What is Inventory Management? Definition, Methods, Techniques
Regularly evaluating your business keeps you on the right track for success. There are several areas of your business you need to focus on, such as sales, email marketing, and inventory.
Inventory management is an integral part of business management. Having a constant idea of your inventory can make or mar your business. It is not a fun feeling when you lose customers who are willing to buy your products because the items requested were out of stock.
Proper inventory management helps you make smart reorder decisions. Buying excessive stocks, especially when they are perishable, is a huge problem associated with poor inventory management.
This article will discuss everything you need to know about inventory management, including methods, techniques, best practices, and tips that work.
Let’s get started.
What is Inventory Management? A Short Definition
Before we can define inventory management, we have to clear the air on the meaning of inventory. Inventory is the number of goods that a business buys to sell to its target market. These goods could be physical or intangible products.
Inventory management is the process of ordering, handling, storing, and tracking your business inventory from the purchase stage right to the sales stage. It is a system that helps you maintain a steady flow of goods for your business at the right time and in the right location.
According to Investopedia, inventory management refers to “the process of ordering, storing and using a company's inventory. This includes the management of raw materials, components, and finished products, as well as warehousing and processing such items.”
Proper inventory management alerts you when your stocks are running low. It stops you from buying excessive stocks. Every business, both small-to-medium scale business and large organizations need it.
The goal of inventory management systems is to give the user information about the inventory levels at all times. It provides business owners an idea of the number of products your business needs to run successfully.You can integrate your inventory management system with other eCommerce software and database software.
Benefits of World-Class Inventory Management Execution
When you execute world-class inventory management processes for your business, you add more value to it. Once you get your inventory management properly organized, the rest of your supply and distribution management systems will be an easy walk.
Some of the benefits of running a word-class inventory management execution include:
1. Less Waste and Lower Costs
Proper inventory management execution helps you reduce wastes and lower your inventory holding costs and write-offs. With it, you will not overbuy or underbuy stocks but get the right amount your business can handle.
When you use inventory management systems, you can optimize your inventory levels for more efficiency.
Save extra costs you would have spent on storage space and maintenance when you use world-class inventory management.
2. Improves Staff Efficiency
World-class inventory management execution requires a high-level of automation for maximum productivity and success. When you set up a proper inventory management system, you save time and human resources on inventory tasks that can be automated.
With the benefit of automation, your staff can focus on more high-value tasks and leave the low-value and time-consuming inventory tasks for computers. This method helps produce more accurate inventory and increases staff productivity.
3. Better Inventory Planning
When you set up an inventory management system, you can have a rough idea of the number of products your business needs at any time interval. This statistic is useful for long-term inventory planning and other related company planning.
For example, your business will know how much it spends on the various inventory management processes. With this information, it can now use it to plan better business budgets and objectives.
4. Improves Cash Flow
Inventory management makes your business cost-efficient and improves cash flow. With inventory management, you know the number of products your consumers purchase, and you can plan for the purchase accordingly.
It prevents you from spending too much cash on products that will sit in the warehouse for a long time. You can use the money saved to spend on other areas of your business.
Types of Inventory
There are four inventory types: raw materials, works-in-process (WIP), maintenance, repair, and operations (MRO) goods, and finished goods.
1. Raw Materials
Raw materials refer to the materials that are yet to be processed or are in a semi-processed form. They are the ingredients used to manufacture finished products.
According to Investopedia, ‘Raw materials are materials or substances used in the primary production or manufacturing of goods.’
Raw materials can be the item you purchase from a supplier or the ones your business produces. For example, a soap-making business could buy raw materials such as lye, herbs, and essential oils from a supplier.
For a candle-making business, the raw materials you need will be wax and decorative ribbons. If the business already produces this, it will use its products directly.
Raw materials are a type of inventory to manage and store with properly executed inventory management systems.
2. Work-in-Process (WIP)
The work-in-progress (WIP) inventory type refers to those unfinished goods going through the production stage but yet to be put up for sale.
This inventory type is strictly for businesses who manufacture their products and do not buy finished goods. The work-in-progress (WIP) inventory refers to products currently in the production stage and is not available for sale yet.
Let’s take the example of a candle manufacturing business. The work-in-progress inventory is those candles that are still drying and not packaged into their finished forms.
For furniture business, it refers to that furniture that is yet to go through polishing, painting, and packaging for sales and distribution.
3. Maintenance, Repair, and Operations (MRO) Goods
MRO goods are an interesting inventory type that does not transition into finished products. This inventory type refers to all the materials used to facilitate the development and production of finished goods.
In the process of production, the Maintenance, Repair, and Operations (MRO) goods get consumed. They are expendable inventory whose sole purpose is to help produce the company’s products. The company does not sell them directly to the market.
For example, candle-making companies use disposable molds to make all kinds of candles. These disposal molds do not make it to the company’s store for sale to consumers.
It is important to note that materials that are not finished products but used in the production stage should make your inventory list. These materials used, which may not be the company’s direct products, need to be tracked. The reason is that they support and facilitate the production of the finished goods.
Some common forms of Maintenance, Repair, and Operation (MRO) goods include:
- Production and repair tools
- Cleaning supplies
- Safety equipment
- Uniform equipment
- Computer systems
MRO goods are either consumed or discarded during the production of the company’s finished product. Although they serve a temporary but important purpose, there is a need to create an inventory for them. Without the MRO goods, it is impossible to produce the company’s goods.
While this inventory type may seem relevantly insignificant to the business profits and cash flow, they still need to be accounted for in financial records. They include purchases from suppliers and storage, which counts as inventory.
4. Finished Goods
These refer to products that have gone through the production and preparation stage and are available for purchase. They are those goods that the business produces itself or buys in finished form from a supplier.
The finished goods inventory does not go through any further development. They are stored in the warehouse in a ready-for-sale state. Retailer business models purchase finished products from a supplier or hire a manufacturer to produce custom products for them.
An example of a finished product for a candle-making company is the finished candle which is ready for sale.
Finished goods can be broken down into other forms. These forms explain the difference in what constitutes finished goods across industries. They give businesses more options for improved allocation and management.
1. Ready for Sale
It refers to products that have either been manufactured or purchased and stored in the warehouse for the market. They are also known as ‘available inventory.’ Once an order is made, they move out immediately to the desired location.
This type of finished goods refers to those goods that customers have already bought and cannot be resold. They are stored in the warehouse temporarily to ship to customers who have pre-ordered them.
It is important to separate them from ready-for-sale products. The allocated ‘finished goods’ inventory usually has a sales order attached to it to separate it from available inventory.
It refers to inventory that has not yet been purchased but has been moved from one location to another. An example is goods being moved to a new warehouse. It can also include goods that have been ordered but are still in-transit to the recipient.
This type of finished goods refers to those purchases that are produced or manufactured to cover the rise in demand for the goods on certain holiday periods. Every manufacturing or retail business has its peak season. For example, during Black Friday, you produce more goods to meet up to the demands.
This type of finished goods inventory refers to items manufactured or produced to protect the company from unforeseen circumstances such as defaulting suppliers.
5. Packaging Materials
The packaging material inventory is one of the least popular types of inventory in the market. It is usually under finished goods.
Packaging materials refer to any item you use to wrap, package and protect goods. They are the protections you use to prevent your finished goods from damage while in storage or during the shipping stage.
Every product has some form of packaging material used. Online retailers use these materials for packaging their goods. Some of the forms of packing materials include
- Bubble wrap
- Packing chips
Many businesses do not think of packaging materials as part of their inventory. Although the packaging cost is minimal and not easily noticeable, it is vital to include it in your overall inventory management and reporting.
Inventory Management Techniques and Methods
Inventory management is only as effective as the way you utilize it for your company. Getting your inventory management running at its best requires the use of proper techniques and methods.
These techniques and methods may cost you time and money to execute, but they are well worth the risk. Selecting the right ones to utilize in your warehouse is not the simplest of tasks.
Small business inventory management is easier to manage than that of large corporations. As your business grows, the more difficult it is to manage your inventory. You will need to utilize advanced techniques and methods to deal with the growing inventory load.
Let’s review some of the best inventory management techniques and methods that work for both small businesses and large companies.
1. Bulk Shipments
Bulk shipment is a technique that involves buying inventory in bulk with the assumption that such a large-scale purchase is cheaper than buying in smaller pieces.
When you buy a product in bulk, the seller often attaches a discount to it. The bulk shipments technique helps businesses to bring down the cost of acquiring products.
This method is common among large organizations and ideal for businesses with large market demand. However, the method can prove problematic with sudden changes to the demand pattern (fall in sales).
