost all their value and can no longer be sold, resulting in what’s known as dead stock or obsolete inventory. There are several reasons why a business doesn’t sell all of its stock, which can include raw materials and components, as well as finished goods. In a fast-moving industry, products can go out of date quickly – for example with computers or mobile phones, fashions can change as in the case of clothing, and sportswear and most obviously, within the food business where perishable items simply go beyond their ‘sell by date’ and have to be thrown away as it’s illegal to sell them anymore.
Inventory or stock appears as an asset on a company’s balance sheet. When it’s decided that a piece of stock won’t sell, the company reduces the amount of its gross stock by the cost of that stock item. The company will also record an expense of equal amount on its income statement. If the expense is negligible, it can be recorded in the company’s cost of goods sold. However, a more substantial inventory write-off should be broken out as a separate item to make tracking losses easier and thus avoiding the risk of distorting the gross margin.
Inventory write-offs reduce a business’s assets, which means it also reduces the businesses overall value. As a write-off is an expense, the business’s net income will reduce by the same amount as the write-off.
How to reduce inventory write-offs
As write-offs lower a business’s net income and retained earnings, it’s important inventory is properly managed to keep track of products and ensure that they have not reduced in value or even become obsolete. In an ideal world, no inventory would ever be written-off, but back in the real world, the objective is to minimise how much inventory has to be written off. Here are some strategies to minimise inventory write-offs.
Don’t buy too much inventory
It seems obvious, but you should avoid overordering too much inventory. This may be based on past experience with a supplier or being too optimistic about market demand, but excess inventory ties up cash and adds to expenses if your sales don’t live up to expectations. It’s important to undertake an analysis of past sales and write-offs, cross referenced with current market and economic conditions before ordering inventory. In the current economic climate for example, supply chain issues are rife, the UK economy is fairly weak, with low predicted growth and consumers are facing a cost of living crisis. These factors will all impact on your decision making.
Re-evaluate purchase plans
Inventory write-offs may be reduced if a business places smaller, more frequent inventory orders. This is especially important for perishable items, but it’s also relevant for fast-moving industries such as technology. Ordering in smaller quantities also helps managers respond more quickly to changes in demand.
You must keep an eye on costs however, as placing smaller orders will inevitably lead to unit prices increasing as you won’t benefit from discounts through economies of scale. More frequent orders means more deliveries are required, with potential increases in shipping and warehousing staff costs. It’s also worth remembering that in inflationary environments, items can cost a lot more next week than they did this, leading to increased costs too.
Check inventory in
When stock arrives at the warehouse, it’s important to ensure that the right goods in the right amounts were actually delivered. Inventory should be thoroughly inspected for damage and those damages returned promptly. Regular checks must be carried out to ensure that inventory data matches the actual stock that’s held in inventory.
Protect your inventory against damage or theft
Proper storage, such as a dry location, chilled environment or shelving that keeps items out of harms way can safeguard inventory from becoming damaged or spoiled and therefore unsellable. Another good idea is to install smoke detectors and perhaps a fire sprinkler system. To prevent theft, consider securing valuable inventory items in secure areas protected with locks, security cameras and alarms.
Sell aging items at a discount
You should consider discounting items that have been in inventory too long, as it’s better to sell an item at a lower price than not to sell it at all. Another strategy is to offer older inventory items as a cheaper ‘add-on’ item or as a free gift with the purchase of a product with higher profit margin or that may be near its own end-of-life. These marketing strategies help shift stock as well as engendering customer satisfaction and loyalty.
Return items to the manufacturer or sell them to another business Try to sell aging inventory back to the manufacturer or to another business. They might have demand from other customers or be willing to purchase it at a discount.
Sell items for parts
Some types of inventory can be disassembled and sold for their parts or raw materials. In some cases, the parts that are sold individually can lead to your stock item being worth less than the sum of its parts. Some business models have thrived on selling component parts rather than finished goods. Depending on what stock you have, it may well have a scrap value which can help recoup some losses.
Create an inventory reserve
Analyse how much inventory had to be written off in past periods to predict how much should go into an inventory reserve, which a business can use to offset the costs of future write-offs. An inventory reserve is a contra asset account that is paired with gross inventory to arrive at net inventory on the balance sheet. The expense is also recognised on the company’s income statement.
Invest in software
The need for inventory write-offs is a tell-tale sign of poor inventory management. Inventory management software can help here by providing a business with an accurate picture of its inventory. Software makes it easy to keep accurate records about what’s in stock, where it’s located and how long it has been there. Managers can use this information to help determine how much and how often they need to place orders — and when write-offs are in order.
Among other benefits, inventory management software can automatically notify business managers when inventory items are approaching their sell-by dates. It can also create or manage the documentation needed for HMRC when inventory is liquidated, donated or destroyed. In addition, software can pinpoint where write-offs are occurring frequently, so managers can identify and address problems.
NetSuite Inventory Management
Inventory management software provides a full picture of a company’s historical inventory data, as well as its current inventory position. This information can inform business managers who are making ordering decisions and prevent them from ordering too much inventory, which may lead to write-offs. Inventory obsolescence is the symptom, not the problem — the problem is a breakdown in the supply chain. The right software can highlight items that have remained in inventory too long and prompt managers to take appropriate action to keep losses to a minimum.
NetSuite’s Inventory Management functionality provides a real-time view of inventory across a company’s locations and sales channels. It helps business managers reduce inventory, free up cash and keep inventory costs low. It also helps avoid stockouts, optimises inventory levels and ensures product availability.
NetSuite’s Inventory Management is a standard feature of NetSuite. ERP Experts can help configure and customise inventory management as part of your NetSuite implementation. Customers can also opt to take out one of our Aftercare support plans so we can support you beyond the initial installation of your NetSuite system.