Inflation and stock: when prices move

The thought "prices will rise, I will stock up now" seems logical to a manager. Sometimes it really does save money, and sometimes it fills the warehouse with slow-moving goods. In this article we do not forecast where prices will go: nobody knows that for certain. The aim is different: to make stock decisions with a calculation when prices are changing, and to avoid the "paper profit" trap. All the figures here are illustrative; put in your own numbers together with your finance specialist.

A simple sum for buying ahead

The rule: buying ahead pays only if the expected price rise is greater than the cost of holding the goods for the extra period they sit. Holding cost has three parts: tied-up money, space and handling, and loss or shelf life.

An example, hypothetical. You buy 100 million so'm of goods a month. The supplier says the price goes up by 6 percent from next month, and you want to take the next two months' goods now. Suppose holding cost is 2.5 percent a month: money 1.5, space 0.6, loss 0.4. The first batch sits an extra 1 month: 100 × 2.5% = 2.5 million so'm. The second sits 2 months: 5 million so'm. Total cost 7.5 million so'm, which is 3.75 percent of 200 million. The saving on price: 200 × 6% = 12 million so'm. Net result: +4.5 million so'm. If the price rises by only 3 percent, the saving is 6 million against a cost of 7.5 million, a loss of 1.5 million so'm. So in this example the threshold is around 3.75 percent.

Add two more items to the calculation: is there space in the warehouse for the new batch, and will the goods' shelf life last through the extra months?

The "paper profit" trap

When prices rise, the book margin looks attractive. Goods were bought at 80 and are now sold at 100: a margin of 20 percent. But to buy the same goods again you must pay 92, so the real margin is 8 percent. If the difference is taken out as profit, working capital shrinks and at the next purchase you cannot buy the same quantity as before.

So:

• set the selling price not from the book cost but from the replacement cost of the goods;
• watch stock not only in so'm but in units and tonnes: the value in so'm can rise while the quantity falls;
• before distributing profit, check that working capital is sufficient at replacement cost.

Demand changes too

When the price goes up, customers sometimes buy less or move to a cheaper substitute. A large batch may not sell at the old speed and turn from ordinary goods into slow-moving stock. So put limits on buying ahead:

• take only A-group goods with steady demand, a long shelf life and modest bulk;
• set an upper limit on days of stock and do not exceed it;
• record the reason and the responsible person for each such purchase.

An example: the batch bought ahead was equal to 60 days of sales. If demand falls by 25 percent it takes 80 days to sell: the extra 20 days of storage eat part of the saving. So test the demand-drop scenario in the calculation too.

Fixing the price by contract

You can fix a price without bringing the goods into the warehouse. For example, agree a price and a volume with the supplier for a quarter and take shipments on a monthly schedule. Write down clearly in the contract how long the price holds, any indexation clauses, the payment term and the consequences of not taking a batch. Such clauses have legal and financial sides, so have a lawyer and a finance specialist look at them before signing.

A practical routine

1. Once a month update the replacement cost of the 30 items that tie up the most money.
2. Set a separate budget for buying ahead and name the person who approves it.
3. Review days of stock and the share of slow-moving goods every month.
4. In the decision work not with a forecast but with two or three scenarios: the price stays flat, rises moderately, rises fast.

Conclusion

The stock rule stays the same when prices move: count the cost, assess demand, set limits and check the result. This article offers general management advice, not financial or investment advice: consult your finance specialist before large decisions. The OmborExpert specialists can help calculate days of stock, turnover and purchase thresholds.