One of the things that you will certainly come across after you have been retailing for more than 2 years is stock obsolescence. Products go through a lifecycle, and at some point they just become obsolete.
Retail companies usually adjust the value of the stock they hold the further it ages until it reaches a point where it is considered “dead stock” and is written off completely. This is to account for the real sale value of the inventory on their balance sheet.
What is Stock Obsolescence?
Stock obsolescence happens when inventory has been sitting on a company’s books for a very long time (e.g 2 years) without being sold, which renders it unsalable.
The rationale behind it is this: If these products have not been selling after all this time and all the promotional events that any typical product goes through in their lifecycle, then these products will likely never be sold and should be considered obsolete.
Why should I care?
It might seem like a trivial accounting issue, but actually stock obsolescence can affect your profitability, since the amount written off will be recorded as an expense. The cost of this stock gets written off once it hits the time limit specified in your provision norms and this amount will be recorded as an expense and the asset value equivalent to it will be taken off your balance sheet.
Since inventory is usually a retail business’s biggest asset, if the situation gets out of hand due to poor inventory management, the proportion of obsolete stock can be very high, and consequently the amount lost with the write off. That’s why you should be proactively preparing for and managing stock obsolescence to be able to make the best out of the situation.
Another problem with letting inventory buildup is that it locks your cash, so you are not able to buy fresh stocks that will drive your top line. Actually a high amount of obsolete inventory is a sign that the company has very poor inventory management process and is considered a red flag in retail.
How to Prepare for Stock Obsolescence ?
Inventory doesn’t get obsolete overnight. It takes time (actually very long time) for stock to reach that stage. Usually stock gets written off after it exceeds 1.5 to 2 yrs, depending on provision norms.
Provision norms are rules that the company set to account for aging inventory, so that its value on its books gets reduced gradually the more it ages. It is taken as an assumption of how much this aging stock will be sold at and how much could be lost upon its sale if it is sold below cost. This is done to make sure the value of inventory on the books is realistic.
Provision norms example could look like this
At 6 months we start to write down 25% of the stock cost
At 1 year we start to write down 50%
At 1.5 year we start to write down 75%
At 2 years we write it down at 100% (write off)
Now you can see from the example above that stock obsolescence actually starts to hit your P&L and balance sheet way before the actual write off time. You are then expected and urged to clear those stock on a regular basis to unlock those provisions that you lost and get them back in your P&L.
Proactively preparing for and managing stock obsolescence is by making sure the amount of stock that reaches write off stage is minimal.
To be realistic enough, we will always assume that we will almost never sell out of a collection completely, and so our goal here is to minimize the amount of obsolescence.
If you are operating multiple store locations you can start moving some products that are not selling at one location but selling well at the other. You can also gather all the quantity in one store and put it on a bundle offer there only to accelerate its clearance.
During your regular sale events (EOSS or MSS) make sure you price this stock properly, so as to maximize its clearance. If this would mean selling them below cost value let it be, if they have already reached write off time. Remember that the alternative is getting 0 $ for it, plus the fact that warehousing them actually costs you money.
If you are having a robust inventory management process in place, then you will always be ahead of your stock and it will not get out of hand (unless something drastic happens). If not, then you have seen here that letting inventory situations run away can prove to be very costly, and you might want to start putting a process in place from now.
Remember, as we keep saying over and over:
Many retail startups fail due to poor inventory planningTweet
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Retailer & Founder of Retail Dogma, Inc.
Rasha has 14 years of retail & ecommerce experience. She has started an ecommerce business in 2008, and later worked at H&M, Bath & Body Works, Victoria’s Secret and Landmark Group. She’s lived in 4 different countries, speaks 3 different languages and holds a BSc in Pharmaceutical Sciences and an MBA in Strategic Management & Marketing.