What Is Inventory Management Process? Flow, Challenges, Implementation

Updated Dec 6, 2022.
What Is Inventory Management - Process Flow, Challenges, Implementation

One of the factors that determine the success of a business is how it manages inventory. Inventory management is a key component of supply chain management, which is the process of tracking, managing, and controlling the inventory of your company.

The items in your physical inventory (raw materials, finished goods, marketing materials, and office supplies) can either increase or decrease your company’s bottom line.

Understanding the inventory management processes and techniques to use can boost your inventory processes for more profitability and productivity.

In this article, you will learn everything you need to know about the inventory management process, the benefits of an efficient inventory management system, inventory management challenges and how to master them, and how to implement an efficient inventory management process.

Let’s get started.

Understanding the Inventory Management Process

Any business that depends on physical inventory for its success needs to have a reliable and efficient method for managing inventory. The inventory management process (IPM) involves the recording, analyzing, and managing of the company’s inventory.

An effective inventory management process means a company enjoys maximum workflow efficiency, maximal return on investment (ROI), and the least costs on inventory.

Inventory Management Process - Warehousing Process
Source: DatexCorp

Running an optimal inventory management process is essential for companies who want to maintain better control of their costs and finances. It has a great impact on supply chain management. Inventory process management affects cash flow, relationships with vendors and customers, and your strategic sourcing or vendor management.

The process you use to track your inventory from delivery to your warehouse to the restocking of your inventory varies by company, industry, and business size. In general, the inventory management process for a company that sells physical products will look like this.

1. Purchase of Inventory

The inventory management process starts with the initial purchase of goods. For businesses that deal with physical goods, the flow of inventory starts from when the raw materials or products needed to run their business operations are purchased.

This first inventory management process is very important and sets a precedence for how other inventory management processes will perform. If you fail to effectively carry out this process, it will affect all the other inventory management processes.

There are lots of vendors in the market that a business can make its initial purchase of inventory from. However, a smart business owner will carry out thorough research on the different vendors to find the best fit for the business.

Does the vendor have the best price? Does it have pricing strategies such as promotional strategies that enable your business to get more inventory at a cheaper price? Is the inventory the vendor has for sale quality?

Another way to research potential vendors and suppliers is to check their records with competitors in the market. Proper market research can provide valuable information about the best vendors in the industry. Research vendor histories from competitors will give your business an idea of the optimal order sizes that work best.

Knowing the right quantity of inventory to order can be a problem for many businesses. Businesses use the Economic Order Quantity (EOQ) to determine the right quantity of inventory to order or produce.

Oftentimes, it is always more beneficial to order more inventory than you need than to order far less than you need. Ordering too little will result in stockouts, affect the company’s revenue and operations, and lead to potential loss of customers.

However, while you want to order more inventory than you need to avoid stockouts, ordering way too much especially if they are perishable inventory leads to overstock situations. Having too much inventory in your warehouse or store can lead to inventory control problems and high holding costs.

2. Delivery of Goods to Company’s Warehouse or Store

After you have purchased inventory, the next step in the inventory management process is the delivery of goods to the company’s warehouse or store by the supplier or vendor. Goods purchased are delivered directly to the receiving area of the warehouse where they are stored till needed.

Examples of goods delivered to the company’s warehouse or store include raw materials, finished goods, and indirect materials that do not contribute directly to the production process but support the daily operations of a business.

Raw Materials

Raw materials refer to unfinished goods which are purchased for further development into finished goods for sale. It also comprises other components used in the production of the finished goods. Manufacturers typically purchase this type of inventory.

Examples of raw materials include steel, oil, gasoline, natural gas, corn, grain, forest resources, lumber, plastic, coal, and others.

Finished Goods

Finished goods refer to products that have gone through the manufacturing process but are yet to be sold or delivered to the final customer.

Businesses that do not operate a manufacturing structure purchase this type of inventory, store it in their warehouse for resale. Finished goods are often purchased by distributors who sell and deliver them to customers.

Many businesses purchase finished goods, add their touch such as packaging or increase their quality with some improvements before reselling and delivering to customers.

