Inventory Management – The Definitive Guide

Inventory management can either be a hassle for businesses or lead to enormous savings.

The lifeblood of a product-driven firm is inventory. It’s what keeps people buying from you and paying you money. Internal inventories are essential for service-based businesses relying on certain products to perform tasks.

Inventory is a crucial component of any business in any situation. And controlling this inventory is essential to ensuring that the right goods are stocked in the right amounts to balance needs without using too many resources.

It would be nearly difficult to keep track of all these moving elements manually. Software for inventory management is essential for companies of all sizes and sorts. It’s crucial for e-commerce companies, in particular, because they need to process and dispatch orders with extreme precision.

What is Inventory Management?

Inventory management helps businesses determine which products to order, when to order them, and in what quantity. Effective inventory tracking starts right from the product acquisition stage up to the point the product is sold. The technique recognises trends and reacts to them to guarantee adequate merchandise to fulfil client orders and proper warning of a shortfall.

Inventory turns into revenue only once the stock kept in the inventory has been sold. Until that point, inventory keeps cash tied up, while still being listed on the balance sheet as an asset. Consequently, having too much stock can prove very expensive and also hamper cash flow.

Inventory turnover is a term used in accounting to determine the frequency with which stock is sold over a period of time. Ideally, a company should not want to maintain a higher inventory of a product than the sales of that product. This will lead to a lower than optimal inventory turnover, which results in dead or unsold stock.

Different Types of Inventory

There are numerous types of inventory that a business could encounter. To pursue good inventory management, it is essential to understand each.

Basic Types of Inventory

There are five basic sorts of inventory regarding the goods a company might sell.

Raw Materials

Any material utilised in the production of completed goods, or the separate parts that make them up, is referred to as a raw material. A company can create or obtain these directly, or they can buy them from a supplier.

Work in Progress Inventory (WIP)

Retailers who produce their goods are again referred to as having work-in-progress inventory (WIP). These are parts or products currently in production but are not yet ready for sale.

Finished Goods

Finished goods are items that have been finished and are prepared for sale. These can have been produced in-house by the company or bought as a complete, finished good from a source.

Most retailers will either buy full, finished products through an established source, such as a wholesaler. Some larger retailers may hire a third party vendor to produce specific products, normally exclusively for the retailer. As a result, finished items are frequently (though not always) the sole sort of inventory that needs to be managed in retail inventory management.

Maintenance, Repair & Operations (MRO) Goods

MRO goods are items used in the production of products but do not directly contribute to the end product.

This can include things like:

1. Tools for production and repair
2. Uniforms and safety gear
3. Cleaning products
4. Equipment
5. Battery
6. Computer networks

And everything that is used up or thrown away during production.

This kind of little inventory could seem insignificant. MRO, however, is inventory that must still be acquired from a source, kept somewhere, and recorded in financial records.

Packaging Supplies

Anything you use to pack and protect goods—either during storage or customer transportation—is a packaging material.

For online retailers, this is consequently of special importance. And could incorporate stuff like:

1. Bubble wrap.
2. The padding
3. Chip packaging.
4. A variety of boxes.

When managing their inventory, many retailers neglect to consider packing supplies. However, as stocks of these products must be constantly used and maintained, it is crucial to include them in total inventory reporting and accounting.

Finished Goods

It’s also helpful to further split finished goods into a few additional sorts of inventory in a retailing context. This dramatically improves inventory visibility for a business, enabling better allocation and management.

Available for Sale

This stock, also referred to as “available inventory,” has been produced or acquired and is stored in the warehouse in preparation for sale. It could be easily picked, packed, and transported whenever needed.

Allocated

This is stock that a customer purchased and assigned to a sales order. As a result, it cannot be sold again and must be eliminated from the inventory figure.

In-transit

This is the unsold stock being moved, such as stock being transferred to a different warehouse or a delivery made in response to a purchase order.

Seasonal

This inventory also referred to as “anticipation stock,” has been produced or acquired especially to meet an anticipated increase in demand. For instance, to cover Black Friday sales or your busiest time of year.

Safety

This serves as a stock buffer to protect you in case of any unanticipated increases in demand or issues with supply.

Inventory Management Versus Inventory Control

Although they may sound similar, inventory management and control are different.

