Why should your inventory management be more effective? According to a Zippia survey, 43% of small businesses don’t track their inventory. They're missing the crucial benefit of inventory management: it’s key to freeing up cash to invest back into your business.
Importantly, an effective inventory management process saves you time, improves your cash flow, satisfies your customers, and makes your inventory decisions data-driven.
“How can inventory management improve your business?” explores why inventory management is key to generating growth, and the various strategies and benefits to successfully manage your inventory.
- Understanding inventory management
- Why is inventory management vital to success?
- The four main types of Inventory
- Inventory management methods
- Inventory management red flags
- Strategies for managing inventory
- How to manage inventory effectively
- Tips for managing your inventory
- What to look for when selecting inventory management software
- How inventory management solutions can help
- Incorporating inventory management for a successful business
Understanding inventory management
In order for your business to sustain growth and profitability, inventory management is crucial. Inventory management encompasses all procedures and processes involved in organizing, purchasing, delivering, tracking, and storing inventory.
The aim of inventory management is to have the right amount of product, at the right time, and in the right place, while maximizing your company's resources. Successful inventory management is cost-efficient as it optimizes your storage, purchasing, and organization of inventory.
By applying a strategy to manage your inventory you can meet customer demand without holding onto excess stock. Through maintaining consistent procedures, you can cut down on waste and importantly, improve your cash flow.
Several methods are available for managing inventory, which you can tailor to your specific industry, product type, and business model. Keep reading to learn how you can implement these strategies in your business.
Why is inventory management vital to success?
For your business to be successful, you need to have cash available to invest back into your business. Also, you need consistent and timely access to goods you are selling to your customers. Poor inventory management ties up your cash, overwhelms your storage facilities, causes late deliveries to customers, and wastes employee time.
The longevity of your business depends on healthy cash flow, positive customer satisfaction, productive employees, and being adaptable to uncertainty. Assessing your inventory management before it causes problems will be essential in avoiding future bottlenecks to growing your business.
Inventory management can aid in your business's success by helping to reduce costs, eliminate inefficiencies, save time on inventory administration, prevent theft, provide trend insights, and make better stocking decisions.
The Four Main Types of Inventory
Inventory can be divided into four main types. Understanding the type(s) of inventory you manage will help determine the most effective inventory management method(s).
Raw materials are basic materials used to produce goods. This includes: parts, intermediate components, ingredients, and materials needed to make and/or repair goods.
- Examples: Lumber, grain, vegetables, wool, and leather.
Raw materials are derived from natural materials, and divided into three main types: plant/tree-based, animal-based, and mining-based.
Raw materials are either direct or indirect to the production of goods.
- Direct materials are primary elements used to make goods.
- Indirect materials are supplementary materials in the production of goods from raw materials.
- Examples: Glue, varnish, and paint.
Work-In-Progress (WIP) are unfinished items in the process of being made to sell.
- Example: A chair needing a coat of paint to be ready to sell.
Maintenance, Repair, and Operations (MRO)
Maintenance, repair, and operations (MRO) are items needed for the production process but are not a component of the product. MRO also includes materials for handling, storing, and sending products.
- Examples: Packing tape, safety glasses, and gloves.
Finished goods are items ready to sell to customers.
Inventory Management Methods
Just-In-Time Management (JIT)
Just-In-Time Management (JIT) involves receiving inventory on an as-needed basis. It's also known as lean manufacturing, which aims to eliminate waste and non-value adding activities in order to improve efficiency.
With JIT, you keep the lowest stock possible, or make goods once orders come in. It's most commonly used for ecommerce or businesses who sell made-to-order and/or offer customization to the customer.
Implement this strategy by either accurately forecasting customer demand on a timely basis and stocking for those numbers, or receiving inventory/creating products as orders come in.
- Waste from unusable inventory is reduced.
- Cash isn't tied up in carrying excess inventory.
- Decreases storage space needed.
- Unexpected changes in demand can create bottlenecks in production and/or supply chain.
- Only suitable for certain types of businesses.
- Reliant on supplier timelines.
- Customer satisfaction may decrease with longer waiting times for their product.
- With keeping the lowest stock possible, forecasting demand for products is difficult and you may run out of required inventory if forecasting is wrong.
Materials Requirement Planning (MRP)
Materials Requirement Planning (MRP) is a method used to determine raw materials, labor, and other resources needed to produce goods at a specific time and place. This method creates a smoother production cycle which keeps up with demand and is often used in manufacturing companies.
Three steps to implement MRP:
- Forecast demand for finished goods to identify all the required components.
