With Christmas over, this would be a pertinent issue for retailers who have stocked up on Christmas goods. While it may seem like it is only relevant to retailers, other business owners could also learn something by considering this scenario. Financial management is an essential skill for every business owner.
This particular question relates to cash flow and opportunity cost. I’ll be using Christmas as the focus for this post but the concepts are equally relevant to other seasonal stock.
You have leftover Christmas stock and are wondering whether you should keep it until next Christmas, or sell it at a loss.
Most people I’ve discussed this with have started from a similar position. They ask the question whether there is a cost to hold the stock in storage? It’s a good place to start but I will break this analysis down a little further.
#1 – What are the Direct Costs?
What are the actual costs associated with keeping stock that you can’t immediately sell? The question about storage falls into this category. If you do not have enough room to store the stock, then it will cost you to store it somewhere else.
If you have purchased your stock on credit, that stock also has an interest cost associated with it since you will continue to pay interest until that stock is sold.
#2 – What are the Indirect Costs i.e. Opportunity Cost?
What if, you have no storage issues and there are no interest costs? In addition, this stock is timeless e.g. baubles and decorations, and would be saleable next season.
It would appear as if there is no impediment to keeping the stock until next Christmas, or is there?
Part A – Consider this example
The cost of your stock is $1,000 and your mark up is 2x i.e. you will sell this stock for $2,000.
So, you could keep this leftover stock for 12 months, try to sell it again next Christmas and potentially get $2,000 if everything is sold – a profit of $1,000. If you sell it now, you will have to sell it at a discount of 75% and incur a loss of $500.
Retail price $2,000
Less Discount (75%) $1,500
Are you comparing a certain loss of $500 against a potential profit of $1,000 12 months later? Many people do this and would choose to keep the stock.
“A bird in the hand is worth two in the bush”
However, the analysis is incomplete. You have $500 in your hands. What could you do with the $500 in that 12 months?
Part B – Consider this now
You use the $500 to purchase new stock with the same markup – 2x. If you turn over your stock every three months (very conservative!), this is what it looks like:
Stock of $500 sold at $1,000
$1,000 from previous sales re-invested into more stock. Sold at $2,000
$2,000 from previous sales re-invested into more stock. Sold at $4,000
$4,000 from previous sales re-invested into more stock. Sold at $8,000
By the time you get to next Christmas, you could have turned the original $500 into $8,000, a potential profit of $7,500.
Cash flow has an opportunity cost – which was the correct analysis?
Yes, this is a simplistic scenario that does not take into account that not all stock will be sold. However, it illustrates the concept of opportunity cost and of how significant a difference it can make in financial decisions.
This analysis is also relevant when considering non-seasonal stock, and holding it too long.
Hope you’ve had a great Christmas!
- A quick guide to using Cash Flow in a Small Business (coachmi.com.au)
- 5 things you should know before you start your business (coachmi.com.au)