What is the main disadvantage of maintaining excessive inventory levels?
Correct Answer
B) Higher carrying costs and tied-up capital
Excessive inventory ties up working capital and increases carrying costs including storage, insurance, taxes, and potential obsolescence or deterioration of materials.
Why This Is the Correct Answer
Option B correctly identifies the primary financial disadvantage of excessive inventory. When contractors maintain too much inventory, their working capital becomes tied up in materials that aren't immediately needed, reducing cash flow flexibility. Additionally, carrying costs accumulate including warehouse storage fees, insurance premiums, property taxes on inventory, and potential losses from material deterioration or obsolescence. These costs directly impact the contractor's profitability and financial efficiency.
Why the Other Options Are Wrong
Option A: Increased risk of material shortages
This option describes the opposite problem - excessive inventory actually reduces the risk of material shortages since you have more materials on hand than needed.
Option C: More frequent ordering required
Excessive inventory actually reduces ordering frequency since you already have large quantities on hand, making this the opposite of what occurs.
Option D: Reduced supplier relationships
Having excessive inventory doesn't harm supplier relationships - if anything, larger orders might strengthen relationships, though this isn't the main concern with excess inventory.
Memory Technique
Think 'CASH TIED' - Carrying costs, Storage costs, Insurance, Taxes, and your cash is TIED up in unused inventory.
Reference Hint
Business and Finance for Contractors - Chapter on Inventory Management and Working Capital
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