What is inventory management?
Inventory management is the process of tracking the goods and materials used by a business to produce or sell products. The goal of inventory management is to ensure there’s always enough stock available to fulfil customer orders while minimising the risks and costs of holding inventory.
Efficient inventory management and regular inventory audits ensure you always have the right quantities of items in the right place ready to meet demand.
- See inventory management software in action: Unleashed Demos
Inventory management in the supply chain
Inventory management is one of the key pillars of effective supply chain management.
When an optimised and holistic inventory management plan is successfully executed, supply chain efficiency increases – and your inventory carrying costs plummet. It is the role of your supply chain management team to ensure an efficient inventory system is in place.
Ultimately, how you manage inventory affects how much cash flow your business has to operate with.
Inventory management in accounting
Inventory accounting deals with valuing and accounting for changes in assets.
In accounting, inventory includes goods in three stages of production: raw materials, in-progress goods, and finished goods.
An accurate inventory accounting system keeps track of changes to inventory at all three stages and adjusts asset values and costs accordingly.
Why is inventory management important?
Inventory management is important because it directly impacts how profitably a business operates on any given day. A study by McKinsey & Company recently found that retailers are sitting on $740 billion in unsold goods – that’s in the United States alone.
Effective inventory management prevents overstocking of unsold products, freeing up capital and resources better allocated to growth activities.
Benefits of inventory management
There are dozens of inventory management benefits we could get into, but the top three are: happier customers, faster growth, and wider profit margins. Allow us to explain.
1. Increased customer satisfaction
How you manage inventory on a day-to-day basis can grow or diminish your customer satisfaction levels. For a consumer, a late delivery can be an inconvenience.
For a business, it can mean lost sales and profits.
Nobody wants to receive incorrect orders or late deliveries. But most consumers are grateful for fast, accurate order management.
Inventory management dictates:
- How quickly you get your products to your customers
- How reliably you can fulfil orders
- How much visibility you can give your customers
Your customers will be much more likely to come back for more if they know your organisation can consistently deliver orders on time and let them know what’s available. This is especially true for business-to-business transactions.
2. Faster business growth
As businesses scale in complexity, their inventory management requirements get more complex as well. New product lines, new staff, new production facilities, and new customers mean new challenges to managing inventory.
The solution is to be proactive.
Putting an effective stock system in place early is key. The later you leave it, the longer it will take and the more it will cost — and the less time you’ll have to do it.
3. Increased profit margins
Inventory management can also bring several direct benefits to your business’s bottom line.
For starters, you can analyse performance and empower salespeople with up-to-date product information. It also eliminates the inefficiencies that lead to lost stock, overstocking, and stockouts — reducing inventory costs and growing margins.
Inventory management works alongside purchasing and supply chain management to lower the cost and effort required to prepare goods for sale. It minimises the time and labour ordinarily spent on inventory admin.
Effective inventory management will mean you’re paying less for goods and making more profit selling them.
Inventory management example: Sam’s Chairs
Sam decides to set up a business selling her handcrafted dining chairs. Each chair she makes requires 6 sizes of wood, plus a cushion.
She goes to her supplier and buys 10 planks of each size of wood she needs, plus 10 cushions. These are all now included in her inventory.
As she turns raw materials into chairs and then sells them, Sam’s inventory levels will change. She’ll need to keep track of:
- How much material she has
- How many chairs she can make
- How fast she can make them
On top of that, she needs to manage customer orders and monitor her business’s performance. Oh, and she needs to know where everything is.
The process of managing all these tasks is called inventory management. And the way those tasks are performed is with an inventory management system.
If that sounds complicated, don’t worry – we’re about to dive deeper into the process.
Here’s how it would look for Sam from our earlier example:
What is the inventory management process?
The inventory management process involves tracking and controlling stock as it moves from your suppliers to your warehouse to your customers.
The inventory management process can be divided into five stages:
- Stock control
- Order management
Stage 1: Purchasing
Purchasing is the process of sourcing and buying the goods, materials, equipment, and services required to produce and sell products.
The purchasing manager or purchasing team raises a purchase order – a legally binding document outlining what the purchasing business needs – which is sent to a supplier. The supplier fulfils the order and delivers the goods or service on the agreed due date.
Inventory management informs how much inventory should be ordered, when to order it, and where costs can be saved.
