For example, if your company sells cleaning products and your top seller is your all-purpose cleaner, but you find yourself with an abundance of scrubbing sponges—make a bundle out of them! Pairing your all-purpose cleaner with a three-pack of sponges not only moves your excess inventory out the door faster but also entices customers to purchase more cleaners since the bundle makes it a great deal. 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.
Alternatively, you can try product bundling obsolete items with a fast-selling item (and even offer free shipping). Ultimately, reducing obsolete inventory is a painless way for product-based companies to boost their bottom lines. Upon closer inspection, the accountants realize the company wrote off hundreds of thousands of dollars’ worth of product last year, much of it 1080p LCD televisions. Its forecast called for 1080p TVs to be big sellers, but far more people bought 4K and OLED sets instead. A purchasing manager made matters worse by buying 200 more 1080p sets than the forecast called for in exchange for a lower price per TV. For young businesses, avoiding obsolete inventory could be a critical step on the path to stronger unit margins.
Items that don’t sell well on their own may perform better as part of a package. Selling a core item with two or three related, inexpensive accessories could help you get rid of slow-moving or excess products. It’s a good idea to price the bundle lower than what it costs to buy all three items separately to encourage sales. Obsolete inventory, also called “excess” or “dead” inventory, is stock a business doesn’t believe it can use or sell due to a lack of demand.
Regular, frequent trend analysis of usage/sales is the main method of identifying potential slow-moving inventory and the reduction of excess inventory. In the first example, the graph indicates a decreasing demand/usage and the “Months on Hand” at 10 months. A close watch on Item AB123 each month may determine an increase in inventory may create an excessive amount. Until there is a clear understanding of the market and production, it would make sense put further purchases on hold. Whether you are in retail, the supply chain, or are a manufacturer you have inventory. Today we are discussing how to analyze the various inventory phases to eliminate or reduce your obsolete inventory.
What is the Obsolete Inventory?
Whether it’s a car, television, or clothing, every product will go through the four stages of a product lifecycle — introduction, growth, maturity, and decline. When a product has matured, it means it’s incredibly profitable due to the cost of production and marketing both being decreased. After this stage, as the market changes and demand shifts, it will enter a decline in profitability and relevance. If these products are not sold before it reaches the end of its lifecycle, it becomes obsolete. One way is to use an inventory management system that helps track inventory throughout its lifecycle.
The second example of Item AB124, with the same Quarter on Hand (QOH) and total usage, tells a completely different story. “Months on Hand” is just over three months and usage/sales are increasing which gives a much different outlook. A typical calculation of Months on Hand (MOH) or Days on Hand (DOH) for Total Year Usage, indicates that both items are both at 4.4 months on hand (MOH). If a particular car model is no longer being produced, the parts that go with it become obsolete and cannot be sold.
Calculating slow-moving inventory
A robust inventory management system like Cin7 Omni can do the heavy lifting for you. The software produces reports, insights, and advanced analytics you’ll find invaluable when making decisions about buying new inventory. When you base your buying decisions on information like this, you have a much better chance of having best-selling items in stock and avoiding those slow movers that can end up being obsolete. A key to reducing and avoiding Obsolete inventory lies in accurately predicting customer demand. By embracing demand forecasting techniques, businesses can make well-informed decisions on how much inventory to keep on hand.
- Obsolete inventory is a drawback to any small business, cutting into profit margins, reducing working capital, and taking up warehouse storage space.
- Not only does too much excess inventory cut into profit margins and cash flow, but it can also limit the chances of getting a business loan.
- Innovative companies can cause internal obsolescence by improving and replacing existing products.
When inventory starts to sell slowly—or stops selling at all—a brand needs to take notice and start making changes. For example, if the shelf life of a product is one year and you still have a lot of that product left after four months, you can classify that as slow-moving inventory. If after another four months you still have that inventory on hand, you can consider it to be excess. After the one-year shelf life of the product ends, then that inventory is obsolete. More specifically, when companies overestimate how many consumers will purchase a product, they often overstock the item, and customers do not purchase the product as quickly or as frequently as the company projected.