Examples of finished goods include processed foods such as sardines and cereals, toys, clothes, and electronics such as laptops and phones.

Indirect Materials

Indirect materials are an important inventory for every business. They refer to those materials that do not contribute directly to the production process but play a huge supporting role in the daily operations of a business.

Without them, the business will experience inefficiencies and struggle to meet its production goals. Businesses of all kinds purchase the indirect materials they need.

Examples of indirect materials include glue and adhesives, oils and lubricants, tape, cleaning supplies, disposable tools, fasteners and fittings, and personal protective equipment such as helmets, gloves, and overalls.

3. Reviewing, Sorting, and Storing of Goods

The third step in a standard inventory management process is the reviewing, storing, and storing of goods in special stock areas. For large businesses with access to warehouse facilities, the receiving area is where goods are received, and it is different from where it is eventually stored. These businesses often have a separate receiving department dedicated to receiving goods.

Small businesses do not have such luxury due to the size of their budget. If they own a warehouse, it serves as a stocking area and storage area. There is no separate receiving department.

After the goods ordered by the company are delivered to the stocking area of the warehouse, the next step is to find the appropriate storage space for the goods. Employees working in the company’s warehouse are in charge of reviewing, storing, and storing goods.

A typical warehouse is divided into five different sections such as the receiving area, slow-moving case storage, bulk storage, pallet storage, and reserve stock.

Regardless of where the inventory is stored, it should be stored in an organizational system that makes it easier to access when needed. Many companies assign stock-keeping unit (SKU) codes and use barcodes on their goods to make it easier to track them.

Organized stock helps increase productivity by cutting down the time it takes employees to find and retrieve products. It also helps streamline production and order fulfillment for the company.

4. Monitoring of Inventory Levels

The fourth step in the inventory management process is the regular monitoring of inventory levels. Businesses carry out physical inventory counts of the inventory in their warehouse periodically.

The periodic counting of inventory complements other automated inventory management measures used such as inventory management software.

Monitoring inventory levels regularly helps the business have an accurate estimation of the amount of inventory in its warehouse. It minimizes inventory issues such as deadstock, stockouts, duplicated or missed orders, and theft and fraud by employees.

5. Placement of Stock Orders

The next step in the inventory management process is the placement of stock orders by customers. Placement of stock orders can be from an internal or external source. It is an internal source when it is an internal department in the company such as the sales department that places a sales order for stocks. An employee can also submit a request for office supplies.

When a customer places a purchase order for the company’s product, the placement of stock orders is from an external source.

6. Approval of Stock Orders

After a customer, an internal department, or employee has placed an order for stocks, the next step in the inventory management process is the approval of stock orders.

Before approval of stock orders can be given, the order has to be verified against the original purchase order, internal purchase requisition, sales slips, and others.

For the approval of stock orders, the warehouse manager works closely with the sales department, financial department, or accounting department.

7. Goods are Taken from Stock

After the approval of stock orders, the next step is to pull out the required goods ordered from the stock areas. If it is the manufacturing department that placed the order, it is sent to production, and if it is an internal request, it is sent to the appropriate business unit or department.

When it is a retailer or customer that places the order, it is routed to them. The efficiency of this step falls on how well the company stored the inventory up to this phase.

As the goods are en route to the customer, businesses use a tracking system to ensure that the goods are properly shipped to the appropriate buyer. Tracking orders up to the fulfillment stage ensures timely deliveries which bring satisfied customers.

Many businesses often use order fulfillment services to avoid the problems and costs that arise from self-fulfillment. Some of the best order fulfillment services include ShipBob, FreightPros, WhiteBox, FedEx Fulfillment, ShipMonk, Red Stag Fulfillment, and Rakuten Super Logistics.

8. Updating of Inventory Levels

Taking goods out of the warehouse or store to meet stock orders reduces the number of inventory in the warehouse. The next step in the inventory management process is to update records of inventory levels and share the updated records with all relevant stakeholders.

9. Restocking of Goods

Restocking goods is the final step in the inventory management process. Low stock levels trigger purchasing of more goods.