Stage 2 (optional): Production
Production or manufacturing is the process in which your finished product is created from its constituent parts. Not every company will get involved in manufacturing — wholesalers, for instance, might skip this step entirely.
All of the parts, materials, sub-assemblies, and components used to produce a product must be tracked, typically via a document called a bill of materials, so that a business has an accurate understanding of production capacity and costs.
Stage 3: Stock control
Stock control is the step in inventory management that deals with goods and raw materials once they’ve been purchased or made by a business before they’re sold. It involves organising where and how inventory is stored and keeping each product line within its minimum and maximum levels.
This part of the inventory management process requires effective auditing of stock levels and warehouse optimisation. The goal of stock control is to ensure the right quantities of goods are stored in the right location to facilitate efficient order fulfilment.
Stage 4: Order management
Inventory management also crosses wires with sales in a process called order management. Order management refers to the processing and fulfilment of customer orders.
There are several steps in the order management process, including:
Because customer satisfaction is a major factor in the success of any business, order management plays a critical role in inventory management and should be frequently optimised for efficiency.
Stage 5: Inventory reporting
Inventory reporting is the recording and analysis of key sales and inventory data to make the best decisions at any given time. It involves tracking multiple inventory metrics to accurately understand the costs that go in and out of a business.
Reporting feeds directly into important inventory optimisation processes, such as demand forecasting and inventory planning, to enable a business to ensure the right budget allocation and systems are in place for maximum success.
Inventory management techniques
No matter the size of your business, employing some of these common inventory management techniques can be a great way to take control of your stock.
Here are a few key inventory management techniques to consider.
Just-in-time (JIT) inventory involves holding as little stock as possible, negating the costs and risks involved with keeping a large amount of stock on hand. The premise is that goods and materials are ordered and used only when they are needed.
While this technique works well in minimising waste and reducing inventory carrying costs, it can lead to painful understocking problems if not managed carefully.
Just-in-case stock control
Just-in-case (JIC) stock control is an inventory management technique deployed to protect against unexpected demand surges and supply chain disruptions. It enables businesses to reduce the risk of stockouts – and the lost sales that come with them – as well as negotiate fairer prices with suppliers.
The major downside of the inventory technique is that it can result in serious cash flow issues as a business’s capital becomes tied up in unsold inventory.
ABC inventory management
ABC inventory analysis aims to identify the inventory that is earning you profit by classifying goods into different tiers. It’s loosely based on the Pareto principle – the concept that the majority of successes come from a minority of efforts.
This inventory management technique enables you to make informed decisions around budget allocation, marketing, and purchasing at the product level.
First in, First, out (FIFO)
FIFO is an inventory costing technique used to measure the value of inventory stock. In FIFO, the items purchased or produced first in a specific product line are the first to be sold to customers.
This technique facilitates easy inventory accounting and ensures you are assigning the correct value when calculating the cost of goods sold (COGS). However, it can be unsuitable for volatile pricing and is more complex than other inventory management techniques.
Last in, First out (LIFO)
LIFO is an inventory costing technique that, unlike FIFO, involves selling the most recently purchased or produced items first and retaining older items until newer ones have been sold.
There are several downsides to this technique: namely, it gives an inaccurate picture of the value of inventory in a business and is not accepted under the International Financial Reporting Standards or the tax laws of many countries.
Learn more: FIFO vs. LIFO – Advantages & Disadvantages
Businesses that use dropshipping essentially outsource all aspects of managing stock. Products are stored and managed by your supplier until they’re sold: when a customer places an order with you, you pass that order on to your supplier and they ship the goods directly to your customer.
While dropshipping means you save on overheads and carrying costs, the major downside of this technique is that it often gives customers a poor experience and leaves no room for quality control before items are shipped.
Vendor-managed inventory, or the consignment inventory management technique, allows a consignor, usually a wholesaler, to give their goods to a consignee, usually a retailer, without the consignee paying for the goods upfront.
The consignor still owns the goods, and the consignee pays for the goods only when they actually sell.
Cross-docking is an inventory management technique that virtually eliminates the need to hold inventory.
Products are delivered to a warehouse where they are sorted and prepared for shipment immediately. They’re usually then reloaded into other trucks at the same warehouse and sent out for delivery immediately.
The inventory cycle count technique involves counting a small amount of inventory on a specific day without doing an entire stocktake. This method helps your business regularly validate accurate inventory levels in your inventory management software.