Accounting Methods for Obsolete Inventory by GAAP
Management may be reluctant to suddenly drop a large expense reserve into the financial statements, preferring instead to recognize small incremental amounts which make inventory obsolescence appear to be a minor problem. Since GAAP mandates immediate recognition of any obsolescence as soon as it is detected, you may have a struggle enforcing immediate recognition over the objections of management. You can improperly alter a company’s reported financial results by altering the timing of the actual dispositions. Though obsolete inventory can still impact ideal profit margins, putting items on sale can help replenish some of the costs by attracting bargain shoppers.
The $1,500 net value of the inventory less the $800 proceeds from the sale has created an additional loss on disposal of $700, which is charged to the cost of goods sold account. Regular review of your inventory will not only help to avoid large write-offs at year end, but will also help with tax planning. We treat it as working capital that is tied up with virtually no promise of return on investment. As Accounting Coach says, clothes go out of fashion, food ages, and new tech comes out before you’ve sold the old stuff. Generally Accepted Accounting Principles (GAAP) rules require you to account for the loss promptly in your bookkeeping.
New inventory, like the latest phone model or a must-have dress, will sell quickly and command a high price. Adjusting the price or offering a discount can help avoid obsolete inventory and keep products moving. Growing numbers of retailers use the term deadstock to refer to obsolete stock which has become collectable. Sneakers are a great example, where customers are willing to pay a heavy premium to grab a limited edition pair. Unlike dead stock which can negatively impact sales, deadstock inventory can increase sales and boost a store’s desirability.
What Is the Difference Between an Inventory Write-Off & Inventory Reserve?
You should check that the client’s methods are consistent with the applicable accounting standards and principles, and that they are applied consistently and accurately. You should also test the accuracy and completeness of the data and calculations used by the client to determine the cost and net realizable value of inventory. One of the main audit procedures to test inventory existence and completeness is to observe the physical count of inventory at the end of the reporting period or at a date close to it. You should verify that the inventory count is conducted in accordance with the client’s policies and instructions, and that the count results are accurately recorded and reconciled with the accounting records.
For an outdated cellphone, maybe you drop the price by a third to attract bargain hunters. Industry standards and guidelines, as well as your own business experience, help with the judgment call. If our product portfolio permits, we can try offering product bundles by selling slow-moving or obsolete items alongside products that perform well in the market. However, we need to keep those similar and be careful not to hurt the well-doing products’ performance.
A write-off involves completely taking the inventory off the books when it is identified to have no value and, thus, cannot be sold. In the past, if the inventory was held for too long, the goods may have reached the end of their product life and become obsolete. Currently, with technology, the state of abundance, and customers’ high expectations, the product life cycle has become shorter and inventory becomes obsolete much faster. Inventory write-off is when a company formally acknowledges the products have lost all value and are now unsellable. This Excess and Obsolete Inventory Policy offers comprehensive guidance on managing shrinkage, obsolescence, and excess inventory within the inventory allowance accounts on ledgers.
This software can help a growing company keep pace with their inventory needs based on their sales. We work for a variety of industries and companies, helping both multi-channel e-commerce businesses and warehouse supply businesses keep track of their inventory and sales. The best way to identify obsolete inventory is to recognize slow-moving and excess inventory before they become obsolete. This allows you to prepare ahead of time and come up with a plan to help move along sales of the product. This can include mark-downs and clearances or focusing a marketing campaign on that product to draw attention to it. Inventory management is a necessary part of business, and you should not solely rely on digital software to track your inventory.
Such items are usually a significant red flag to potential investors and financing institutions and need to be addressed timely. The reasons for accumulating obsolete Inventory can vary, but most commonly, we attribute such cases to poor planning on behalf of management, poor inventory management, or product quality. Inaccurate estimates for customer demand lead to overstocking and straining the business with significant cash tied up in slow-moving and excess inventory.