Your manufacturing, sales, supply chain, and fulfilment are all included in inventory management. Without an inventory management system, it won’t be simple to manage inventories, suppliers, production lines, etc.

Inventory control outlines how a company controls the currently stored inventory. Understanding your current inventory levels, where it is maintained, and whether or not it is in a sellable condition is known as inventory control. Inventory control also refers to how a company operates to reduce the time spent maintaining inventory.

Why is Inventory Management important?

A company’s ability to serve consumers and increase revenue depends on effective inventory management. For several reasons, efficient stock management is crucial. A company will overspend on stock and lose money by storing extra inventory if it orders more raw materials than it needs to create its products. If inventory management orders insufficient raw materials, there won’t be enough goods to satisfy demand.

Essential Terms and Techniques in Inventory Management

Formulas and analysis are used in several inventory management strategies to plan stock. Others depend on protocols. Every technique aims to increase precision. Its requirements and inventory determine a company’s methods.

ABC Analysis

This technique determines the most and least preferred stock categories.

Batch Monitoring

This strategy clusters comparable things to keep track of expiration dates and find defective items.

Shipments in Bulk

This approach considers supplies that suppliers load straight into trucks or ships. Bulk inventory is purchased, stored, and shipped.

Consignment

If your company uses consignment inventory management, you won’t pay a supplier until a product has been sold. Up until your business sells the inventory, that supplier still owns it.

Cross-Docking

This technique entails unloading goods from a supply vehicle onto the delivery truck directly. Storage is essentially done away with.

Forecasting demand

Predictive analytics of this kind aids in predicting consumer demand.

Dropshipping

Dropshipping is sending products from a supplier’s warehouse straight to a client.

Economic Order Quantity (EOQ)

This method outlines the precise quantity of inventory a business should order to cut holding and other expenditures.

FIFO and LIFO

You move the oldest stock first using the first in, first out (FIFO) method. According to the last in, first out (LIFO) theory, since prices are constantly rising, the most recently purchased inventory is the most expensive and therefore sells first.

Just-In-Time (JIT) Inventory

Companies employ this technique to keep stock levels as low as possible before replenishment.

Lean Manufacturing

This methodology focuses on clearing the manufacturing system of waste or items that do not add value to the customer.

Materials Requirements Planning (MRP)

For production, this system encompasses planning, scheduling, and inventory management.

Minimum Quantity of Orders

A business that relies on minimum order quantities will only purchase the bare minimum of inventory from wholesalers with each order to keep prices down.

Reorder Points:

Using this technique, businesses may determine how much inventory they must keep before placing another purchase and then manage their inventory accordingly.

Process of Inventory Management

Knowing the specifics might help with your stock management and inventory planning because many factors go into inventory management.

Forecast Demand

The first step in inventory management is demand forecasting. Making a reasonable prediction about the future demand for your products is the process of demand forecasting. Various methods exist to calculate these numbers, and it might be challenging to estimate the driving variables, quantity, quality, pricing, and other considerations.

Place Purchase Orders

Inventory control is essential because it allows you to anticipate needs before they become urgent. Depending on the situation, supply and demand can change significantly. You can determine when to purchase orders using a system already in place.

Produce Goods

Producing more goods than you can sell will cause capital to be locked up, depleting your company of crucial funds. Conversely, if you produce too few goods, you risk running out of stock and missing out on sales. The thorough information provided by inventory management helps you determine how much merchandise you need and when.

Stock Inventory

After manufacturing or buying your goods, you must efficiently and transparently stock your inventory. Keeping stock that considers your items’ requirements are essential, whether you’re storing finished products or raw materials used to make finished things.

Sell Products

The next step is to sell your inventory and get your goods to customers. By giving you information on the number of available items and facilitating swift product location inside a warehouse, inventory management aids in efficiently moving goods.

Sales Report

For the success of your business, keeping track of your inventory and sales is essential. Data and reports can pinpoint your company’s weaknesses and potential growth areas.

Important Formulae in Inventory Management

For various needs, several formulas might be utilised. Here are a few varieties and how they can grow a business.

Economic Order Quantity (EOQ) Formula

Your EOQ is the ideal stock quantity to keep your ordering and holding costs minimal. A company can save a lot of money by using the EOQ. The formula for EOQ is:

EOQ = √(2SD/H)

Where:

S = Ordering or setup costs

D = Annual Demand (in number of units)

H = Holding or Carrying Costs

This is, however, a simplified formula. In reality, you may need to account for other factors, like inflation, bulk discounts etc.