- Determine the number of raw materials and components needed to meet demand for finished goods.
- Check existing inventory and plan to allocate resources.
- Once you understand what you have and where, you can accurately allocate necessary resources to meet the demand.
- Schedule the production of goods to meet demand on time.
- With inventory in the right place for production, schedule time and labor needed to complete the finished goods.
- A smoother and organized production cycle.
- Decreased storage needed for unused goods.
- Can aid in identifying errors and bottlenecks.
- Lots of data is needed, and sales forecasting needs to be accurate.
- Inaccurate forecasting can lead to problems with holding onto excess finished goods or running out of product to sell to customers.
- Flexibility is limited.
- Time and effort are needed to determine the allocation of resources on a timely basis.
Economic Order Quantity (EOQ)
Economic Order Quantity (EOQ) is an equation which determines the optimal amount of inventory to purchase per order, to minimize inventory costs. By identifying the ideal number of units to buy, while minimizing holding costs, the EOQ method aims to reduce excess inventory.
To calculate EOQ, use the following equation:
EOQ = √(2DK/H)
- K represents demand (i.e., units sold per year).
- D represents setup cost per purchase order.
- Setup cost includes shipping, processing, and handling costs associated with each purchase of inventory (usually fixed costs).
- H represents holding cost per year, per unit.
- Holding cost is the cost associated with holding onto inventory on a per unit measure.
The EOQ number you calculate is the ideal amount of inventory to purchase per order to minimize order and holding costs. However, you must decide when to place your orders.
- Minimizes cash spent on ordering and storing inventory.
- Ideal for cash flow management.
- Provides a practical solution for determining how much inventory to purchase per order.
- Assumes demand remains constant throughout the year.
- EOQ is most suitable for businesses with constant demand and holding costs throughout the year.
- Requires accurate demand forecasting to minimize costs.
- Assumes no discounts for purchasing large quantities of inventory.
Days Sales in Inventory (DSI)
Days Sales in Inventory (DSI) is a measure of the average time, in days, it takes for your company to turn inventory into sales. This formula provides insight into the liquidity of your inventory.
The lower the number of days it takes for your inventory to become sold goods the more efficient your company is. It's important to note the ideal number of days is relative to the industry you are in, so you should make industry-specific comparisons.
To calculate DSI, use the following formula:
DSI = (average inventory/COGS) x 365
- average inventory = (beginning inventory + ending inventory)/2
- COGS = (beginning balance of inventory + cost of inventory purchases - cost of ending inventory)
By finding this figure, you can understand how long it takes for inventory to leave your storage facilities. This information helps make better decisions about when to order more inventory, how much inventory to store at once, and provides insight into your company's performance.
- Provides a way to compare your company's performance against others in your industry.
- Improves understanding of how your inventory is moving.
- Determines the liquidity of your inventory.
- Can be used in conjunction with other methods to improve inventory ordering accuracy.
- Provides little guidance on how to organize and manage inventory.
- Should be used with other methods to provide a comprehensive analysis.
The ABC method categorizes inventory into three groups based on their profitability:
- A: The most valuable products generating the highest profit (the top 20% of goods that bring in 80% of revenue).
- B: The products between most and least valuable (around 30% of goods).
- C: The products vital for profit but don't matter much individually (around 50% of goods bringing in 5% of revenue).
This method is based on the Pareto Principle, which states 80% of results come from only 20% of effort. As recommended by BusinessNewsDaily, you should prioritize managing of the 20% of goods bringing in 80% of your revenue.
After categorizing inventory, focus on managing A products. These products require the most attention for ordering, stocking, and shipping. You can efficiently store and stock inventory by prioritizing A items, followed by some B and a little amount of C items.
This method is ideal for companies with limited time and resources; as it allows them to focus on inventory generating the most revenue and leaving the fastest.
- Prioritizes profitable inventory.
- Strategically allocates resources.
- Provides insight into customer demand and helps forecast sales.
- Decreases storage expenses.
- Limited ability to consider new products or seasonal demand.
- Requires tracking changes in customer purchasing habits.
- May over or under-stock B and C items.
- Limited to certain businesses - businesses selling variations of the same product type may not find this method helpful or accurate.
- Requires lots of data to group inventory categories.
Inventory management red flags
When should you re-evaluate your current inventory management practices? It may be time to implement changes if you:
- Consistently hold excess product.
- Experience cash flow issues due to tied-up cash in inventory.
- Are consistently running out of products customers want.
- Find problems with phantom inventory (your POS system says you have it, but it doesn't actually exist in your storage facilities).