It is a cost-efficient method that saves the company cost per unit purchase. Businesses apply the technique for goods with high customer demand.
While it may save you money in terms of unit per product purchase, it requires some extra costs such as warehousing costs. Except the product is a fast-moving one, the cost of warehousing can rise steeply over time.
The bulk shipment method can save businesses from running low on supply in the case of contingencies or shortages.
There are clear financial benefits from using the bulk shipments technique for your inventory management such as low cost and abundance of supply.
However, it requires you to commit a large percentage of your company’s capital to the purchase. This commitment cuts down the resources you have as working capital for other needs.
The age-long bulk shipment inventory technique is one of the oldest inventory techniques in the world. It is not recommendable for all businesses. You can only utilize this technique if you are sure that you can sell the bulk products in good time.
If there is no demand for your project, or you cannot foresee finishing the bulk shipment supply before it perishes, it is best to try other more suitable inventory management techniques.
Pros of Bulk Shipment
- Highest potential profit rate for businesses.
- Low shipment costs.
- Perfect for goods with a predictable demand pattern.
Cons of Bulk Shipment
- Higher Risk Attached. Goods are at a higher risk of damage or spoilage with this technique.
- Increased warehousing costs.
- Fluctuating demand can cause huge problems.
- High labor costs.
- Higher inventory audit cost.
2. ABC Inventory Management
The ABC Inventory Management technique is a simple way to organize and track your inventory. It is roughly based on the famous Pareto Principle.
The Pareto Principle was invented by an Italian economist Vilfredo Pareto and states that for many outcomes roughly 80% of consequences come from 20% of the causes. It is also called the 80/20 rule.
Here is how the principle works. If you are working on an assignment at the office, only 20% of your input (time, resources, effort) influences 80% of the output (results, rewards).
The ABC Inventory Management brings a loose form of the Pareto Principle to inventory management. According to the ABC inventory management technique, 80% of your inventory’s value comes from 20% of your total inventory.
The ABC technique helps you pinpoint the valuable 20% and encourages you to organize your inventory around it.
Here is how to use the ABC inventory management technique successfully.
- Calculate the number of inventory per product you receive in a year.
- Assign a value to each product and set a goal for them. A perfect example of a goal would be to bring down the purchasing cost of the product.
- Categorize each item based on the value they bring to your business. You will have three categories: A, B, and C.
The A category represents high-value items, those items that yield the biggest profit for your business.
The B category is in the middle range, they are not as valuable as A but more valuable than the last grade. The C category has the lowest value and yield.
The idea of the ABC inventory management method is for businesses to devote more controls, time, and safety measures based on the ABC classification. For example, items that are in the Category A inventory will require more frequent management and be kept in the safest spot in the warehouse.
For items that are in the last grade, Category C.they will experience a loose approach to inventory management. With this technique, businesses can focus their inventory attention on the goods that have the best value for them.
Pros of ABC Inventory Method
#1 Save Money
The ABC inventory method saves companies money by helping them identify their most valuable inventory product and set their focus on protecting and controlling it. With this method, companies will be more efficient at inventory management.
Items that are in the C classification will not consume similar or more inventory resources than those in the A and B classes. Your company’s productivity and profit will increase when you focus more on the A classified items.
#2 Better Inventory Planning
Businesses have limited resources. There are times when businesses will have to make tough inventory choices based on the funds available.
When faced with this dilemma, companies can use the ABC inventory method to identify what products they can afford to understock and those that they cannot.
The A classified items are the ones that the business cannot afford to understock, while the C are the easy targets for defunding and purchasing cuts as a result of tight budgets.
#3 Protection of High-Value Stock
With the ABC inventory method, you can better organize your inventory for more efficiency. Dedicate more time and resources to handling high-value stock in the A category. This method allows for better protection for your most valuable items, which contributes 80% value to your company.
For example, you can place items in the C category at the more open part of the warehouse, then the B category will follow, and then the A category. The A category will take up the part of the warehouse with the best protection.
Cons of ABC Inventory Method
#1 Prioritizes A Small Number of Products
The ABC inventory method encourages businesses to prioritize items in the A category above those in the B and C categories. While this may help increase profits, the problem is that businesses tend to neglect the B and C category, which can cause you to lose money from that side of the business.
#2 Does Not Work For One-Product or Same-Value Businesses
The ABC method does not work for businesses that have only one product or where every product manufactured has the same value. It is also hard to determine which products fall into categories A, B, or C.
There is no real science behind the classification. It is premised on the assumption that business owners can tell which of their products fall into the various categories.
Backordering is a simple inventory method where a company receives offers and payments for goods that are not yet in its inventory. Instead of losing customers due to finished inventory, you can use backordering to allow customers to make orders even when you do not have enough products in stock.
This method has numerous advantages for businesses, one of which is that the company does not use its fund to purchase the inventory. It is the customer order and payment that pays for it. It is a common method used by retail businesses.
Also, businesses can make accurate inventory purchases, since they know the exact amount of people that want to purchase the product.
Backordering is a dream for most businesses, but it can quickly become a logistical nightmare if you do not handle it well. The method works best when you have only one out-of-stock item.
In this way, it is easy for you to create a new purchase order for that single product and inform customers of the expected delivery time. However, when it is for multiple products, tracking the orders can easily become a logistical nightmare.
Backordering increases your sales despite the unavailability of the item in your store. Because it is more favorable to use the backordering method instead of the out-of-order tag, many businesses are favorably disposed to the method.
Customers are more willing to wait on orders if the item value is huge. Items with smaller value do not enjoy as much backordering success as those with high value.
Retailers use the backordering inventory method to save themselves from the possibility of overstocking items. They use “Pre-order” or “Get yours when it comes back in stock” tags to create an expectation in the customer that the product will take time to deliver.
Some businesses work 100% on a no-stock approach. They collect pre-orders from customers and then buy in bulk.
Pros of Backordering
#1 Increased Sales
Backordering helps businesses boost their sales despite the problem of out-of-stock products. Through this method, customers can make an order for a product, and the business moves to get that product to them.
#2 Increased Cash Flow
The cash flow available to your business increases with the backtracking inventory method. With this technique, businesses can reduce the amount of cash they commit to buying inventory at once. The money can be utilized for other business needs.
#3 More Flexibility for Small Businesses
Backordering is an effective inventory management technique suitable for small businesses that do not have the resources to manage large inventory. Small businesses can sell as many products as they want with this method.
#4 Lower Risk and Holding Costs
The inventory risk associated with this method is low. Since the business does not have the product in its inventory, it does not have to worry about the cost of maintaining them.
Cons of Backordering
#1 Customer Dissatisfaction
Customers can easily get frustrated at the delayed delivery time, or not feel favorably disposed to having to wait to get their products. It can cause you to lose customers.
#2 Longer fulfillment times
Backordering takes a longer time for fulfillment. The process of sale down to the delivery stage with backordering takes a longer time to reach than when the product is in stock.
4. Just in Time (JIT)
Just-in-time (JIT) inventory management is a smart way of arranging your inventory designed to cut inventory cuts, increase efficiency, and decrease waste. With this method, you get inventory once your business needs it.
JIT inventory management is a technique that involves producing only the amount of goods demanded at that time. It is also called the Toyota Production System (TPS).
The technique was invented in Japan largely in the 1960s in response to the problem of limited natural resources. Because of the low amount of raw materials available, the country’s culture does not allow for any form of wastage.
Different inventory management systems based on the JIT techniques have come into prominence. They include IBM’s continuous-flow manufacturing (CFM), Motorola’s short-cycle manufacturing (SCM).
Today, the method is popular among many businesses. Companies like Tesla, Zara, Xiaomi, and Apple use this method.
The popularity and attraction of dropshipping have further increased the appeal of the JIT inventory management method.
It makes it possible for businesses to sell a product before they even purchase it. The business does not have to handle the inventory physically, they buy the ordered item from a third party and have them deliver it directly to the customer.
The JIT technique helps reduce the amount of inventory volume that a business has to manage. It is suitable for retailers who do not have much storage capabilities to handle the bulk purchase of their products.
When a business utilizes this inventory method, it eliminates the risk of dead stocks, Dead stocks refer to those inventories that spend a long time in the warehouse of companies and have high holding cost overtime.
The method is risky because it involves purchasing the item only when it is needed. It can prove problematic or result in customer dissatisfaction when you fail to deliver because of an unreliable supplier or an inefficient fulfillment system.
For a business to use this method, it has to be highly agile and have the capacity to deal effectively with the shooter production cycle. It must have access to reliable suppliers. A deep understanding of the important customer metrics such as customer demand and sales cycles is also essential.