Companies use inventory levels to restock goods and materials they need to avoid stockouts. With knowledge of real-time stock quantities, companies can easily place orders as soon as their inventory gets depleted below its minimum levels.

Businesses can use demand forecasting to make accurate forecasts on the number of goods to restock to avoid purchasing excessive stocks which lead to dead stock situations.

The availability of advanced inventory management tools that provide deep data analytics and process automation makes it possible for businesses to create, implement, and streamline inventory control.

Inventory Management Process - Plamergy
Source: Planergy

Benefits of an Efficient Inventory Management System

You cannot operate an inventory management process (IMP) efficiently without having an inventory management system (IMS) in place. An inventory management system is a process that tracks inventory through the whole supply chain, from the initial purchase down to the end sales.

This system is designed to optimize performance in several areas such as inventory control, order management, inventory forecasting, multichannel sales, warehouse management, and synchronization, comprehensive reporting and data analysis, and purchase order creation and management,

When done properly, an efficient inventory management system brings the following benefits to your company. They include improved process and staff efficiency, less waste and lower costs, more effective long-term inventory planning, and increased customer loyalty and stronger brand recognition.

1. Improved Process and Staff Efficiency

An efficient inventory management system reduces the time your employees spend on low-value, time-consuming, and tedious inventory tasks. The time and energy saved can be used on improving their skills and responding better to high-value tasks for more productivity and efficiency.

Humans are susceptible to making errors while carrying out low-value inventory tasks such as the physical count of inventory. By automating the inventory management process, there is minimal need for human intervention and better accuracy.

Updating of inventory which takes time when done manually is automated with an efficient inventory management system in place. Employers do not have to worry about stock inventory while carrying out more significant tasks.

2. Less Waste and Lower Costs

An efficient inventory management system provides you accurate inventory information in real-time. With this information, businesses can optimize their inventory levels more efficiently and spot low stock situations and replenish stocks on time to prevent stock-outs.

Having accurate inventory information available to you in real-time helps minimize your holding costs, inventory write-offs, and the tendency to buy more inventory than you need.

When you purchase excess inventory than you need, you create additional expenses for your company over time such as more storage space to store the inventory, holding costs, depreciation and amortization costs, and other related expenses. If the goods are perishable, you are likely to make a loss if you cannot sell them on time before they spoil.

An efficient inventory management system does not only protect you from bloated inventory levels but helps you know when you are overselling and need to restock. It helps ensure the supply of goods meets the demand for it.

3. More Effective Long-Term Inventory Planning

An effective inventory management system makes the inventory management process easier and more transparent. It does not matter if you are a manufacturer, distributor, or service-based business, having a comprehensive view of your inventory levels makes it easier to make long-term plans.

Businesses can refine their overall inventory management processes, and make adequate long-term plans for production, sales, and supply chain management. The inventory management system plays a significant role in effective long-term inventory planning.

4. Increased Customer Loyalty and Stronger Brand Recognition

A functional inventory management system helps businesses increase customer loyalty and boost their brand image. Customers will always want to make repeat purchases from companies where they encountered a responsive and smooth ordering process, including timely delivery.

In situations where the ordering process is full of frictions, the company will likely switch to a competitor. An effective inventory management system keeps customers happy and willing to make more purchases, leading to increased customer lifetime value (CLV).

Benefits of Inventory Management Systems
Source: TheThus

Inventory Management Challenges (and How to Master Them)

Like everything else, the inventory management system has its drawback. The best and well-optimized inventory management system was created by humans, therefore it is susceptible to potential flaws and problems. Here are some inventory management challenges and how to overcome them.

1. The Complexity of the Inventory Management Process for Employees

The inventory management process involves a lot of moving parts. Companies adopt a formal method of approaching each component to help reduce the possibilities of miscommunication, risk, and errors.

However, many companies underestimate how fast their employees can not just understand but commit to using the new inventory management process. When employees who are meant to lead the process are not accustomed to the new policies and whatever equipment, tools, and systems you are putting in place, the inventory management process becomes a challenge.

Just like a business devotes time and resources to onboard a new employee, it should also devote time and resources to ensure that all its employees understand and commit to the new policies and the inventory management software.

