Companies spend money (working capital) on spare parts inventory that they don’t actually need.
They end up holding them for a long time before deciding to remove those parts and incur the cost of the obsolescence.
Perhaps a better idea would be to not buy those parts in the first place.
In this short video Phillip Slater explains.
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Working Capital Isn’t Free
Video Transcript
Hi, my name is Phillip Slater for the next couple of minutes I’d just like to give you something to think about.
Here’s a news flash. Your working capital isn’t free!
Although we seem to sometimes act as if it is.
You see companies spend money on spare parts inventory that they don’t actually need to spend.
They buy parts that they don’t need and they end up holding them for a long time before deciding to remove those parts and wear the cost of the obsolescence.
Perhaps a better idea would be to not buy those parts in the first place.
And I think that we get a better focus on that when we start to really understand that money isn’t free.
So, in this context it doesn’t matter whether you capitalize your spares and so they become part of your balance sheet.
Or whether you expense them when you purchase them and they go straight on to an operations or a profit and loss report.
What does matter is that in both circumstances you have spent the company’s cash.
So that’s cash out the door, spent with a supplier to provide those spare parts. Simple right?
The only issue is: cash isn’t free. Spending your cash means that you can’t spend it on something else.
You see for all companies the supply of cash is limited, the organization only has so much money to spend and it has to make choices about how and where it spends that money.
Should it spend it on more spare parts? Or should it spend it on more efficient capital equipment?
There are options and choices to be made.
And in accounting terms those options provide what’s known as an opportunity cost. So if I spend my money on a spare part that sits on the shelf and never gets used I’ve lost the opportunity to spend that money on more efficient plant and equipment.
Now in addition to that of course there’s the cost of managing what’s there and that’s a whole different discussion.
But the important point today is this: When you spend money on spare parts, it is not free. The money costs money.
That’s just something to think about.
My name is Phillip Slater.