Stock Write-offs Explained: Turning Losses into Gains in 3 Simple Steps
The thought of writing off unsold stock is enough to make any business owner or manager nervous. Whether it's worth $100,000 or $1,000, it's a guaranteed loss to your profit and loss that packs an emotional punch.
It's easy to let old stock accumulate. We've all been there – the shelves filled with unsold goods, products hidden away in corners, or that mysterious top shelf of your pellet racking collecting dust for far too long.
The emotional connection we have with unsold stock can be challenging to overcome. But making the bold move to let it go is one of the smartest thing you should do for you and your business. (And not just because of the tax benefits.)
Here's how breaking up with your stock can lead to a significant improvement in your bottom line, and how to manage it effectively in three easy steps.
Stock Write-offs Explained in 3 Simple Steps
Step 1: Understand Why It Happened
Before you start clearing your shelves, it's vital to look back and learn from your stock management history. Understanding the core reasons behind why stock accumulates often boils down to these key reasons.
1. Expectation vs. reality
Quite simply, did you think you were going to sell more than what you actually did? It's common to overestimate future sales, and ordering more stock than what you can sell quickly leads to unsold inventory piling up.
2. Regressing demand
Has the demand for your product regressed far quicker than what you anticipated? Sometimes the market's demand for your product can suddenly drop, leaving you with more stock than you can move.
3. Ordering incorrectly
Was it an incorrect order? Did you flat out make a mistake and order too much of something you didn't need to?
4. Industry-specific reasons
Certain industries inherently involve stock write-offs. With supermarkets, for example, it's impossible to sell every item before its expiration date. Similarly, fashion and retail face challenges as trends change rapidly. A shirt being sold today might not be one that's in demand tomorrow, so there'll be natural write-offs stemming from people's naturally-shifting tastes and trends.
5. Ad hoc events
Unexpected disruptions caused by external factors could result an influx of stock that doesn't match current demand. For example, we know of businesses affected by freighting inconsistencies during the Covid-19 pandemic where they received nothing for months, then got a year's worth of stock in the space of three weeks.
Once you've understood the reasons why you have an abundance of unsold stock, you then have the power to influence future decision-making. If it was a result of a mistake, why was the mistake made? Was it something you could have controlled or foreseen through better marketing or sales, or should you not have bought it in the first place?
Key takeaway: Analyse the reasons behind your unsold stock and apply the lessons to future inventory management.
Step 2: Consider the Context of the Write-Off Period
Context is crucial when considering stock write-offs. The next step, therefore, is to look at the timeframe over which the write-off was created, plus considering the value of the write-off as a percentage relative to annualised purchases.
1. What timeframe did the stock accumulate over?
Consider the timeframe over which the stock accumulated. Is it over a few months or several years? This context is crucial when deciding to write off stock.
Here's a real-life example of a business that needed to write off a substantial sum – $600,000. That's a heck of a lot of money; more than what most people pay for their first home. Firstly, we looked at how long it had been since they'd done a proper cull of stock deemed obsolete and no longer of any real value. It turns out they hadn't done a write-off for nine years. Considering $600,000 over nine years is a very different exercise compared to $600,000 over six months.
2. What's the value of the write-off in relation to your annualised purchased?
Next, evaluate the percentage of total purchases affected by the write-off. By understanding how this value relates to your annual purchases, you can better grasp the impact of unsold stock on your business.
Going back to our previous real-life example, the value of the $600,000 equated to 4.5% of the business's annualised purchases. While the management team was initially hesitant to write off that much stock, it became easier to justify writing off stock worth $600,000 over nine years accounting for 4.5% of annual purchases, compared to losing 25% in just 6 months. This didn't mean management ignored the first step of looking back and learning, but ultimately considering the context made it less of a bitter pill to swallow.
3. How do these compare relative to your industry?
Lastly, explore relevant industry benchmarks to gain perspective on natural write-offs in your specific business. These benchmarks can provide valuable context for your decision.
There are no hard and fast rules of what these timeframes or percentage should be. For the latter, traditional wisdom says between 2.5% to 5%. Instead, we believe you should be optimising your stock at all times. At the same time, don't expect perfection – especially in the retail industry, whether that's perishable groceries or rapidly-shifting fashion.
Key takeaway: Context matters. Consider the timeframe the excess stock accumulated over and the value of this stock as a percentage relative to your annualised purchases, keeping in mind what's typical for your specific industry.
Step 3: Focus on New Opportunities
Lastly, the (good) decision to break up with your stock should be based on the time and opportunity cost of selling that stock versus what you could be doing instead.
After all, if you were faced with writing off $600,000 worth of inventory – an eye-watering sum, regardless of the size of your enterprise – you might think, why wouldn't I just try to sell it? Well, here's why.
1. You've got unsold stock for a reason
Here's the thing. Trying to sell unsold stock may seem like an attractive idea, but in most cases, it's not recommended. Your stock has been sitting around for a reason, and it's often challenging to sell it quickly without investing a significant amount of time and resources.
2. Focus on what you do have
Alternatively, you can use the time and energy to focus on new opportunities instead. Explore new clients, build new accounts, sell more to existing clients, or invest in faster-moving stock items and solutions. Nine times out of 10, this is a more efficient use of your team's time and resources.
3. The tax write-off means more money in your pocket
It's a cliche for a reason – it's a tax write-off. If you're clearing out $600,000 worth of stock and you've got a 25% company tax rate, that's $150K in your pocket when you next lodge your tax return.
Key takeaway: Writing off redundant stock isn't just about clearing space; it's about optimising resources. The best use of your team's time and energy is focusing on new opportunities, and remember the tax benefits you can claim as a result.
Breaking up with your stock might not be easy, but it can lead to financial stability and a more streamlined, profitable business. The decision to say goodbye to dead stock requires a careful analysis of past mistakes, and considering the context and impact of the write-off. Ultimately, it's about making the right choices for your business's long-term success.
In the end, remember that breaking up with your stock is hard, but often it's the smartest decision you can make for your business. By understanding the reasons behind stock write-offs, evaluating the time frame and percentage of total purchases, and focusing on new opportunities, your business is going to have a more prosperous future.
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