Ensure all your employees involved in the inventory management process go through training sessions, step-by-step guides, manuals, and other resources they need to carry out their duties efficiently. Training should be comprehensive as a mistake in the inventory management process can result in great financial loss.

An efficient inventory management process is a game-changer for your company and your employees. It helps them increase their productivity and efficiency by reducing the time they spend on low-value and time-consuming tasks that no one likes to do.

Oftentimes, employees perceive new changes as a threat to their jobs or interpret them to mean more work. Show them the massive benefits it brings not just to the company but to them. Combining inventory management techniques with modern inventory management software helps ease the transition.

When planning to onboard your employees to the new workflows and inventory management process your company is adopting, do not underestimate the time and training your team needs. Vendors and customers may also need to understand the improved inventory process for smoother transactions.

2. Risk Remains a Factor

Efficient inventory management which requires companies to use automated workflows and formalized processes help diminish the risk due to inefficiencies and errors, but it does not fully eliminate it.

The biggest inventory management challenge is that even with the best inventory management system in place, risks remain a factor (albeit a reduced one). Even though the inventory management process is seen as a life-saver, it does not fully eliminate the risk of errors.

For companies to keep the risk of errors and inefficiencies at bay, they have to monitor the inventory management process to pick out potential errors and improve the process.

The above statement is particularly true for companies that work with inventory management software that lack advanced data analytics and self-learning artificial intelligence supporting its process automation.

Even though the inventory management software automates the inventory management process, if left unchecked, you can still end up making inventory mistakes. Some of the possible inventory mistakes include overbuying and unselling inventory.

To mitigate the risk factor, you must integrate your inventory management process into your quality control and supply chain management solutions. Such a connection will help prevent missteps in the production and sourcing stages that can affect your return on investment (ROI) and your company’s reputation.

3. Implementing Inventory Management System Can Be Expensive

Apart from the cost of the initial investment in an inventory management system, other costs (both labor and monetary) can make the inventory management system expensive to implement.

For large companies with multi-location warehousing, implementing an inventory management software that cuts across all warehouses requires significant time, effort, and money to achieve.

If your company is making the switch from manual inventory management processes to automated ones, it has to invest in training employees on the system and process before it can go live.

Inventory management systems are expensive due to their enterprise focus. Many small and medium-sized businesses do not have the budget to pay for enterprise-level prices for full access to inventory management features.

Thanks to cloud-based inventory management software that makes access to their features less expensive, small and medium-sized businesses can enjoy access to affordable inventory management software.

Some of the best inventory management software with affordable costs for small businesses include Zoho Inventory, QuickBooks Inventory Management, Ordoro, TradeGecko, ShipMonk, and Zenventory.

For companies with multi-location warehousing, warehouse inventory management software provides warehouse management features that help track and control inventories across locations efficiently. The software helps you track in-transit inventory and stocks in different warehouse locations.

Some of the best warehouse inventory management software include NetSuite, InfoPlus, Odoo, Rackbeat, and ChannelAdvisor.

4. Quality Control Problems

The most efficient inventory management process can prevent your products from damaging before it reaches the final consumer but it cannot alter the quality of your products.

If your product quality is poor, you will lose customers to competitors who offer better quality products than yours. Timely delivery of your products does not atone for its poor quality.

Since the focus of the inventory management process is on inventory and not on production, there is little you can do to improve your inventory management process to solve quality control problems. It can only improve quality control problems such as incorrect items or damaged products packaged for delivery.

The only solution to poor quality products is for the production team to improve the product’s quality.

5. Insufficient Order Management

One of the most popular inventory management challenges is insufficient order management. Order management refers to the process of receiving, tracking and fulfilling customer orders.

When a company fails to have an efficient order management process in place, it stands the risk of overselling products which leads to stockouts. Delay in inventory delivery can easily result in poor customer experiences.

The best way to prevent insufficient order management is to automate reorders. Set an automatic reorder point based on historical and seasonal data trends with your inventory management software.

When your inventory reaches the order level, the inventory management software prompts you on the need to restock or place an order for more inventory on your behalf.