Economic order quantity (EOQ)
The economic order quantity is the optimal order quantity at any given point in time. An optimal EOQ minimises total holding and ordering costs. As an inventory management technique, EOQ involves using a specific formula to calculate ideal reorder quantities for each SKU. In doing so, you can ensure the efficiency of your replenishment process.
Inventory management methods
There are two common methods or systems for managing inventory: Periodic and Perpetual.
Here are the differences.
Periodic inventory management
Periodic inventory management is an inventory and accounting methodology where inventory and its value are measured at set intervals.
In periodic inventory management staff physically count every item in stock at the end of a set time – typically once per accounting period. This provides an ending inventory balance, which can be compared to the opening inventory balance to calculate an average inventory figure.
The average inventory can then be used in conjunction with inventory accounting metrics such as Cost of Goods Sold (COGS) to calculate figures such as the inventory turnover ratio.
Perpetual inventory management
Perpetual inventory management is an inventory and accounting methodology where inventory and its value are measured continuously.
In perpetual inventory systems, the number (or volume) of goods is tracked in near-real time.
Stock-on-hand values are also updated live.
COGS is often calculated according to the average landed cost methodology, which takes a weighted average of the different prices paid for goods to calculate their value.
Inventory management strategies
There are myriad strategies for storing and selling your products better. When deciding which to implement, consider your overarching business goals and the resources available to you.
Demand planning is when a business attempts to predict what future customer demand will be for each product they sell. This strategy enables businesses to better allocate their spending and resources and understand upcoming storage requirements.
Planning begins with data analysis, which feeds into forecasting – predicting demand based on historical data and market trends – and extends to procuring the right suppliers and organising the warehouse (or investing in a new one).
Inventory optimisation is applying a calculated approach to inventory management to keep costs and excess inventory low while improving customer satisfaction and fulfilment times. It also focuses on ensuring there is enough capital available in a business to facilitate healthy growth.
If inventory management is the tracking and organisation of inventory within a business, inventory optimisation is the strategy used to audit how efficiently those processes are being carried out.
Warehouse management plays a critical role in managing inventory effectively. By optimising your warehouse layout, processes, and staff training you can minimise the time and cost of labour efforts required to manage inventory.
Learn more: How to run an efficient warehouse
Best inventory management practices
Inventory management best practices enable businesses to optimise their stock control processes while avoiding risks and bottlenecks.
10 key inventory management best practices:
- Correctly categorise your inventory.
- Implement perpetual inventory management software.
- Set optimal safety stock levels.
- Perform regular stock takes.
- Convert historical data into business intelligence.
- Avoid unreliable spreadsheet-based inventory systems.
- Determine and maintain the smallest inventory levels required to meet demand.
- Mitigate supply chain risks by prioritising supplier management.
- Track (and improve) the velocity of your goods.
- Optimise your warehouse layout to facilitate faster fulfilment.
For more best practices and a detailed breakdown of each of the steps above, check out our best-practice stock management guide.
5 tips for managing inventory more effectively
Effective inventory management is critical for retailers and business-to-business firms dealing in stock. Recent research found that 99% of retailers are losing revenue due to unsold inventory stock.
Here are five powerful tips for boosting your inventory management efficiency.
1. Focus on your needs
A warehouse full of inventory can be daunting to manage. One way of making it easier is to identify the items that are the most important and focus on them first.
It’s highly unlikely that every item in your warehouse will have the same demand from customers. Keep the top-selling items in stock, and you’ll have made a great start at keeping your customers happy.
2. Engage with suppliers
In any stock-based business, it’s crucial to manage supplier relationships effectively. Developing constructive relationships with your business’ key suppliers is important to secure reliable supply, unlock competitive pricing and understand emerging trends that may impact your business.
3. Optimise your inventory control process
Dealing with different order quantities, replenishment cycle times, safety stock, forecasts, and seasonality be complicated. But it doesn’t have to be. Tweak each operation according to your specific business — making sure to keep track of what works and what doesn’t.
4. Use real-time data
Information is a powerful tool, but only when it’s accurate and up to date.
Real-time data and analytics — from layered inventory tracking right through to forecasting data, automatic ordering and individualised safety stock — can make a real difference to your business.
For the most accurate data, consider using perpetual inventory management software, as it is the best way to ensure the information you need is always at your fingertips.
5. Take your inventory mobile
Mobile technology has revolutionised inventory management. Barcode scanning, for example, makes receiving and tracking goods much faster — and helps eliminate unnecessary errors.