Days Inventory Outstanding (DIO) Formula

Days Inventory Outstanding (DIO) is the days before the stock is sold. A smaller DIO is generally better because it produces income more quickly. But remember that distinct markets, goods, and business strategies will have varying average DIOs. The formula for DIO (for a period of one year) is:

Days Inventory Outstanding = (Average Inventory / Cost of Goods Sold) x 365

Where:

Average Inventory = (Beginning Inventory + Ending Inventory) / 2

Cost of Goods Sold (COGS) = Revenue – Gross Profit

DIO is expressed in terms of the number of days.

Reorder Point

Reorder Point is when you should place a fresh order for the stock to meet the upcoming demand without running out of stock. The formula for Reorder Point is:

Reorder Point  = (Average Daily Demand x Lead Time in Days) + Safety Stock

Where:

Average Daily Demand is the average number of units sold in a day.

Lead time is the delivery time taken after the point where the fresh order has been placed.

Safety Stock is the additional inventory stored as a safety net to meet an unexpected increase in demand or lead time.

Safety-stock

Safety stock is necessary to prepare for unanticipated events and is a backup in case you run out of stock. To satisfy demand, it’s critical to maintain safety stock, but too much can strain your cash flow. The formula for safety stock is:

Safety Stock = (Maximum Daily Demand * Maximum Lead Time) – (Average Daily Demand * Average Lead Time)

Find the Maximum Demand and the Maximum Lead Time within the same period for calculating Average Daily Demand and Average Lead Time.

Benefits of Inventory Management

Inventory management done right can benefit your company’s expansion in various ways. Here are a few of the benefits:

Cut Expenses

It costs money to buy merchandise, manage storage, pay for insurance, and pay personnel. Inventory should be managed well to cut expenses.

Boost Cash Flow

Optimising your inventory level can free up more money to spend on other essentials.

Prevent Stockouts and Overstocking of Goods

Both carrying excess inventory and experiencing stockouts are expensive. Both of these situations can be avoided with better inventory management.

Better Terms Can Be Negotiated With Suppliers

You can bargain with suppliers more effectively if you have comprehensive knowledge of your inventory. For instance, knowing that you sell a lot of one item during a particular year’s season may enable you to negotiate a lower price with your supplier.

Enhance the Customer Experience

Customers are more likely to return and maintain their loyalty when they know they can depend on you always to have stock and provide the best deals.

Increase Profitability

You can improve the profitability and expansion of your company by comprehending your inventory, demand, and turnover.

Effective Inventory Management practices

You may adequately maintain your inventory using a variety of ways. 

Inventory Classification Using ABC Analysis

ABC analysis is a technique for organising your inventory into a hierarchy of most-to-least-important things. The top-priority “A” goods are the best sellers; “B” goods are worthwhile but medium-priority items; and “C” items are lower priority.

Recognise Your Reorder Point

Knowing when to order extra stock requires a reorder point calculation that fits your company’s demands. Having sufficient supply stops unexpected stockouts brought on by market fluctuations. A formula can also enable you to retain less inventory when necessary during business downturns.

Keep Safety Stock Readily Available

Excess stock on hand guards against shifting lead times, shifting client demand, and varying market conditions. By maintaining safe stock, you may avoid stockouts and guard against inaccurate forecasts, which could cost you money, clients, and market share.

Inventory Management by Batch and Expiration Date

You may avoid having any obsolete or expired merchandise by keeping track of your inventory batches and expiration dates. Neglecting to keep track of unsalable goods will deplete your financial resources and endanger your company.

Increasing Inventory Turnover Rates

Understanding market demands can be improved with your inventory turnover rate calculation. You can decide how to stock your inventory better by analysing your products’ needs. You might experiment with price, client demand forecasts, or stock liquidation to maximise turnover rates.

Monitor KPIs for Inventory Management

By setting specific objectives for each day, week, quarter, or year, tracking inventory key performance indicators (KPIs) can help eliminate guesswork.

Reduced Dead Stock Counts

Reducing dead stock will be perfect for streamlining operations because it can waste resources. Real-time data tracking allows you to reduce lead times, eliminate unnecessary stock, and boost forecasting accuracy by keeping track of your inventory.