6. Changing Demand

A tricky part of the inventory management process is predicting demand. Customer demand is not always stable and fluctuates according to seasons. Businesses that fail to track changing demand can quickly end up having more inventory than customers are demanding, and vice versa.

The solution to changing demand is to use demand forecasting tools usually integrated with inventory management software to more accurately predict demand. Accounting and sales data play a crucial role in predicting demand accurately based on shifting customer preferences or seasonal trends.

How to Implement an Efficient Inventory Management Process

Developing a winning and efficient inventory management process involves knowing a few best practices such as knowing your budget, planning your warehouse, and choosing and implementing the right software.

1. Organize Your Budget

The first step in implementing an efficient inventory management process is to know your budget. An efficient inventory management process connects your enterprise resource planning (ERP) and accounting software with procurement. It helps you make the best use of your budget to achieve your financial goals.

Knowing and meticulously organizing your budget is the foundation of your inventory management process.

Managing your budget determines the scope of your inventory management process and how much cash flow your business can afford to invest in inventory. It is detrimental for your business to have the bulk of its cash flow trapped as inventory, it causes strains on other business activities that need funding.

There are two ways to organize your budget. The first way is to use ABC costing which identifies and adds cost to raw materials for effective planning in the long run. The second way is to use budgeting software to automate the budgeting process.

2. Plan Your Warehouse

After organizing and reviewing your budget, the next step is to plan your location. The warehouse is the location where your products are stored till an order is made.

Some companies have several warehouse facilities which necessitate the need for a more structured inventory management process. These companies use warehouse inventory management software to help track and manage their inventory levels across different warehouses.

Picking a warehouse is more than finding a vacant space where you can store your products. There are different kinds of warehouses, not all spaces are suitable for your products.

A steel manufacturer will have a different warehouse need from a frozen food distributor. Consider the best room temperature for your product to save yourself the trouble of ending up with damaged goods.

After you have chosen your warehouse facility, the next step is to manage the logistics of inventory. There are two ways to do this: either manually or by using inventory management process tools. Doing it manually is time-consuming and leaves a lot of room for errors since the human factor is strongly present.

The best way to implement an efficient inventory management process is to use an inventory management process tool or software. It helps you automate your inventory tasks and simplifies the process of transferring inventory from one warehouse to another.

3. Choose and Implement the Right Software

The third step in implementing an efficient inventory management process is to select the right software. Picking the right software and tools for your inventory management process is far from an easy task. Ensure you do thorough research before going ahead to pay for any software.

There is no lack of options when it comes to inventory solutions. They are abundant on the market, and there are even several free inventory management tools, which makes the choice difficult..

Despite the abundance of options, not all will contribute to the success of your inventory management process. If you are looking for inventory management software for a small business, ensure it does not have an insane price, contains the needed functionality, and is easy to use..

Consider the following factors before choosing an inventory management software.

Price Range

Choosing an inventory management software to track and manage your inventory management process first comes down to the size of your budget. An inventory management software may have all the functionalities you want but if it is way over your budget, there is little room to maneuver.

Setting a price range helps you narrow down the number of options available to you. Before you start looking at other factors, you first want to make sure the options available to you are within the limits of your budget.

Understand Your Real Needs

What do you plan to use the software for? Before you go-ahead to implement the inventory management software, you have to first understand how it can help solve your real needs. Different inventory management tools in the market cater to different needs and want.

When choosing an inventory management system, look out for the following:

  • Does it support process automation backed by artificial intelligence? Smarter process automation helps you relieve most of the menial tasks from your worker’s workflow. It also improves inventory accuracy, reduces costs, delays, and waste.
  • Does it provide full data transparency including complete data analytics? You need this feature to help you make more accurate decisions. Full data transparency provides you more valuable strategic insights and helps you make better demand forecasting.
  • Does it integrate with the existing software used by your sales, accounting, and marketing department, as well as your entire procure-to-pay (P2P) process? Does it work well with your existing supply chain and supplier relationship management solutions?
  • Does it have a proven track record of longevity and performance with lots of positive reviews from clients across different industries?
  • Does it provide training and educational tools to help your employees adjust easily to the change?
  • Does it have a responsive customer support team?