Sales apps, meanwhile, empower salespeople with inventory data on the road. You can keep track of key business processes from home, on holiday, or wherever you are.
To achieve this, you need to invest in a robust inventory management system.
Inventory management systems
There are two main types of inventory management systems: manual and automated.
A manual inventory management system is one where data must be updated and exported manually. Examples of this might be a pen and paper tracking system or an Excel spreadsheet.
An automated inventory management system – also called an automated inventory system – streamlines common inventory processes such as demand forecasting, stock control, order fulfilment, and production.
Inventory management software
Inventory management software refers to a perpetual inventory system that captures and controls inventory data, allowing businesses to better manage their stock. It helps you reduce your admin time and drastically cut back on unnecessary inventory costs – both of which positively impact your bottom line.
Inventory software also integrates with other tools, including:
- Ecommerce software
- Point of Sale (POS) software
- CRM software
- Analytics tools
- Connector apps
Inventory management tools
Modern warehouses and retail stores are often equipped with handy inventory management tools that can be implemented to improve and streamline your inventory processes. Here are some examples.
Useful inventory management solutions include:
- Barcode scanners: Handheld devices used to quickly scan the barcodes of products and improve total inventory accuracy within a warehouse.
- Label printers: Machines that print courier labels and custom stickers for faster shipping processes and better identification of goods within a warehouse.
- Shelving, racks, bins: Items used to better store and categorise goods within a warehouse.
- RFID scanners: Handheld devices used to digitally track products within a warehouse and, in some cases, throughout the entire supply chain.
- Forklifts, pallet trucks, scissor lifts: Warehousing equipment that makes it easier and faster to retrieve, relocate, store, and manage inventory inside a warehouse.
- Warehouse robotics: Technology systems designed for automating various warehouse processes. For example, the picking and packing process.
Several of these tools work in tandem with modern inventory management systems.
5 types of inventory management
Inventory management must be flexible to work inside so many different business models. As a result, it comes in all shapes and sizes.
1. Traditional inventory management
Traditional inventory management refers to paper- or spreadsheet-based systems where inventory is managed manually. This type of inventory management is best suited to very small businesses with fewer materials and products to manage.
2. Automated inventory management
Automated inventory management involves the use of modern inventory systems, such as software and barcode scanners, to streamline or eliminate the tedious manual processes involved with managing goods.
3. Consignment inventory management
Consignment stock is goods held by one business but owned by another – typically the wholesaler or manufacturer – and management of this inventory, therefore, requires special considerations.
4. ERP inventory management
An expensive alternative to inventory software, ERP systems are a type of software platform that integrates inventory management with finance, logistics, accounting, planning, and other key business functions.
5. 3PL inventory management
Third-party logistics (3PL) inventory management is a type of inventory control that enables a business to track and manage stock held by a fulfilment service provider – often across multiple 3PL warehouses.
Inventory management examples in business
Inventory management can look a little different depending on the size and industry of your business. To better highlight these contrasts, let’s explore some of the more common inventory management examples you’re likely to encounter.
Retail inventory management
In the retail sector, inventory management largely deals with the tracking of merchandise inventory – that is, finished goods ready for sale.
Retail inventory management is typically a fast-moving environment. Products on shelves need to be replaced promptly to avoid missed sales. Because the need to meet customer demand is especially high for retail shops, retailers must walk a fine line between running out of stock and carrying more inventory than they can manage.
Warehouse inventory management
Warehouse inventory management is perhaps the most known example of inventory management in a business. This refers to the controlling of goods and materials inside a warehouse – a facility specifically designed for holding inventory.
Wholesalers and large retailers or distributors are most likely to use warehouse inventory management because they typically hold more stock than smaller operations.
Ecommerce inventory management
Ecommerce inventory management refers to the tracking and control of goods sold online through various ecommerce marketplaces and platforms.
Because of the high volume of sales associated with ecommerce, it presents unique challenges around ensuring there is enough stock available to meet demand.
There are several types of ecommerce inventory management, including:
- Amazon inventory management
- WooCommerce inventory management
- Shopify inventory management
- Magento inventory management
The good news is that the challenges and solutions are largely the same. Multichannel inventory management allows sellers to connect all their sales channels in one place, making it a top-priority feature in ecommerce inventory software.