- Struggle to make inventory purchasing decisions.
- Consistently have orders arriving too late to meet demand.
- Spend too much on storage and ordering costs.
- Spend too much time tracking down inventory.
- Are unsure whether to add or remove certain products.
- Struggle to understand demand for your products.
- Are constantly unsure of where your inventory is located.
- Experience decreasing customer satisfaction due to late deliveries.
- Experience errors in tracking, ordering, and maintaining inventory.
With an effective system to manage your inventory you should be able to answer most, if not all, of the following questions:
- How much of each item is in stock?
- Where is each item located?
- Which products have the most customer demand?
- When do you need to make an order for each product type?
- When should you remove a product?
- Can you track down inventory in case of a recall?
- Is your current system capable of growing with your business?
Strategies for managing inventory
Use ERP software designed for inventory management.
Automate your inventory management system.
Leverage real-time data & analytics to optimize inventory management.
Use demand planning tools to forecast accurately.
Integrate mobile technology for real-time inventory updates.
Engage customers and suppliers on payment terms.
Encourage customers and suppliers to migrate from paper to digital payments.
Embrace modern technology solutions.
Unlock trapped cash.
Reduce liquidity risk.
How to manage inventory effectively
1. Define product sourcing and storage methods
To implement effective inventory management it is important to select reliable and timely suppliers. Depending on your suppliers, it may be beneficial to make bulk orders or to order less inventory more often to improve cash flow.
Determine how you will be alerted to order more inventory: do you have inventory management software notifying you, or will physical counts by employees alert you?
Additionally, it is vital to optimize how inventory is stored. Establish clear processes and procedures for organizing and receiving orders, and ensure these methods are consistent and standardized across all your storage facilities. Lastly, to prevent theft of inventory, ensure your warehouse security is up-to-date.
2. Decide how to track inventory data
To determine how to track your inventory, consider the amount of current inventory and data you need to ensure your business runs smoothly. If you have fewer than 100 items, a spreadsheet might suffice, but as your business grows consider using an inventory management software.
Creating tracking tags for inventory helps you know where your inventory is at all times. These tags can include the item's supplier, colour, product type, lot number, and more.
3. Create an internal SKU system
A Stock Keeping Unit (SKU) system uses a unique combination of letters and numbers (typically eight digits long) assigned to different product types. With a SKU system you can track how much of each product type you have, making it easier to know when to order more.
SKUs quickly identify unique characteristics of each product type. In a retail environment, letters and numbers on a SKU will let employees know what type, colour, size, and/or brand a product is. For example: a SKU for a men's large polo shirt from brand X in blue might read as XXX-PO-BLU-03.
4. Organize inventory storage areas
In your storage facilities, you should use zoning techniques by assigning each product type to a specific area. Additionally, to minimize errors and confusion keep raw materials, work-in-progress, MRO, and finished goods in different areas.
To make your inventory tracking informative, consider which inventory is being moved out first. You can determine which inventory is leaving first using one of these three methods:
- First in, first out (FIFO): Oldest stock leaves first.
- Last in, first out (LIFO): Newest stock leaves first.
- First expired, first out (FEFO): Similar to FIFO, but in this case, it's determined by expiration dates.
Once you've settled on a method, you can organize inventory accordingly to ensure the inventory you want to leave first will be sent first.
5. Use forecasting to order inventory
As explained by Forbes Advisor, ideally, you should maintain just enough inventory to cover predicted sales over a certain period. To determine necessary inventory, use forecasting; estimating inventory needs using past sales, current promotions, season, and market trends.
Use forecasting to decide how much inventory to order and when. This helps reduce storage space and free up cash flow.
6. Establish inventory receiving procedures
Once you have decided how to organize your inventory, create consistent procedures for receiving it.
Best practice is to receive stock against the inventory order receipt to ensure all ordered items arrived and are in acceptable condition. After inspecting and sorting goods, store them in their designated places.
While stocking new inventory, use shelving methods like LIFO, FIFO, or FEFO.
7. Keep track of inventory levels
Keeping track of your inventory will help you determine your reorder points for each good. Deciding how to track inventory levels is based on two methods:
- Continuously keeps track of inventory levels.
- Updates changes in inventory in real time as inventory is sold and received.
- Often uses a Point of Sales (POS) system and/or an inventory management system.
- Updates cost of goods sold continuously.
- Often used by smaller businesses with low inventory levels and/or only a few products.
- Establishes inventory levels and cost of goods sold using periodic physical inventory counts.