Determine How You Will Track Inventory

How you plan to track your inventory is an important factor to consider when looking out for the best inventory management process solution. Do you plan to track your stock inventory using RFID tags, barcodes, or serialization?

Not all inventory management process solutions can use any method for tracking your inventory, especially solutions targeted at small to medium-sized businesses. It is necessary to ensure that the inventory management software you pick is compatible with your inventory processes.

Using an inventory management process solution that is incompatible with your method for tracking inventory is inefficient and more costly compared to if you had used no solution in the first place. To avoid this, define your tracking method before choosing an inventory management solution.

Decide What Integrations You Would Need

When choosing an inventory management software, it is of utmost importance to choose one that can integrate with your current software and tools.

If you choose an inventory software that cannot integrate with your existing business software, you face the time-consuming activity of entering all data manually. You are also at risk of data loss and time delays when transferring data from your business software to the inventory management software.

Your inventory management software should integrate with your existing business software such as accounting, enterprise resource planning (ERP), and customer relationship management (CRM) software.

Inventory Management Process FAQ

What Are the Types of Inventory?

There are four main types of inventory commonly used by businesses. They are raw materials, Work-In-Progress (WIP), finished goods, and maintenance, repair, and overhaul (MRO). 

Raw materials refer to materials that a company uses to create finished products. For example, in a chocolate factory, cocoa and sugar are the raw materials. When the finished products are made from raw materials, the raw materials are unrecognizable from their original form.

Work-In-Progress inventory refers to raw materials that are sent for processing but are not yet converted into finished goods. It is the middle ground between raw materials and finished goods. When raw materials are being worked on, it is called work-in-progress inventory. It includes raw materials, labor, and overhead costs.

Finished goods are the final items that you are ready to sell. It is the most straightforward inventory type that everyone can easily understand. Finished goods go through production and quality check before it is put up for sale. Any inventory you see on a website falls under finished goods.

Raw materials, work-in-progress, and finished goods are the three main types of inventory accounted for in a company’s financial account. 

Maintenance, repair, and operating supplies (MRO) inventory refer to supplies that support the production of a product or the maintenance of a business. It is also known as overhaul inventory. 

Although they are not accounted for as inventory items in a company’s financial record, they play a crucial role in the production process. They help maintain and repair equipment, tools, and machines used in the production process.  

MRO inventory is necessary for assembling and selling the finished goods inventory but they are not part of the product. It is mostly relevant for manufacturing industries. Examples of MRO are uniforms, gloves, pens, paper, highlighters, lubricants, nuts, screws, and more. 

How to Manage Inventory More Effectively?

There are many ways you can effectively manage your inventory for increased profitability and cash flow management.

The first tip is to prioritize your inventory. Dividing your inventory into different categories based on their priority helps know which items are fast movers and which are slow movers. It is a good practice to segregate your inventory into three groups: A, B, and C.

Items in group A are high-ticket items that are slow-moving and you only need few quantities, while items in group C are the low-ticket items that are fast-moving items you need to turn over quickly. For group B, put items that move out too slowly to be in group C and move out too quickly to be in group A.

The second tip is to track all information about your inventory. Ensure that you keep detailed records of every item in your inventory. The information you want to track includes stock-keeping units (SKUs), barcode data, suppliers, countries of origin, and lot numbers. 

Another tip is to audit your inventory regularly. Different businesses have different timeframes for auditing their inventory. Some do it once a year, others monthly, weekly, and even daily. Physically count your inventory regularly to ensure that what you have on records matches up with what you have.

Another way to manage your inventory more efficiently is to practice the 80/20 inventory rule. The popular rule states that 80% of your profits only come from 20% of your inventory stock. Find that 20% of your inventory stock that generates four-fifths of your company’s profit and prioritize them.

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Anastasia Belyh

Editor at FounderJar

Anastasia has been a professional blogger and researcher since 2014. She loves to perform in-depth software reviews to help software buyers make informed decisions when choosing project management software, CRM tools, website builders, and everything around growing a startup business.

Anastasia worked in management consulting and tech startups, so she has lots of experience in helping professionals choosing the right business software.