Pros of JIT
#1 Improved Cash Flow
JIT reduces the number of products you keep in your wardrobe, thus saving you money that would have been tied with the purchase of these products. With these techniques, businesses have more cash to spend on other aspects of their businesses.
#2 Smaller Inventory Storage Costs
Your storage cost is at a minimum with the JIT technique. It is an ideal model for retailers who do not have a warehouse and do not want to worry about excessive holding costs.
#3 Solves The Problem of Deadstock
JIT prevents stocks from turning into deadstock in your store. You only purchase what is in demand, allowing you to accurately purchase inventory that matches your customer demand. The problem of stocks spending too long in the store is minimal with this method.
Cons of JIT
#1 Possible Fulfillment Problems
The method relies heavily on the ability of suppliers to deliver the products ordered on time. Once the supplier defaults, it puts the business under serious pressure and can cause a delayed delivery.
#2 Little Room for Error
There is zero room for error with the JIT technique. You have to accurately determine what the customer demands are to avoid deadstock. Customers that want a quicker delivery may not be too keen to wait for longer than 24 hours for delivery.
Consignment is an interesting inventory management technique involving retailers receiving stocks from wholesalers, but the ownership of the stocks is in the hands of wholesalers until the product is sold.
Consignment inventory management involves two main parties for it to be a success. They are the consignor (the wholesaler) and the consignee (the retailer).
The consignment inventory management method has benefits for both the wholesaler and retailer. Both enjoy higher sales with this method.
It is also safe for retailers as they can return any leftover stocks (in good condition) to the wholesaler without having to reimburse the cost of the goods. Retailers are only required to pay wholesalers when they sell the product.
The biggest challenge with this method is in maintaining the smooth flow of goods from the wholesalers’ warehouse, to the retailers’ store and then to the customers’ hands. All the process involved has to be done quickly to avoid customer dissatisfaction.
This technique requires a strong relationship between the consignor and the consignee. It is an inventory model built on trust, with some wholesalers not willing to take on the risk for some retailers.
From a wholesaler’s point of view, they carry more of the risks. Many wholesalers are adopting this method to boost their sales.
Pros of Consignment Inventory Management Technique for Retailers
#1 Retailers Can Offer A Wide Selection of Products
The consignment inventory management technique allows retailers to offer a larger selection of products to customers than they would if they had to pay instantly for every purchase. It is great for small businesses that do not want to tie down their capital on outright inventory purchases.
#2 Return Unsold Goods at No Cost
Retailers can return unsold goods in good condition to the wholesaler without worrying about paying a dime.
Pros of Consignment Inventory Management Technique for Wholesalers
#1 Test New Products
Wholesalers use this method to test their new products. Retailers are more willing to take on products with this method. Also, it transfers the marketing away from wholesalers to retailers.
#2 Product Performance Tests
Wholesalers use it to test how their products are performing on the market. They can use it to collect all sorts of information about their products.
Cons of Consignment Inventory Management Technique
#1 Uncertainty of Sales
Wholesalers spend money to ship the products to retailers, whole retailers accrue costs to maintain the product. When the product remains unsold, it results in a loss for both sides, with the wholesaler bearing most of the risk.
6. Dropshipping and Cross-Docking
Dropshipping is a business model that allows you to sell products without coming into physical contact with them. Your supplier produces the products, stores them, and delivers them to the customer. At no point does your business come in contact with what you are selling.
This inventory management technique is cost-effective for businesses that cannot manufacture and fulfill their products. It is one of the most popular inventory management techniques globally.
Cross-docking is a practice where incoming orders for your products are transferred immediately to outbound trucks trailers or rail cars for delivery. There are little or zero warehousings involved in the process.
For cross-docking to work, you need an extensive network of transport vehicles to carry your products to the customer. It involves transporting your goods from one vehicle to another. In the process, it might involve staging areas where products are assembled.
Dropshipping and cross-docking absolve you of the burden of storing the inventory and fulfilling it to your customers. Many online stores adopt these methods because of the cost reduction with the elimination of warehousing and shipping costs.
Cross-docking involves transportation logistics costs. Walmart is the perfect example of a company that uses the cross-docking inventory management technique. It is the perfect solution for perishable products that require quick shipping and products that have a stable demand pattern.
Pros of Dropshipping
#1 Increased Cash Flow
The dropshipping method requires zero inventory cost, which means that businesses have increased cash flow to run their businesses. It also eliminates the risk of going into debt as businesses do not have to purchase products and store.
#2 Low Inventory and Fulfilment Cost
Dropshipping helps to reduce the cost of inventory and fulfillment. The model helps businesses with low capital and resources to take care of the stages of production such as inventory and fulfillment. A third-party handles the storage, labeling, packaging, and delivery of the products.
Cons of Dropshipping
#1 Poor Customer Service
The customer service with drop ship products is poorer than when businesses handle it themselves. It can result in the loss of customers. Businesses that use this method have to rely heavily on the supplier for product quality and efficient delivery.
Pros of Cross-Docking
#1 Eliminates The Need for A Warehouse
Cross-docking does not involve the warehousing of products. Goods are constantly on the move from one vehicle to the other. It reduces warehousing costs drastically and makes goods shipment faster.
#2 Increased Customer Satisfaction
With the elimination of warehousing, customers receive their goods quickly. It improves customer satisfaction.
Cons of Cross-Docking
#1 Requires Transport Carriers
Although warehousing costs get eliminated, it requires a sufficient number of vehicles to operate efficiently. The lack of a large number of transport carriers makes it impossible to implement this technique.
7. Inventory Cycle Counting
The inventory cycle counting involves the calculation of a small part of a business’s total inventory on a fixed day. It does not require you to take inventory of all your products.
Inventory cycle counting is a common method used by businesses to accurately track their inventory from time to time. The method keeps your inventory holding cost low and helps you get your products to your customers quickly.
There are many ways you can utilize the inventory cycle counting technique for your business. Some of the best practices include count one category at a time, count categories based on seasonality, and mix up your cycle count schedule.
Count One Category at A Time – This type of inventory cycle inventory involves counting one category of inventory at a time.
Count Categories Based on Seasonality – This type involves counting categories that are in high demand during their peak seasons. You can easily spot and fix any issue you find with this method.
Mix Up Your Cycle Count Schedule – This type involves mixing up your cycle count to allow for greater flexibility in inventory management. It also shrinks the chances of employees exploiting the inventory system for theft.
Pros of Cycle Counting
#1 Cost-Efficient and Less Time
The cycle counting technique is cost-effective and does not exhaust a lot of valuable business time. Businesses can utilize that time for other pressing needs.
#2 It Does Not Disrupt Operations
Calculating one category at a time means that other products can continue regular operations without having to halt inventory.
Cons of Cycle Counting
#1 Less Comprehensive
The cycle counting technique is a less comprehensive inventory management method than its competitors. You only do a small portion of the inventory and do not have the full picture at the end of the day.
8. Inventory Kitting and Product Bundling
Inventory Kitting or Product Bundling is an inventory management technique where you group, pack and sell different products together. The technique is excellent for companies who sell separate items together.
When you make a sale, the inventory management technique automatically accredits the sales to each item sold together. Here are the various ways companies use the inventory kitting and product bundling technique.
1. Packed Sets
The packed sets refer to products packed into a bundle to make purchasing decisions easier for customers. An excellent example is the gift sets, where customers buy packaged gift items. It saves them the stress of having to pick each gift to put in the bundle.
2. Subscription Boxes
They refer to bundles that businesses use to sell multiple products to customers. It is beneficial to both the business and customers. Business gets increased order value, while customers enjoy the convenience and easy decision-making it brings.
3. Pre-Assembled Products
This type of inventory kitting is fantastic for businesses whose products require assemblage to work. You sell other parts needed with the product to your customers. This method will result in better service and customer satisfaction.
4. Custom-Made Products
When separate tracked items in your inventory come together to form a product, it is inventory kitting. For example, if cotton material and buttons were individual stock items in your inventory management system, when they come together to make a shirt, it can be considered inventory kitting.
Pros of Inventory Kitting
- It offers more flexibility and convenience options to customers,
- It improves the average order values and helps businesses gain more cash flow.
- Businesses can use it to sell off their deadstock.
- It helps keep inventory holding costs low.
Cons of Inventory Kitting
- If not done properly, it can lead to customer dissatisfaction
9. Lean Manufacturing
The Lean Manufacturing inventory management technique is a simple way of minimizing waste and improving efficiency for businesses. With this technique, there is very little room for waste. It is also called lean production or ‘lean.’