Manufacturing inventory management
Manufacturing inventory management is a core function of production management and involves several unique aspects – specifically, the control of the various raw materials, components, and assemblies required to build a product.
This example of inventory management comes with a long history of optimisation efforts, as manufacturing businesses frequently seek to create a lean business environment.
A large part of inventory management for manufacturers is the elimination of wasteful activities and the reduction of costs associated with holding and creating goods.
Learn more: The 8 Types of Inventory in Manufacturing
Useful inventory management formulas
For new business owners, the following calculations might seem daunting, but don’t let that deter you. These inventory metrics are essential for keeping stock levels optimised.
Economic Order Quantity (EOQ) formula
It’s important to buy the right amount of inventory stock – neither too little, nor too much. Use the EOQ formula to determine the optimal order quantity – one that minimises the costs of ordering, receiving and holding inventory.
Economic Order Quantity can be calculated by using the formula:
√2(Setup Cost Per Order × Demand Rate) / Holding Cost Per Year Per Unit = EOQ
The Days Inventory Outstanding formula provides an accurate picture of a company’s inventory management and overall efficiency. Generally a low DIO is preferred, but to make sense of it, you need to take into account the industry and market dynamics.
Days Inventory Outstanding can be calculated by using the formula:
(Average Inventory / COGS) × Days in Period = DIO
Safety stock formula
Safety stock can be a life-saver. It helps businesses keep selling goods when supply gets shaky.
Knowing how much buffer stock to hold will help your business navigate safely through demand and lead time fluctuations.
It might seem daunting but all you need to know are your purchase and sales orders history.
Safety stock can be calculated by using the formula:
(Max Daily Usage × Max Lead Time) – (Average Daily Usage × Average Lead Time) = Safety Stock
Reorder point formula
Use the reorder point calculation to determine when to reorder stock.
Small business owners often rely on intuition and past experience to know when to place another order, but as the business grows, this quickly becomes unsustainable.
Reorder point can be calculated using the formula:
Average Daily Usage × Average Lead Time) + Safety Stock = Reorder Point
Cost of Goods Sold (COGS) formula
Use the cost of goods sold formula to calculate the cost of producing and selling specific goods – and your overall production costs.
Cost of goods sold can be calculated using the formula:
(Beginning Inventory + Purchases) –Ending Inventory
- Save time calculating formulas: visit our inventory calculators page.
Useful inventory management terms
Let’s look at some of the basic terminology and formulas you need to know before diving deeper into inventory management systems.
Cost of goods sold
Cost of goods sold (COGS), otherwise known as cost of sales, refers to the direct costs of producing goods. This includes the cost of the materials and labour directly used.
Finished products, or finished goods inventory, refers to the number of manufactured products in stock that are ready to sell.
In an inventory management context, lead time is the period between an order being placed to replenish inventory and when the order is received.
Point of sale (POS)
The point of sale, or point of purchase, is the time and place in which a retail transaction is completed. It usually involves an invoice and options to make payment.
Purchase order (PO)
A purchase order is a document created by a buyer and sent to a vendor requesting goods or services. The buyer will, at a minimum, specify what products are being ordered, the quantity, the agreed price, and delivery and payment terms.
A way of bringing products or services to market so that consumers can buy them. Sales channels can be direct if it’s selling directly to consumers, or indirect if an intermediary is involved.
Otherwise known as inventory levels, stock levels are the quantity of goods or raw materials kept on the premises of a business.
A supply chain is a system of organisations, people, activities and resources involved in supplying a product or service to a consumer.
Inventory management FAQs
Before you go, here are the answers to some popular questions about inventory management.
What is inventory?
Inventory is the goods that your company handles with the intention of selling. It might be raw materials that you buy and turn into something entirely new, or it might be a bulk product that you break down into its constituent parts and sell separately.
What are the 4 main types of inventory?
The 4 main types of inventory are:
- Finished goods: The products you sell to your customers.
- Raw materials: The inventory you use to make your finished goods
- Work-in-progress inventory: Essentially, unfinished goods — inventory that is part-way through the manufacturing process
- MRO inventory: MRO stands for maintenance, repair and operating. This is the inventory you use to support the manufacturing process
Are inventory and stock the same thing?
‘Inventory’ and ‘Stock’ mean slightly different things. Stock generally means finished goods ready for sale, while inventory refers to stock, plus all the other kinds of inventory – especially components, parts or ingredients that go on to become stock.
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