June 28, 2017      3 min read

Inventory is vital for any goods sector business; retailers and wholesalers rely on inventory for sales, while manufacturers need inventory to keep the production process running. Being able to accurately determine inventory levels is important – too little and your business can’t function; too much and your business risks being swamped by inventory carrying cost. Let’s look at some of the key reasons why accurate inventory levels are so important.

Preventing understocking

Running short on inventory is a critical error. Stock outs not only directly cause a loss in business sales, but also erode customer loyalty. A great reputation is hard earned and easily lost, and failing to fulfil orders due to insufficient stock is an easy way to compromise your business’ positive image.

Accurate inventory levels prevent understocking by ensuring that staff have the right signals to reorder inventory, and by maintaining appropriate levels of safety stock. If staff follow a reordering rule, such as order more bolts after inventory drops below 500 units, or if reordering is automated, it is critical to ensure that the inventory count that triggers this process is accurate. If the number of bolts in stock is overestimated and reordering does not occur until inventory drops to 200 units, the business risks not being able to get the required inventory in stock in time. In this example, assuming the bolts are a critical component, the particular risk is needing to stop the entire production line until more stock arrives.

Preventing overstocking

Likewise, accruing too much inventory can have negative impacts on your business’ bottom line. Procuring inventory is often expensive, and each item of stock that is needlessly purchased costs the business money that may be better invested elsewhere. Stock that sits waiting in a warehouse is held at your own risk (or your insurer’s). The likelihood of shrinkage and obsolescence increases with the amount of stock that is owned. Additionally, costs such as storage and handling increase with inventory – and can readily add up. Although holding some safety stock is necessary to prevent stock outs, it is important to keep this buffer stock at reasonable levels.

Clearly understanding the amount of stock on hand is important to prevent an unnecessary build up of excess stock. If stock is systematically underestimated (for example, if a bill of materials records one more unit of bolts than is actually used), excess stock can quickly build up, particularly if automatic reordering is implemented.

Evaluating sales performance through inventory levels

Accurate inventory levels are also crucial to tracking meaningful sales performance. Understanding the sales performance of each product is important for identifying poor performing products, as well as planning for seasonal and occasional spikes in demand. Keeping comprehensive records of sales and inventory movements is useful to figure out which products are selling well and which are lagging behind, taking up valuable warehouse and shelf space. Recording inventory levels over time, as opposed to simply keeping count of current stock, is marginally more work, but provides a useful source of business intelligence.

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