Businesses use this method to prevent overstocking their warehouses with excess products, to get ineffective and inconsistent processes, and to eliminate low-value tasks.
The Lean manufacturing inventory management technique consists of five principles: value, value streams, flow, pull, and perfection.
Pros of Lean Manufacturing
#1 Eliminates Waste
The Lean manufacturing technique helps businesses eliminate wastes in all areas including manufacturing and the warehouse.
#2 Worker Satisfaction
Workers gain massive satisfaction from the inefficiency and redundant tasks that are cut off from their workload. It improves workers’ efficiency.
#3 Lower Inventory Holding Costs
The cost of warehousing is lower with the lean manufacturing method. Businesses can use these savings for new product lines and other aspects of their businesses.
Cons of Lean Manufacturing
#1 New Inefficiencies
There is a danger of overusing lean manufacturing, which can see your profits drop drastically.
#2 Low Margin for Error
With lean manufacturing, you have to get all your calculations accurate, a single mistake can hurt your business.
10. Six Sigma
The six sigma inventory management method helps businesses improve their business performance while helping reduce excess inventory. Six Sigma is a data-driven method that prioritizes efficiency by seeking to reduce product inefficiency to the barest minimum.
The inventory management technique aims to improve production efficiency as high as 99.99966% over the long run. With this technique, you will produce better products for your customers and see your customer satisfaction and retention rates hitting high marks.
Six Sigma is a statistical model that improves the company’s production and warehousing process. There are two major types of Six Sigma: DMAIC and DMADV. Both types are all about improving the company’s production and inventory processes till it reaches the ultimate level of Six Sigma, 99.99966% product efficiency.
DMAIC is a five-step process that stands for define, measure, analyze, improve, and control measures. It is suitable and effective for improving your current business processes.
DMADV is better suited for developing a new business process, product, or service. It stands for define, measure, analyze, design, and verify. The process utilizes thorough data analysis to produce the desired results for your business.
Fortune 500 companies and other businesses use the DMADV process to develop a high-quality product or service. The six sigma inventory management technique cuts product efficiency and saves your business lots of money.
Pros of Six Sigma
#1 Eliminates Waste
The Six Sigma inventory management technique helps businesses cut down on their product inefficiency, thus eliminating all forms of waste in the process.
#2 High Customer Retention Rates
The technique is all about making your products as perfect as possible for customers. When customers get high value from your products, they will keep coming back for more and spreading the word about your products.
Cons of Six Sigma
#1 Time Consuming
The data-driven approach requires a minute-by-minute inspection to produce large volumes of data. It takes time to gather and then process the data. The process of collecting and analyzing it is often complicated and not suitable for small businesses.
11. Safety Stock
The safety stock inventory management technique is a simple method of ordering excess inventory more than what your target audience is demanding. It is super effective and helps prevent stock-outs due to unforeseen occurrences such as increased customer demand and sudden disruption in the supply chain.
The concept of safety stock is to have an emergency inventory that gives you more flexibility during emergency periods. It has a formula that when judiciously utilized can be a huge game-changer for a company's inventory management.
Safety Stock = (Maximum Daily Usage x Maximum Lead Time) – (Average Daily Usage x Average Lead Time)
Pros of Safety Stock
#1 Serves As A Backbone for Businesses
Safety stock can serve as an emergency inventory if the company experiences malfunctioning products, experiences a shortage of supply, or increased demand for products.
#2 Never Run Out of Stock
The technique ensures that businesses always have stocks in their warehouse at all times. There is no shortage of stocks with this method.
Cons of Safety Stock
#1 High Inventory Holding Cost
Businesses will have to spend more on inventory from the purchase to holding it in their stores. It will also reduce the amount of cash flow available to companies.
Best Inventory Management Software and Systems
Best Cloud Enterprise Resource Planning (ERP) Business Software Solution
NetSuite is one of the best inventory management software for businesses. It is a unified business management suite that offers multiple services for businesses such as CRM, HR, eCommerce, ERP/Financials, and inventory.
The cloud ERP business and CRM software have over 24,000 customers using its services from 200+ countries. It supports numerous languages such as English, German, Danish, French, Japanese, Korean, Chinese, Portuguese, Spanish, Russian, and lots more.
NetSuite offers businesses greater visibility and control over their businesses. It is a flexible platform that you can use to customize, configure and automate various aspects of your business.
With its native business intelligence feature, you get real-time analytics of your business process including your inventory from your dashboard.
Making inventory management decisions is simple thanks to the wealth of data displayed that helps analyze business approach and results.
Best Inventory Management Software for Growing Businesses
Zoho Inventory is an inventory management software that helps businesses increase their sales and keep track of their inventory. The software helps you run a more efficient business.
The software integrates with eCommerce platforms such as eBay, Amazon, Shopify, and other Shopify alternatives. It makes it easy for small businesses to expand their online presence with its multi-channel inventory management system.
Zoho Inventory helps you manage your offline and online orders. You can create backorders, purchase orders, and other order types with the software.
Track every item in your inventory efficiently with its batch tracking and serial number feature. It makes it easy to track the movement of your products from purchase to final shipment.
The platform is integrated with multiple shipping providers such as EasyPost. Businesses get real-time shipping rates and information about the available shipping providers.
Zoho Inventory works with other Zoho software such as Zoho CRM and Zoho Books. You can automatically sync all your contacts and other data for easy management.
Best Inventory Management Software for Small Businesses
QuickBooks has an online inventory management software that helps small businesses effectively manage their inventory. The platform allows you to manage your inventory in real-time. It shows you what inventory is coming into your warehouse and which one leaves it.
The software auto-updates your inventory as it moves in and out of your store. You can use the platform to effectively manage your orders from vendors, and organize them for easy reordering.
QuickBooks inventory management software informs users when their stock is running low, which helps prevent out-of-order situations.
Users can utilize its auto-calculation feature to calculate the cost of every item on their catalog using the simple first-in, first-out (FIFO) inventory management technique. You can get accounting reports about your business such as total sales, taxes, and fast-selling items.
The platform syncs with your eCommerce platforms such as Shopify, Amazon, and BigCommerce.
4. Stitch Labs
Best Inventory Management Software with Multiple Integrations
Stitch Labs helps you to manage your entire business operations in one place. The platform makes it easier for businesses to control and track all aspects of their businesses.
The inventory management software helps you gain control over your inventory. You can easily plan purchase orders, track receipts from vendors with its purchase order management feature.
You can use it to track your business landed costs such as manufacturing, import duty, freight, and others. The platform informs you when your stocks are running low, preventing you from experiencing low stock problems.
Stitch Labs’ inventory management software helps you manage your inventory in multi-location such as stores and warehouses. It automatically updates your inventory records as you buy, sell, or transfer inventory.
With the software, you can easily transfer your inventory from one location to another and track them effectively. Users get detailed reports about their stocks and other inventory statistics.
Stitch Labs integrates with eCommerce platforms, third-party logistics, accounting, and warehousing management systems. They include BigCommerce, eBay, Easyspot, Etsy, FedEx, Magneto, QuickBooks, PayPal, Shipwire, ShipStation, and lots more.
Best Inventory Management Software for eCommerce Businesses
SellerCloud is an all-in-one eCommerce solution that helps businesses seamlessly control their inventory, catalog, accounting, purchasing, shipping, and fulfillment. It simplifies the eCommerce process for businesses.
With this inventory management technology, businesses keep accurate tabs on their inventory, including details about where they are and the number of each product in-store.
When you are running low on items, SellerCloud immediately alerts you of the shortage. You can re-order directly from your supplier on the platform. The software always updates your product availability and status across all the channels you have.
There is no need for you to do manual stock updates, it automatically updates your record with every sale you make and restock.
SellerCloud is perfect for eCommerce businesses that have inventory in multiple warehouses. The software efficiently tracks these inventories. It can track all manners of inventories such as in transit and non-sellable types.
Best Product Data and Inventory Management Software
ChannelAdvisor is one of the best inventory management software that helps businesses to automate their inventory. It protects them from the risk of overselling their products and not quickly replenishing them with more.
The software assists businesses in launching and tracking their inventory across several marketplaces such as eBay, Walmart, and Amazon. You can automate the process of filling your inventory quantity and pricing across these global marketplaces.
With the platform, businesses save themselves the error of having duplicate product data which causes inaccuracies to the business accounting reports.
ChannelAdvisor helps businesses with little experience selling on different marketplaces to optimize their product to meet up the requirements. Users can utilize its powerful robust data transformation engine tools to improve and supplement their product and data.
The platform saves valuable time businesses would have spent manually, tracking and reevaluating calculating their inventory.
