Let’s explore the effects of obsolete inventory on small-business owners, then look at ways to get rid of it—and avoid it in the future. Monthly or quarterly audits are ideal to stay on top of stock levels and spot obsolete items early. Use flash sales, bundle promotions, or donate unsellable stock to reduce excess inventory quickly.

Inventory management software is a manufacturer’s or distributor’s best bet at reducing the risk of inventory obsolescence. It enhances forecasting accuracy and provides real-time visibility into stock levels. By leveraging historical sales data and market trends, these systems allow businesses to predict future demand more precisely, helping to avoid the pitfalls of misaligned procurements. A practical method for calculating obsolescence costs is to use historical data and predictive analytics. By analyzing past trends and patterns, businesses can forecast future obsolescence rates and adjust their inventory management strategies accordingly. For instance, a company might use software tools like SAP or Oracle Inventory Management to track inventory levels, monitor shelf life, and predict when items are likely to become obsolete.

Utilize inventory management software

Though carrying some obsolete inventory is inevitable, it’s important to help avoid accumulating too much inventory that is at risk of losing its value. Businesses may end up with obsolete inventory when they fail to accurately forecast demand based on historical sales data, market trends, and other factors. When the obsolete inventory is finally disposed of, both the inventory asset and the allowance for obsolete inventory is cleared. Second, the balance sheet is affected as the value of inventory under current assets decreases. The write-down reduces the carrying amount of inventory to its net realizable value which impacts the total asset value reported.

You can assign a team of employees to actively work improving inventory processes that will reduce your levels of obsolete inventory. Scientific approaches to inventory optimization hold enormous potential, despite the complexities involved. Existing technology, whether driven by formulas, artificial intelligence or modelling, is currently unable to take account of all variables. But advanced scientific methods and tools can help you to go further in reducing E&O without service level suffering. Where you have a large number of items to manage, you will benefit greatly from using technology to optimize at an individual item level. The limitations of the technology do not mean you shouldn’t use it, they just mean you should seek to understand those limitations and work with them.

How to identify obsolete inventory

For the vast majority of organisations, it will be better to focus on our 10 steps. In simplistic terms, sales organisations like high inventories, since they never have to worry about stock outs. Having everything available on demand makes their vital revenue-generating role easier. Production and supply chain organisations, on the contrary, look to control costs and maximise efficiency. This natural and healthy tension comes for resolution to the S&OP process. The problem here is that if customer demand is unknown and MRP is being used to plan deterministically, you are just passing your variability, and stock imbalances, up the supply chain.

Obsolete Inventory: How to Prevent and Manage Excess Stock Before It Hurts Your Bottom Line

Instead, identify classes of item suitable for a different approach and then test it before scaling up. Remember that forecasting is not the only game in town when it comes to reducing E&O. Setting up inventory practices to mitigate this uncertainty is a more reliable approach than trying to second guess it. In reality, there is a lot of “noise” to deal with – demand goes up and down, forecasts are frequently revised.

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. Since obsolete inventory is no longer sellable, it’s no longer considered an asset since it can’t be sold.

Supply chain forecasting involves using data and research to make predictions on all aspects of the supply chain to ensure a business runs smoothly and continues to grow. obsolete inventory This includes having insights into production lead times, labor needs, warehousing, order fulfillment, and shipping. Companies determine inventory obsolescence through regular reviews and analysis of inventory turnover, sales trends, and product lifecycle. Items that have not moved within a certain period, usually based on historical sales data, are flagged for potential obsolescence. Within a factory, this comes down to reducing cycle times while maximising throughput. With third party suppliers, the key lever is finding more local sources of supply.

• Failing to account for obsolete inventory accurately can result in overstated profits and assets on financial statements.
• He has a highly informative writing style that does not sacrifice readability.
• Roger Johnson has more than 30 years of private and public company experience as CFO, VP of Finance, Controller, and Director of Finance and Administration.
• A contra asset account may include an allowance for obsolete inventory and an obsolete inventory reserve.

Products typically become slow-moving inventory, then excess inventory, and finally , obsolete inventory. For example, there are companies in the aerospace industry that do a good business by inventorying seldom used parts. These parts can sell at premium prices as only certified parts can be used on aircraft. In each situation, look at the cost of retaining the excess or obsolete inventory. Obsolete inventory takes up space in the warehouse and counts as an expense on the balance sheet. Ultimately, obsolete products can decrease profitability and the success of a company.

Whatever your options to reduce inventory levels, the first step is to identify which items are potentially in excess and at risk of becoming problematic, whether raw materials or finished goods. Hopefully, this offers you a new method to identify inventory issues before they become a financial burden. A business may purchase too much of a product due to poor company forecasting, an inefficient inventory management system, or inaccurate lead times.

The key to managing inventory levels is to have visibility to inventory trends. Usage or sales trends are important indicators of potential inventory issues. The trends should be evaluated monthly or quarterly, depending upon your industry. Alternatively, getting rid of obsolete inventory will reduce expenses, minimize losses, and improve company cash flow. Beach toys, Christmas decorations, and Halloween costumes are all examples of seasonal products that will eventually become obsolete. While small businesses could hold onto these items until the season rolls around again, doing so can be costly and limits cash flow.

We and our partners process data to provide:

Regular inventory audits, analysis of sales trends, and monitoring product life cycles can help determine when items are becoming obsolete and should be addressed. Due to poor inventory management, a batch of vaccines was forgotten in storage and not used before their expiration date. Since expired medical products cannot be legally sold, the entire batch must be written off as obsolete inventory, resulting in both financial loss and additional disposal costs. Failing to account for obsolete inventory accurately can result in overstated profits and assets on financial statements. On a lighter note, GAAP allows for tax deductions on obsolete stock if sold, donated, or destroyed. The write-down of inventory, while a non-cash expense, can influence operating cash flows.

On the flip side, underestimating demand equals missed sales opportunities. Accurate demand forecasting is essential to balancing inventory levels with market needs, thus preventing obsolescence and minimizing financial losses. The financial implications of obsolescence extend far beyond the immediate costs of unsellable inventory. When inventory becomes obsolete, it directly affects a company’s balance sheet. Obsolete inventory is typically written down or written off, reducing the value of current assets.