by Dennis Knutz, ASA, CMIR
 
The Cost of Holding Surplus Inventory can be surprisingly high. Surplus Inventory (idle non-performing assets, excess to the companies needs.) can come from all departments within an organization.
 
Surplus inventory can consist of a wide variety of items from spare parts and supplies, IT and office equipment/ furniture, manufacturing machinery and process equipment, mobile equipment, raw materials and finished goods to entire manufacturing plants and production lines as well as real estate.
 
Holding costs, also called carrying costs, are expressed as the cost of holding one item of inventory in stock for one year. This may be expressed as either a percentage of the total book value or FMV (Fair Market Value) of the inventory, or as a dollar amount. For example, if the holding cost of an item is 20% per year and the value of that item is pegged at $1,000,000, the potential holding cost of that item would be $200,000 per year. That may seem high, but many factors influence the cost of holding inventory.
 

The most obvious holding costs include:

  • Warehouse space (rent for the required space)
  • Equipment, materials, and labor to upkeep and operate the warehouse
  • Required maintenance or operating costs for the surplus, such as utilities for a surplus building
  • Insurance, security, taxes and interest on money invested in the inventory and space
  • Some stored items become obsolete before they are used, reducing their contribution to revenue while having no effect on their holding cost
  • Some are damaged by handling, weather, or other mechanisms. Some items are lost through mishandling, poor record keeping, or theft, a category euphemistically called shrinkage.)
  • Costs for record keeping and physical stocktaking of inventory
  • Environmental concerns
  • Holding cost also includes the capital opportunity cost
 
Typically, holding costs are estimated at approximately 15-45% of the asset’s actual value (FMV) per year. Studies completed a few years ago concluded the average holding cost for surplus assets and stores inventories was 20% of the book/FMV value. Determine if there are any other costs you can think of that are incurred simply by being in possession of an item. If you can think of any, treat them as holding costs, (ie. Government rules, regulations and laws that preclude the use of an asset
without modification.)
 

Surplus Inventory Management Considerations:

How are capital assets managed, tracked, maintained and identified? How are maintenance material and labor costs associated with these assets tracked and maintained? Check to see if your company uses a machinery maintenance program.
 
Time is Money. Your unit stands to capture a 38% tax break* from the timely disposition and write-off of these items. It is prudent that your disposal process is complete from start (identification of obsolete/surplus items) to finish (disposal of items) within 30-90 days (check with your Corporate Accounting).
What are your key priorities when managing surplus assets/stores disposition?
  • Maximizing return
  • Minimizing loss
  • Safety & environmental issues
  • Tracking and reporting results
  • Keeping your client in the loop and happy
 

Summary
Process development and management are the keys to a successful Investment Recovery program.

Holding cost drives the disposition process. All holding cost calculations must be reviewed and verified with your CFO (or delegate.) Client satisfaction is a key holding cost that is most difficult to measure, but may be the most important one to consider. 
Reprinted from ASSET 2.0, the Investment Recovery Business Journal, Vol. 5, 2008

© The Investment Recovery Association