Best Inventory Management Software for Manufacturers
Katana is a manufacturing and inventory management software that helps small businesses to control their inventory from the manufacturing stage till it gets sold to the consumer. It is software that is packed with enough features for scaling small businesses.
The visual interface is easy to use, and its dashboard keeps users on track at all times about their inventory status. With Katana, businesses can see the inventory they have in stock such as raw materials and finished goods without having to do a manual count.
The movement of your inventory in and out of your store is tracked by the software. You get information about the number in transit, your orders awaiting delivery, and the current stock available in your store. It can also track your inventory across multiple warehouses.
Katana integrates with popular eCommerce and accounting software providers such as Xero, QuickBooks, Shopify, and WooCommerce.
The Inventory Management Process Step-by-Step
The inventory management process (IMP) is a subset of the larger supply chain management. It refers to the various methods that businesses use to record, track, and control their inventory. These methods have a huge impact on your business process.
Managing your inventory management process helps businesses gain both short-term and long-term returns from their inventory. A standard inventory management process covers the production stage to the final sale.
Businesses have to pay close attention to their products such as raw materials used for production, office supplies, and sale materials. It is important to note that every item in your physical inventory can play a role in either enhancing or depleting your business. How effective your inventory contributes to your business success lies in the manner you manage it.
Effective inventory management plays a crucial part in growing a business. Simple things like staying on top of your inventory can make you stand out from your competitors and attract more customers.
You can enjoy the benefits of proper inventory management if you gain the right understanding of the inventory management process. Businesses of different sizes can apply suitable inventory management techniques, methods, and software to boost their productivity and profitability.
Understanding the Inventory Management Process
All businesses should have a firm understanding of how the inventory management princess works. Even if the business does not rely on physical items, there is an urgent need for businesses to use the inventory management process to record, analyze and manage their stocks.
Building an effective Inventory Management Process (IPM) makes it easy for businesses to track, manage, analyze every item they own. When you do the process right, you get maximum workflow efficacy, higher return on investment, and lower business costs.
If you want to save expenses on your inventory, you need to optimize your inventory management process. The effect of this optimization can also impact other areas of your business such as supply chain management, customer relationships, and vendor relationships.
Core Inventory Management Techniques
Core inventory management techniques refer to the core techniques that businesses use to manage their inventory. They refer to the go-to popular techniques that both small businesses and large enterprises use to record, track, and control their inventory.
1. Inventory Control
Inventory control, also known as stock control, is a general inventory management term that refers to the process of cutting down inventory management costs. The technique believes that with these cuts, businesses can better optimize their return on investment, profitability, and meet customer demands.
For many businesses, there is no distinction between inventory control and inventory management. They are used interchangeably, with very thin lines of distinction.
The difference between inventory management and inventory control lies in their scope. Inventory management is the process of tracking all stocks to know the number of stocks to produce and present in your warehouse, when to restock, and what to restock.
Inventory control on the other hand focuses on regulating inventory that is present in the warehouse, the location of these inventory in a multi-warehousing system, and the maintenance and proper storage of these items.
2. Stock Review
The stock review refers to the act of comparing available stocks to the number of stocks you will need in the future. Doing stock review the traditional way (physical counting) leaves much room for error. Apart from humans' love affair with errors, it is also time-consuming and labor-intensive.
Businesses’ stock review needs are better served with the use of automation technology. This technology makes it easy for businesses to maintain minimum inventory levels and promptly reorder goods as stocks run low.
3. Cycle Counting
Cycle counting, also known as cycle inventory, is a technique of counting a portion of inventory at a fixed period based on a repeating schedule. Ultimately, every item in the warehouse gets counted but not at once. The period for counting the whole cycle is usually a year.
4. ABC Analysis
ABC analysis is a simple inventory management method that involves classifying your inventory into three groups based on their importance and quantity.
- The first group is the A goods. They are highly valued goods with a low available quantity.
- The second group is the B goods. They have a moderate available quantity and value.
- The third group is the C goods. They are low-valued goods with a large available quantity.
The ABC analysis allows businesses to properly analyze their inventory, and better delegate their resources to the various categories. For example, the first group consists of expensive products and requires the best storage conditions. However, they move slowly compared to other goods so businesses need to keep a smaller inventory for this.
The B and C groups are not as valuable as the A group but they sell faster and are needed in larger quantities.
ABC analysis works best when you use modern inventory management software instead of the physical counting method or outdated technology. Save your business time and labor costs associated with using an outdated or manual approach.
5. Just-in-Time (JIT)
The Just-in-Time (JIT) inventory management system requires in-depth analytics and precise logistic arrangements to ensure that customers get their goods instantly on-demand.
This method requires a lot of data to pull off. Some of the common data trends you have to watch out for with these methods include seasonal demand, geography, customer buying pattern, and more.
When you utilize the data gathered properly, there are a lot of immense benefits it brings to the table. For example, it reduces your storage cost by saving you from stockpiling inventory in your warehouse. It also reduces lead times.
However, when businesses fail to gather enough data to make an informed decision or get wrong data, the gains can easily be eroded. Just-in-Time (JIT) requires comprehensive data analysis tools to make it a roaring success for businesses.
Step-by-Step Inventory Management Process
Different industries use different inventory management processes, and even within the same industry, different businesses can utilize different processes based on their size.
A typical inventory management process will take the following steps.
Step 1: Goods Delivery
Goods are delivered from the supplier to a receiving warehouse. It could be raw materials, finished goods, and indirect materials that have boosted the business operation but are not utilized in the production cycle.
Step 2: Review, Sort, and Store Goods
The next step is to review, sort, and store goods in different stock areas in the warehouse. Large businesses have the advantage of having a larger storage space with well-defined compartments. Many large businesses even run multiple warehousing systems for their inventory.
Small businesses on the other hand do not have the resources to build well-segmented warehouses for their inventory. The warehouse of small businesses usually serves as the receiving department and stocking area. Businesses assign stock-keeping unit (SKU) codes to their inventory for easy tracking.
Step 3: Monitoring of Inventory Levels
Regular monitoring of inventory levels stored in your warehouse is an essential step in the inventory management process. You can monitor your inventory levels either by physical counts or by using automated inventory management systems.
Properly monitoring inventory levels helps you stay up-to-date about your available inventory. It saves businesses from common inventory problems such as dead stocks, stockouts, theft and fraud, and untracked orders.
Step 4: Placement of Stock Orders
The next step in the inventory management process is the placement of purchase orders. Once a customer orders a product, the sales department sends a stock order to the appropriate authority in the company for approval.
Step 5: The Stock Order Approval
The receiving authority then authenticates the purchase against existing data such as internal purchase requisition, original purchase order, and sales slip before approving it. Records of the approval are kept.
Step 6: Transporting Goods Out of The Store
After the approval of the purchase order, the next step is for the goods to move out of the warehouse. The goods are loaded in a vehicle and then sent directly to the customer as finished products.
If it is an internal purchase order, the stocks can be sent to manufacturing if the department made the request or sent to other departments that made requests for the goods.
Step 7: Updating the Inventory Records
With goods leaving the warehouse in the previous step, the next step involves updating the records to reflect the removal.
Step 8: Restock When Inventory Is Low
When you update your inventory records and discover you are running low on goods, it is time to restock. Contact your supplier to deliver new orders and track the progress of your order up to the delivery.
Thanks to advanced technology and robust artificial intelligence, businesses of all sizes can easily develop, implement and streamline their inventory control.
Inventory Management Tips and Best Practices to Save Money
Although different businesses utilize different inventory management techniques and processes, there are tips and best practices that work across all these divides. Best practices evolve with time and can help businesses save money and improve their inventory efficiency.
Here are the best inventory management tips and best practices you can utilize for your business.
1. Use Your Data
When inventory management was all physical, and there was no inventory management software, small businesses could not leverage large amounts of data about their inventory, Gathering these data proved costly.
Today, with a large pool of inventory management software to pull from, businesses can effectively leverage a large amount of data. The best source for any inventory management system is the company’s data.
The best inventory management involves the collection, aggregations, and recording of insights of your data. Whether you are a big or small company, your data can help you make better-informed decisions about your inventory needs.
A data-driven approach generates the results you need to improve your business, lower your cost and increase productivity and effectively across all levels.
2. Maximize Your Inventory Turnover
Inventory turnover refers to the number of times a business sold particular goods and reordered them, usually within a year.
When you maximize your inventory turnover, your business will experience a sharp rise in profits. With this tip, you can reduce your holding costs and effectively determine the best time for reorders.