To determine when you should physically count your inventory, consider the following options:
- Cycle counts: Break your inventory into sections and count each section on a rotation schedule.
- Spot checking: Make periodic counts of a few items to catch random errors.
Tips for managing your inventory
To achieve better inventory management:
- Audit your inventory consistently.
- Analyze your supplier performance.
- Practice the 80/20 rule.
- Be consistent with your procedures and practices.
- Track sales of inventory.
- Order restocks yourself for better visibility and control.
- Invest in an inventory management software that integrates with your other technology.
- Understand your inventory carrying costs (cost of keeping all your inventory).
- Calculate how much safety stock you need.
- Safety stock = (Maximum daily usage × Maximum lead time in days) – (Average daily usage × Average lead time in days)
- Outsource your inventory storage and fulfillment if you need to.
- Calculate what the reorder point is for each product type
- reorder point (ROP) = (daily average usage x lead time) + safety stock
- daily average usage = how many units are sold daily.
- lead time = the amount of time it takes from ordering to receiving stock.
- reorder point (ROP) = (daily average usage x lead time) + safety stock
What to look for when selecting inventory management software
An inventory management software can help you better keep track of your inventory and give you data-driven insights. If you are looking for an inventory management software look for the following features:
- Real-time inventory tracking.
- Demand forecasting capabilities.
- Product shortage alerts.
- Offers bar code scanning to optimize intake and tracking.
- Prevents holding onto excess stock.
- Inventory analysis capabilities.
- Optimizes your employees' time.
- Tracks inventory across multiple locations.
- Allows you to tag inventory types.
- Customizes to your business needs.
- Integrates with your current softwares.
Overall, choose an inventory management software which best matches your business needs and offers your visibility into your inventory trends and organization.
Examples of inventory management software:
- Cin7 - Seamless management of multi-location inventory. Tracks your COGS in real-time and integrates with 700+ softwares.
- Ordoro - Streamlines shipping and label creation process. Tracks inventory and alerts you of when to restock. Has features ideal for dropshipping businesses.
- Katana - Real-time planning and monitoring for manufacturing businesses with multiple software integrations. Allows setting of reorder points and tracks availability of raw materials and finished goods.
- ShipHero - Efficient features for ecommerce businesses in need of warehouse and inventory management. Integrates with leading ecommerce and marketplace platforms.
- Sortly - Tailored for small businesses, allows you to organize your inventory with customizable fields. Has in-app barcode and QR code scanners and notifies you of stock shortages.
- Fishbowl inventory - Tracks inventory in real-time across multiple locations. Has the capability to implement MRP for your business.
How inventory management solutions can help
Efficient cash flow and inventory management are intertwined in the success and growth of your business. Being ineffective at inventory management and/or struggling to maintain appropriate cash flow levels can have a detrimental effect on your business.
Software programs optimize your inventory management and allow you to stay on top of your cash flow. They increase visibility and tracking of your purchases, enabling you to make better inventory decisions. Plooto allows you to keep track of all your bills in one place, and integrates with existing accounting software, making it easier to answer questions about what was purchased, how it was paid for, and how it affected cash flow.
You can streamline your process of inputting invoice details by using Plooto Capture, which automates the recording of invoice details by extracting them using best-in-class Optical Character Recognition (OCR) technology. Once reviewed, bills are published into your accounting software and a payment is created on your Plooto dashboard. Then, once payments are made, Plooto automatically syncs payment information back to your accounting software - saving you the headache of manually updating bill payments.
Incorporating inventory management for a successful business
Implementing an effective and consistent strategy to manage your inventory promotes growth and success of your business. Inventory management software can aid in real-time tracking of inventory, provide data insights, and help to make the inventory management process more efficient.
Streamlining your inventory management frees up cash to invest back into your business, improves customer satisfaction, and enables data-driven decisions.
That's it from us! We hope you've been able to learn about the importance of inventory management and different ways to implement its methods.
FREQUENTLY ASKED QUESTIONS
What is Inventory Management
Inventory management encompasses all procedures and practices involved in organizing, purchasing, delivering, tracking, and storing inventory. You can implement numerous inventory management strategies to help you manage your inventory.
What Are the Different Types of Inventory
Inventory can be divided into four types: Raw materials, Work-In-Progress (WIP), Maintenance, Repair, and Operations (MRO), and finished goods.
What is an Example of Inventory Management
Just-In-Time (JIT) inventory management involves keeping the lowest stock possible and/or receiving/creating inventory once orders are made. This method is also known as lean manufacturing, which aims to eliminate waste and non-value adding activities.