Obsolete inventory percentage
/What is the Obsolete Inventory Percentage?
The obsolete inventory percentage is used to derive that portion of inventory that is no longer usable. The percentage should be tracked on a trend line and compared to the results of similar businesses, to see if a company is experiencing an unusually large proportion of inventory problems. Trend line tracking can also be used to see if there has been a gradual change over time that should be rectified.
How to Use the Obsolete Inventory Percentage
Actions taken that relate to this percentage can include the following:
Changes in the reserve for obsolete inventory, if the percentage is varying from the long-term trend.
Changes in the amount of activity to disposition obsolete inventory in a manner as advantageous to the company as possible.
Actions taken to reduce the underlying causes of obsolescence, such as buying in smaller quantities, switching to a production system that is based on customer orders, better management of engineering change orders, and so forth.
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How to Calculate the Obsolete Inventory Percentage
To derive the obsolete inventory percentage, summarize the book value of all inventory items which have been designated as not being needed, and divide it by the book value of the entire inventory. The formula is as follows:
Book value of inventory items with no recent usage ÷ Total inventory book value
= Obsolete inventory percentage
Example of the Obsolete Inventory Percentage
The warehouse manager of Mole Industries wants to investigate the extent of obsolete inventory in his warehouse, so that he can remove items and consolidate the remaining inventory. He prints a parts usage report from the company's manufacturing resource planning system that only shows the cost of those items that are in stock and have not been used for at least two years. The total cost listed on this report is $182,000, which is 19% of the total book value of the entire inventory. The warehouse manager brings this high percentage to the attention of the purchasing manager, who immediately contacts suppliers to see if they will take back the obsolete items in exchange for a restocking fee.
Disadvantages of the Obsolete Inventory Percentage
While the obsolete inventory percentage can be a helpful measure, there are also some problems with it - which are as follows:
Lagging inventory. The metric identifies obsolete inventory after it has already become a problem, offering little real-time value for proactive inventory management.
Oversimplification. The metric focuses solely on the percentage of obsolete inventory, potentially overlooking root causes, such as demand forecasting errors or supply chain inefficiencies.
Varying definitions of obsolescence. Different companies may define "obsolete" inventory differently, creating inconsistencies that can impact the reliability of the percentage.
Neglects financial impact. While the percentage highlights the scale of obsolescence, it does not directly measure the financial impact, such as write-down costs or storage expenses.
Potential mis-use in decision-making. Management might overemphasize this metric, leading to hasty decisions such as aggressive inventory write-offs, which could disrupt operations or customer service.
Dependent on accurate inventory data. If inventory records are inaccurate or not updated, the calculated percentage may be misleading, resulting in poor strategic decisions.
By addressing these disadvantages, organizations can use complementary metrics and modern inventory management systems to create a more comprehensive approach to managing obsolete inventory.