3. Use the ABC Inventory Management Method
The ABC inventory method helps you maximize your turnover. Businesses that operate with multiple good types are best suited to use the ABC inventory style. All products are not created equal, they all have varying values assigned to them.
The ABC inventory method recognizes the huge different gap between products and helps businesses make better-informed decisions. Using the Pareto Principle “80% of all effects come from just 20% of causes,” the ABC technique splits products into three categories.
- A Products – High-value items with low quantity: They contribute about 70% of the company’s total inventory value and just 10% of the inventory goods.
- B Products – Moderate value items with moderate quantity: They contribute about 20% of the company's total inventory value and just 20% of its inventory goods.
- C Products – Low-value items with high quantity: They contribute about 10% of the company’s total inventory value and 70% of its inventory goods.
When assigning merchandise to these different categories, the B and C products take the bulk of quantity because they tend to move faster than the A products.
However, the A products are the most valuable and give the business its biggest profits per item. These A products should be kept in the safest part of the warehouse.
4. Forecast Demand
Another best practice for inventory management is to forecast demand for your products. Forecasting your demand is a tricky adventure that many businesses get wrong. Demand for physical products is volatile and hard to catch up with.
Some of the reasons why accurate demand forecasting has proved difficult include price changes, product ranges, external features like season varieties, promotional offerings, multiple sales channels, and more.
However, businesses need to plan for demand to optimize their inventory for the best results. If you depend solely on spreadsheets and data from your records, you may not get accurate results. Why? Because these past data do not take into consideration the present trends affecting demand.
With the introduction of intelligent inventory management systems, businesses across different industries and with varying sizes can automate the whole demand forecasting process. This switch gives more accurate results and takes into consideration present trends.
5. Use Automation As Much As Possible
Automation makes everything easier, more cost-efficient, and less labor-intensive. When you use workflow automation for your inventory management, you improve efficiency and lower your company’s dependency on humans.
Workflow automation refers to the process of applying technology to do work that would have needed manual labor to do. It helps the company save time, resources, and labor power that would have been utilized on these tasks.
Apart from automating your inventory management processes, you can also automate all parts of your supply chain. Automation helps accelerate business productivity and profitability. It frees up the workforce to concentrate on other aspects of your business.
Any business can apply workflow automation to its inventory management. Here is a breakdown of areas you can automate.
- The counting of your inventory.
- Keep inventory records across multiple channels and stock locations.
- Automate your purchase orders and backorders.
- Track your inventory in-transit to the customer or another location.
- Set future actions for different inventory situations.
- Receive alerts about low inventory.
- Apply bulk actions.
- Track your revenue.
6. Track by Batch and Expiry Date
Another tried and trusted tip to boost your inventory management is to track by batch and expiry date of your inventory. You can use this for raw materials to finished products.
When you track your inventory by batch and expiry date, you make it easier to trace the origin of the inventory, its expected destination, quantity, and lifespan.
Many companies, especially those with perishable products, track their inventory by batch and expiry date for several reasons:
Eliminates Spoilage of Inventory
The batch and expiry date inventory tracking method helps avoid inventory spoilage. It does this by making it easy for businesses to find out when the products will expire.
Helps Identify Which Products To Sell First
When you track by batch and expiry date, you can use the data provided to make an informed decision about what order to sell your items. Naturally, you sell the items with a shorter expiry date first before the ones with a longer one.
Ensures You Are Selling Quality Products
There are a few things more damaging to a business reputation than sending expired or substandard products to customers. Apart from increasing customer dissatisfaction, it gives you more customers spreading the bad news about your products.
When you utilize the batch and expiry date best practice, you avoid making the mistake of selling expired goods to customers.
7. Maintain A Stable Pipeline Flow
Pipeline in inventory management refers to those items that your customers have purchased but are still in your business’ supply chain. As long as the products haven’t reached your customers, you still track them as a part of the inventory.
Ensure that your pipeline is always flowing, and you are tracking it effectively. This act will prevent you from running into stockouts. Always seek ways to improve how long it takes to deliver the products.
8. Use Decoupled Inventory
Decoupled inventory, also known as decoupled stock is an inventory management practice that involves setting aside goods to serve as emergency supplies.
It provides an additional safety measure in the event of disturbance to the production or supply chain. The inventory you set aside for emergencies is called safety stock.
Decoupled inventory helps you reduce the risk associated with a complete halt of production or when there are stockouts. Businesses can fall back on these safety stocks to fix the problem in the short term while buying time to fix the inventory issue.
Decoupled inventory works best when you use it with pipeline inventory. When used correctly, they can help you strike the right balance between cost and risk for effective inventory management and business growth.
9. Use Inventory Kitting
Inventory kitting helps businesses to increase their average order value of the items in their inventory. It is also called “product bundling.”
The essence of inventory kitting is to sell separate products as a single bundle in form of packages. When a customer purchases one of these packages, businesses have to link the sale to the inventory records for the separate items.
Inventory kitting or product bundling has numerous benefits for businesses.
- It increases the average order values of products.
- It helps indecisive customers make a decision.
- It keeps inventory holding costs low.
- It is an effective way of selling deadstock.
- It makes it easy to track and maintain inventory levels.
Inventory Analysis: Inventory Management KPIs to Improve Performance
KPIs (Key Performance Indicators) play a key role in inventory management for businesses. By simply extracting, analyzing, monitoring, and acting on key inventory indicators that are relevant for your business, you can improve its quality.
When you use KPIs for your inventory management, you improve your profits, cash flow, and overall performance.
Finding the right inventory management KPIs can be difficult. Although these KPIs are comparable to global standards, small businesses and large organizations often find themselves having to rely on their objectives to choose or create the right KPIs.
Inventory management KPIs help businesses monitor their ongoing performance and reach their business objectives. Businesses will benefit immensely from categorizing their inventory and analyzing its performance.
Here are five inventory management KPIs that can assist businesses in reaping the full rewards from their inventory.
1. Inventory Turnover Ratio
Inventory Turnover is an inventory management KPI that measures the number of times an inventory is sold and replaced with another within a given timeframe. The time frame can be three months, six months, or up to a year, depending on the business preference.
The mathematical formula for this ratio is Cost of Goods Sold (COGS) / Average Inventory = Inventory Turnover Ratio.
When you analyze your inventory turnover, you get the clarity and accurate information needed to make informed decisions. Businesses can set plans for all levels involved in inventory management.
Inventory turnover ratio helps businesses to forecast their cash flow better, knowing when they will need to restock their inventory based on past performance.
With this KPI, it is easy to identify which products are underperforming in terms of sales. Businesses can use this information to set up plans to boost the sales of the underperforming sales lines and products.
When you utilize the inventory turnover ratio, you get more cash flow for your business and more shelf space to store more inventory.
The KPI helps to improve supplier relationships and inventory logistics. You can also slash the cost of transportation involved in inventory management if you properly apply the inventory turnover ratio.
2. Inventory Write-Off
Inventory Write-Off is an inventory management KPI that shows inventory that has no value for your company. It is different from the popular write-down, which refers to a situation where the inventory value depreciates. Inventory Write-Off represents a total loss of inventory value for your business.
There are many reasons why an inventory could be written off. They include theft, damage, and technological obsolesce.
Inventory Write-Off is the monetary value of the stock to be written off. The normal routine for most businesses is to allocate it to their company’s Cost of Goods Sold account, but this can distort your Gross Margin percentage. The better option is to create a separate Write-Off account for this purpose.
When using this KPI, you have to examine the cost of the inventory write-off to your business. If the write-off level is concerning, there is a need to examine deeper the reasons for it. Except it is necessary to correct your inventory, be cautious when you decide to tow this line.
The whole idea of inventory write-off is to scrape off slow-moving or non-saleable items to create room for more profitable options. Inventory write-off when done well can boost your inventory efficiency, productivity, and profits.
As a business, inventory write-off should be done periodically. Set up a process to track this important KPI.
3. Holding Costs
Holding costs is one of the most important cost factors in inventory management. Apart from holding costs, you also have shortage and fulfillment costs.
It is essential to find out where the holding costs apply to your business and the best way to determine its value. You need an inventory valuation method to determine the productivity and profitability of your business.
Holding costs, also known as carrying costs, refer to costs that a business incurs while storing and maintaining its inventory. Ideally, businesses want to keep their holding costs and other costs as low as possible. The first step to achieving this goal is to determine the business’ current holding cost.
Costs associated with holding costs include insurances, security, labor costs, costs of equipment used, and the cost of the space where the stocks are kept.
When calculating the holding costs for your business inventory, calculate it as a simple dollar value of the various costs associated with holding your inventory. You can calculate the various costs that make up the holding costs separately for better accounting but also group them for reporting purposes.
