Phantom inventory also known as “Ghost inventory” is a vexing and puzzling issue in supply chain management. It refers to the stock that a system records as available, but in reality, does not exist.
Phantom inventory can arise from various factors, including theft, damage, misplacement, miscounting during stockkeeping, unreported sales, or system errors.
Although the ramifications of phantom inventory may not be immediately apparent, they significantly impact operational efficiency, profitability, and customer satisfaction. This article seeks to explore the concealed expenses and ramifications of phantom inventory within supply chain management.
Thе issuе with phantom invеntory liеs in its ability to skеw thе actual invеntory status, impacting various aspects of thе businеss. Opеrating a supply chain management systеm based on inaccuratе data can lеad to consеquеncеs ranging from minor inconveniences to catastrophic business choices.
But what leads to a “ghost inventory” or “phantom inventory”- let’s see.
4 Causes of Obsolete Inventory (Ghost Inventory)
Here are the root causes of ghost inventory popping up across the supply chain.
1. Inaccurate Inventory Tracking
This task of tracking inventory is laborious and quite a repetitive process. When people do it manually, you may not be able to count inventory as often as you would need to. This may result in missing out on the latest changes in inventory. This is what causes phantom inventory.
2. Human Error
Errors are likely to creep in during data entry if it is a manual process. And if there are mistakes while inputting data in one system. It might affect your entire inventory management system. Inaccurate inventory levels lead to stockouts and lost sales across channels which can become a costly mistake.
3. Software Glitches
When your tracking software does not scan the inventory accurately or input it correctly into the schema. This can result in the wrong inventory count, it is one of the reasons for phantom inventory.
4. Supplier Issues
If your supplier shares the wrong count of the SKUs or Stock Keeping Units. Therefore, it is best to do cross-checks. When you do these cross-checks for the numbers, you may end up assuming that there are more units than actually present in the warehouse.
This is what phantom inventory means and does.
So, to proactively combat the above-mentioned causative factors, you must aim to automate inventory tracking. With minimal human intervention, an intelligent inventory management system can be depended upon to track inventory levels in real time. This increases inventory cycle frequency and scope. It reduces the chances of ghost inventory.
What are the Hidden Costs of Phantom Inventory or Obsolete Inventory Management?
Inventory management is a critical aspect of any business. However, It has many twists. Like, doing inventory comes with hidden costs that management might overlook.
- One of the most significant expenses is the cost of warehousing and storage facilities that are necessary to keep stock safe and secure.
- Another hidden cost associated with inventory management is the risk of obsolescence. As products stay on the shelf for months, there is a higher chance that is might become obsolete. This results in a lower selling process or companies may even write them off.
- Transportation costs also significantly contribute to increasing inventory costs. When some businesses order large quantities of items from suppliers, they may need to pay additional fees for freight delivery or expedited shipping services.
- The longer products sit on the shelves without being sold, the more money you lose due to depreciation. This means your investment loses value over time as in that time new models have come out or the customer preferences have changed.
Understanding these hidden costs of ghost inventory is crucial in developing an effective strategy to maximise profitability while minimising unnecessary expenses.
So, the solution to this is to reduce the hidden costs of the inventory. But before that, we need to know how to identify such an inventory.
Obsolete Inventory Example
For instance, imagine Kream Kookiez Inc. is a cookie maker. Kream Kookiez makes a batch of 10,000 cookies that it cannot sell after March 10th. They cannot do so because those cookies are not edible after that date. In other words, their sell-by date is March 10.
Kream Kookiez sells 7,500 cookies by March 10. This means that there are 2500 cookies that they cannot sell. These 2500 cookies are now in “obsolete or ghost inventory”.
As soon as the company identifies this ghost inventory, they need to write it off. This is a GAAP requirement. (GAAP stands for Generally Accepted Accounting Principles).
Businesses can try and sell their obsolete products at a discount or donate them. For this company, looking for a buyer for these cookies after their sell-by-date is probably an illegal activity.
GAAP rules require businesses to set up a reserve account for obsolete inventory on their balance sheets. They use up the reserve money as they dispose of their obsolete goods.
This can reduce profits considerably. Obsolete inventory can be the cause of significant losses.
So, companies must find a way to reduce their hidden costs. By doing so, they can speed up efficiency save money and increase profit. There are quite a few ways to reduce hidden costs. Let’s see how companies can achieve them.
How to Reduce the Hidden Costs
Reducing hidden costs in ghost inventory can significantly impact your business’s bottom line. Here are some tips to help you achieve this goal.
- Consider implementing an inventory management system that accurately stores stock levels and demand. This allows companies to identify slow-moving or obsolete items and make adjustments accordingly, reducing the amount of excess inventory you hold.
- Negotiate with suppliers for more favourable payment terms. Longer payment terms mean less cash tied up in inventory-carrying stocks. However, ensure this does not compromise your relationship with your supplier.
- Adopt just-in-time (JIT) where it is possible. JIT involves receiving goods only when you need them rather than keeping them in stock beforehand. By reducing the amount of time products spend sitting idle in warehouses and storage facilities, you will reduce hidden costs by a lot. This usually happens a lot in the food industry.
- Review transportation expenses regularly as they significantly contribute to carrying cost expenditures. It is best if you optimise delivery routes and use carriers who offer competitive rates without sacrificing service quality.
- Invest in employee training programs that focus on improving efficiency across all areas of operation such as warehouse layout optimisation and lean supply chain management principles implementation.
As the influence of phantom inventory spans across revenue, operational efficiency, customer satisfaction, and supplier relationships, it becomes imperative for businesses to understand and mitigate this hidden problem.
In supply chain management, an accurate inventory count is not only for operational needs. This is a strategic advantage.
Such an inventory can have tangible effects on a company’s bottom line. It is quite like a ghost that every player in the supply chain management must be aware of.
THE SOLUTION: With regular audits, robust inventory systems improving operational standards and stringent management, companies can prevent this. It is the only way to maintain smooth business operations.
FAQs: Understanding the Hidden cost and Effects of Ghost Inventory
What is damaged inventory?
Thе procеss of rеcording and managing inventory that bееn damaged is thе damaged inventory account, еxpirеd, or othеrwisе unusable. It involves tracking losеs, еvaluating writе-downs, and adjusting financial records to rеflеct the rеducеd value of damaged goods.
What are some hidden costs in invеntory?
Hiddеn costs in inventory include storagе еxpеnsеs, obsolеscеncе, shrinkagе duе thеft or damagе, and thе opportunity cost of tying up capital in еxcеss stock. Thеsе costs can greatly impact profitability if not carefully manaеd and accountеd.
How does inventory affect thе prices?
Inventory derives the cost of goods sold (COGS) directly by adding it to the COGS calculation. Increased invеntory costs rеsult higher COGS, rеducing profitability unlеss offsеt by higher salеs pricеs or incrеasеd еfficiеncy of invеntory management.
What are inventory turns?
Invеntory turns or invеntory turnovеr mеasurеs how wеll a company managеs its invеntory by calculating thе numbеr of timеs invеntory sells and personnel replaces ovеr a pеriod of timе, usually a yеar. It is calculatеd as thе ratio of itеms sold to avеragе invеntory.
Conclusion
Phantom inventory poses a substantial threat to supply chain management, causing operational inefficiencies and hidden costs that can erode profitability. Rooted in inaccuracies like manual tracking errors, software glitches, and supplier miscommunications, the consequences of ghost inventory range from increased warehousing expenses to lost sales and depreciated assets. To combat these challenges, businesses must prioritise supply chain experts like Qodenext. They can get services like automation, accurate tracking systems, and strategic inventory management practices.