Tracking your holding costs from time to time can save your business costs and help you maximize opportunities for greater productivity.
For example, if your inventory levels drop due to shorter demand for products, you can rent out some of the available excess storage space to other businesses to cut down on your holding costs.
Understanding your holding costs will help you develop a suitable business template for your inventory management needs.
4. Average Inventory
Average Inventory refers to the median value of your business inventory over a set timeframe. Businesses use the average inventory ratio to reduce the effect of seasonal fluctuations on their inventory.
This inventory management KPI is an indicator that shows businesses the average volume of inventory they have in hand and how fast they are selling. It is a simple inventory ratio that helps businesses track the performance of their inventory over a certain period.
5. Average Days to Sell Inventory
The Average Days to Sell Inventory is one of the best inventory management KPIs that helps improve the company’s performance. This KPI checks the timeframe it takes for a company to create or purchase an inventory, and sell it to its customers.
Every business needs to calculate and know its average days to sell inventory ratio. They can utilize this information to improve the ratio or to use it to know the number of inventory they need.
Inventory Valuation Methods: FIFO, LIFO, WAC
There are three main types of inventory valuation methods: FIFO, LIFO, WAC. Before we dig deeper into what these various inventory valuation methods mean for business, we need to find out what inventory valuation is all about.
Inventory valuation refers to the total value of the products that make up a company’s inventory at the end of a particular period.
Finding the right inventory valuation method for your business is essential for growing your business. Some of the benefits of using the right inventory valuation method include increased productivity and increased profitability.
Here are three of the best inventory valuation methods:
1. First-In-First-Out (FIFO) Inventory Valuation
The first-in-first-out (FIFO) inventory valuation method refers to the ordering of inventory of items based on when they were manufactured or purchased. With this method, the first items produced or purchased are sold first before others.
The FIFO method is popular among businesses that deal in perishable goods. Many businesses use this method without even knowing about it. They sell products principally on the first-come-first-serve order, where goods are sold based on how long they have stayed in the storage facility or expiry date.
Companies sell their products based on the order in which they are purchased or produced. For example, a company bought shoes on two different occasions at different price points in a week.
The first set of shoes numbered one hundred, and each sold for $10. The second set of shoes numbered two hundred, and each sold for $20. Let’s assume that at the end of the week, the company sold a total of 50 shoes.
With FIFO, we use the price point for our first transaction to determine the value of the inventory sold, i.e the value when we purchase 100 shoes for $10 each.
After selling 50 shoes, we can use the simple Cost of Good Sold (COGS) to calculate the amount the business made from the sales. Here is how it is done.
COGS = (50 shoes x $10 FIFO cost) = $500
Remember we bought 100 shoes at $10 each, and only sold half of them. We also bought 200 shoes at $20 each and yet to sell them.
You can find the remaining inventory value by using this simple formula.
Remaining inventory value = (50 shoes x $10 cost) + (200 shoes at $20 cost) = $4,500
FIFO inventory valuation method helps businesses avoid stocks from spoiling in their storage facility. It is a no-brainer method that every company involved in the sale of perishable products or goods with an expiry date should use.
2. Last-In-First-Out (LIFO) Inventory Valuation
The last-in-first-out (LIFO) inventory valuation method is the FIFO inventory valuation method in reverse. It is a method where the most recent goods purchased or manufactured are sold first before any other ones.
The cost of goods sold using this method is higher while the inventory balance is lower when compared relatively with the FIFO method.
Here is an example of how businesses can use the FIFO inventory valuation method for maximum results. Let’s use the same example we used for the FIFO method.
A company purchases 100 shoes at $10 each first, and then later bought 200 shoes at $20 each, all in the same week. After selling 50 shoes, the value of the inventory sold using the Cost of Goods Sold formula will be:
COGS = (50 shoes x $20 LIFO cost) = $1,000
Remember we bought 200 shoes at $20 each, and only sold fifty, which leaves us with 150 shoes to sell. We also bought 100 shoes earlier at $10 each.
You can find the remaining inventory value by using this simple formula:
Remaining inventory value = (100 shoes at $10 cost) + (150 shoes at $20 cost) = $4,000
3. Weighted Average Cost (WAC) Inventory Valuation
The weighted Average Cost (WAC) inventory valuation method refers to the average cost of all items purchased during a given timeframe. It is a popular method used by businesses that do sell single products or do not have much inventory variation.
Let’s take the same example we used for the FIFO and LIFO inventory valuation methods. A company purchases 100 shoes at $10 each, and then 200 shoes at $20 each. Here is how you calculate the weighted average cost for this example.
We have to calculate the total number of goods purchased, i.e 100 shoes plus 200 shoes which gives us 300 shoes. Then we have to calculate the price of the goods purchased ($10 x 100 + $20 x 200) = $5,000.
To find the weighted average cost, use this formula:
Weighted Average Cost (WAC) = Total Cost of Inventory / Total Number of Inventory
WAC = $5,000 / 300
WAC = $16.67
The weighted average cost for this transaction is $16.67 per shoe sold.
After selling 50 shoes, here is how we will find the Cost of Goods Sold (COGS).
COGS = (50 shoes x $16.67 average cost) = $833.50
Remember we bought 100 shoes at $10 each, and only sold half of them. We also bought 200 shoes at $20 each and yet to sell them.
You can find the remaining inventory value by using this formula:
Remaining inventory value = (250 shirts remaining x 16.67 average cost) = $4,167.50
40 Inventory Management Terms You Need to Know
Inventory management is deeper than we often envisage it to be. Small business owners can quickly become overwhelmed with its systems, processes, and terms that come along with proper inventory management.
With these popular inventory management terms and their definitions, individuals with little inventory management knowledge and experience can talk like a pro.
- ABC Analysis refers to the method of classifying inventory items based on their value.
- Average Inventory is the sum of the ending inventory (EI) and the beginning inventory (BI) divided by two over a period.
- Average Inventory Cost refers to an inventory valuation method type that calculates the average cost of items over a timeframe.
- B2B is an acronym for business to business. It refers to a situation where a business buys products from another business
- B2C is an acronym for business to customer. It refers to a situation where businesses sell their products to consumers or when a consumer buys goods from a business.
- Back Order (BO) refers to an order a customer places on a product that cannot be immediately fulfilled to the customer because the company does not have it in stock yet.
- Barcode Scanner refers to any device that is used to identify items that have a barcode attached to them.
- Beginning Inventory (BI) refers to the value of unsold inventory at the start of the business calendar.
- Bundles are separate products that are assembled to sell as a single unit.
- Carrying Costs refers to the total cost involved in holding and storing inventory in a storage facility such as a warehouse until it gets sold.
- Co-Managed Inventory refers to a situation where inventory is managed by both the company and a third party
- Consigned Inventory is the process where suppliers retain ownership of the goods and do not charge you until a customer places an order for it.
- Consumables refer to any material which does not form a part of the final product but is essential to support its operations.
- Cost of Goods Sold (COGS) refers to all the costs involved in purchasing or producing goods such as materials, tools, and labor used. However, it does not include indirect costs incurred such as advertising and distribution.
- Cross Dock refers to a situation where a company receives inventory at their storage facility and instantly moves it from an inbound trailer to an outbound trailer with minimal handling or cost.
- Dead Stock refers to those stocks that are yet to be sold after a long time, beyond what can be considered sellable.
- Dropshipping refers to the process where businesses use a vendor to send goods ordered by the customer directly to them. With dropshipping, businesses never come in contact with the goods.
- Ending Inventory (EI) refers to the value of unsold inventory at the end of the business calendar period.
- First-In-First-Out (FIFO) is an inventory valuation method that operates on the principle that items purchased or manufactured first, should be the first to be taken out and sold from the warehouse.
- Inventory Count is the process of counting all the inventory you have in your storage facility by physical counting methods. It is also called a stock take.
- Inventory Shrinkage is an accounting term used to describe inventory items that have been damaged beyond repair, stolen, or lost between the time frame between its purchase and just before the sale.
- Inventory Valuation refers to the process of adding the monetary value of unsold inventory to the company’s total asset while preparing the financial records.
- Inventory Variant refers to the various variations that a company can store a single product in its warehouse. For example, a company can stock a particular type of shoe in various sizes and colors.
- Inventory Visibility refers to the ability of the business to know the number of inventory in their storage facilities, where it is, and how it is being used.
- Last-In-First-Out (LIFO) refers to a type of inventory valuation method where products that are recently added to the warehouse get sold first before other older ones.
- Lead Time refers to how long it takes a supplier to deliver products to your desired location from the moment you issue a purchase order.
- Multichannel refers to a retail model where products are sold in multiple marketplaces at the same time. The most popular multi-channels used by retailers involve the use of their website with other marketplaces such as Amazon, Etsy, and eBay.
- Omnichannel refers to a retail model where a business integrates all its sale channels into one platform.
- Order Fulfillment is the process of delivering sales orders from your storage facility directly to customers.
- Order Management is the process of organizing, managing, and fulfilling all the sales orders that a company receives. Every aspect of the process from receiving orders, to processing the payment, to the packaging, packing, and shipping of the product, down to the delivery and all aspects of customer communication is involved.
- Overselling refers to a situation where a business takes more orders for items more than what is available in store. The main cause of overselling is poor inventory management.
- Periodic Inventory Management refers to a type of inventory system that involves counting and updating your inventory through manual processes on a periodic basis.
- Perpetual Inventory Management refers to a type of inventory system that involves the use of automated processes to track your inventory so it stays up to date at all times.
- Pipeline Inventory refers to any inventory (manufactured or purchased) that is on its way to the company’s storage facility but it is yet to reach them.
- Purchase Order (PO) is a commercial document that a business gives its supplier that contains details about the items, quantities, and prices. Businesses use this document to add new products to their inventory.
- Sales Order (SO) is a commercial document that a business gives its customer when they make a purchase. The document contains details about the products to be received, and the price to be paid or owed.
- Scientific Inventory Control refers to the process of using mathematical models to find optimal ordering policies and stock levels.
- Stock-Keeping Unit (SKU) refers to unique alphanumeric code attached to different inventory types in storage facilities to make it easy to organize and identify the different products.
- Supply Chain refers to the complete flow a product passes through from manufacturing till it reaches the final consumer. The products in the supply chain could include raw materials to finished goods. All stages the product goes through such as manufacturing, warehousing, and fulfillment are part of the supply chain process.
- Third-Party Logistics (3PL) refers to the use by companies of third-party businesses to handle the processes involved in inventory management on their behalf. It includes the warehousing of the product and the fulfillment to the customer on behalf of the company it is serving.
Common Inventory Management Questions
A warehouse management system refers to the process and software used by businesses to control and manage the day-to-day warehouse operations.
According to TradeGecko, “A warehouse management system (WMS) is software that allows for visibility, maintenance, and improvement of your warehouse’s overall operations and processes.”
The warehouse management system shares a lot of similarities with the inventory management system. It monitors and tracks all the happenings in multiple warehouses irrespective of their location.
With the right warehouse management system, businesses can effectively control their inventory and warehouse operations such as collecting goods, fulfillment, and distribution.
The reasons why businesses use inventory management vary from one business to another based on industry and size. However, across businesses, they are necessary goals behind the adoption of inventory management.
The necessary goal of inventory management is to make it easier for businesses to organize their inventory activities through automated and streamlined avenues. Increasing the visibility of inventory is another goal businesses have behind using inventory management for their stocks.
Simply applying smart inventory management techniques to your business gives it the boost it needs to perform efficiently for more productivity and profitability. Small businesses can save costs including holding costs and labor costs from utilizing the right inventory management techniques.
The best way to measure your success as it concerns inventory management for your business is to use numbers to track it. Compute your data before you start using inventory management techniques and compute the ones you recorded after using inventory management techniques.
Put the results side by side and compare your performance. If your inventory statistics improve after using inventory management techniques, it is proof that you are gaining some level of success from it.
If your inventory statistics decline after using inventory management techniques, it is proof that you are not utilizing it well or using the wrong techniques.
Ask yourself these questions. Have your out-of-stock levels dropped? How about mis-shipments and mis-picks? Has the number of dead stocks in your inventory fallen?
If your answer is yes for all this, congratulations, you have successfully implemented inventory management.
The team responsible for the inventory management success depends on the structure of the company. In many companies, they use the all-hands-on-deck approach, which means not one person is accountable for inventory management success.
If you want to see inventory management effectiveness for your business, allow several teams to be responsible for different parts of the inventory workload instead of one team.
For example, put the purchasing team in charge of the purchase order. Let them know they are accountable for making sure that they are not over or under-purchasing items. Every purchase order should be monitored by the purchasing team.
The merchandising team is accountable for the proper listing, promotion, and prices of the inventory.
The warehouse team which is headed by either a warehouse manager or inventory specialist is accountable for handling all inventory. If the business has multiple storage facilities, they are responsible for delegating proper stock levels in each location.
Apart from these tasks, the warehouse team is accountable for more inventory management tasks. They include managing the reception, picking, and shipment of goods. The team is tasked with ensuring that the process of picking, packing, and shipping goods run smoothly.
Reporting is the number only factor that should determine ordering frequency. The importance of reports to the inventory management process cannot be overemphasized.
Businesses can use their sales reports to determine ordering frequency, especially during the peak season. By looking back at the numbers sold in the previous seasons, businesses get a rough idea of the demand to expect and can plan more effectively towards it.
Purchasing decisions are made a lot easier with the right information. Reports are the go-to place for accurate information about your business.
You can also break down sales reports into various channels to get a better knowledge about what stocks sell best for each channel and the demand quantity.
Peak seasons are the best period for businesses to make sales for their products. It is the period in the year where the demand for a particular product is high, and the time where businesses generate the most revenue.
To enjoy the immense benefits of peak season, you must have proper inventory management in place.
If you have experienced peak seasons as a business, and yet to maximize its potential, or you are nearing your first peak season, here are some helpful tips to help you maximize the opportunity.
#1 Check your inventory levels and ensure that they are all correct.
#2 Check your shipping supplies and ensure that they are properly stocked and all set for usage.
#3 Hire extra hands if needed to help your company better manage the higher demand levels during this period.
#4 Use past reports about your sales record to help you make an informed decision about the right amount of inventory to have in the warehouse.
#5 Ensure that all stocks are in their proper locations.
#6 Use inventory management software. It makes your inventory management tasks easier. Inventory management software can help you better accommodate high demand and fluctuations during the peak season better than you can do manually or with a spreadsheet.
As an inventory manager, you need to master the following inventory management skills: direct reports, customer service, inventory control, inventory levels, logistics, and interpersonal skills. You also need to have the ability to pay attention to details.
The best inventory method for most businesses is FIFO (First-In-First-Out). It is the best because it represents the actual flow of inventory that most businesses use.
The FIFO inventory method means that businesses sell their products based on how long they have stayed in their storage facility. Old products get moved out of the warehouse before the newer ones.
FIFO provides an accurate view of cost and profitability. Businesses that deal with perishable and expiring goods use this method.
The difference between warehouse management and inventory management lies in the human factor. Inventory management has its focus on the effective management of products, while warehouse management involves managing warehousing logistics and employees.
Inventory management takes a simpler approach by emphasizing one central system, while warehousing management is more complex and involves divisions of warehouses into compartments.
Every business needs to control its inventory for it to be successful. The difference between inventory management lies in its definition and scope.
Inventory management consists of all the activities a business takes to manage and maintain its inventory levels and demands. According to Investopedia, “Inventory management refers to the process of ordering, storing and using a company's inventory. This includes the management of raw materials, components, and finished products, as well as warehousing and processing such items.”
Inventory control on the other hand refers to the various practices implemented or adopted on the inventory between the time when it is purchased from the supplier to the time it turns into a final product for sale.
According to TradeGecko, “Inventory control, also known as stock control, is regulating and maximizing your company’s warehouse inventory.”
The scope of inventory management involves tracking your inventory to know when to restock, what to restock, what to produce, the amount to produce, what price to sell at, when to sell, and other inventory questions.
Inventory control on the other hand refers to the regulation of stocks in the warehouse. Its focus is on knowing the number of stocks available in the warehouse, the location of the warehouse, and the maintenance of the products.
Take Your Retail Inventory Management to the Next Level
Inventory management plays a key role in the success of any retail business. The benefits of inventory management for businesses include increased productivity and profits, increased return-on-investment, lower labor costs, lower holding or storage costs, and better inventory efficiency.
The best way to take your retail inventory management to the next level is to use inventory management software. Using software for your inventory management has more advantages for businesses than physical count or the use of spreadsheets.
There are many inventory management software available for businesses in the market. NetSuite is the best Cloud Enterprise Resource Planning (ERP) software solution for businesses. Zoho Inventory is the best inventory management software for growing businesses.
If you own a small retail business, the QuickBooks Inventory Management software is the best fit for you. Stitch Labs is the best inventory management software with multiple integrations, while SellerCloud is the best inventory management software for eCommerce businesses.