Learning how to effectively manage inventory is critical for any business that sells physical goods. Everything related to your products, from timely ordering to correct receipt, tracking and storage, is part of inventory management. It's important that you get these things right because mistakes here directly affect your bottom line.
By minimizing lost sales, misstocking and over-ordering, inventory management increases your profits and may even reduce your taxes.
What is inventory management and why is it critical to success
Inventory management is the general term for the processes and procedures that affect the ordering, receiving, storage, tracking and payment for all the goods that a company sells.
Lagerstyring vs. Supply Chain Management
Inventory management is an important part of supply chain management, but the terms are not interchangeable. Supply chain management monitors the flow of products from raw materials and production purchases to final distribution. Inventory management is about capturing, tracking and storing the products you have and providing data to an up-to-date market.
For a small business or self-employed, supply chain and inventory management processes easily go hand in hand. However, it's important to know the differences as you grow and start outsourcing supply chain and warehouse tasks to staff or outside contractors.
Why it is necessary to learn how to manage inventory
Any business that sells products needs to manage the products properly to survive. If you don't have items in stock to sell, or if you can't find items to fulfill orders, you have no income. It's that simple.
However, inventory shortages are only the first obstacle caused by poor or no inventory management. It's very easy to order excess inventory if you don't keep a close eye on inventory, leaving you cash-strapped in the short term. Over time, inventory overruns also lead to lost profits due to expired, obsolete, and otherwise unsaleable inventory.
And let's not forget corporation tax. Too much unsold inventory at the end of the year equals higher property taxes and income taxes. Fortunately, you can avoid these obstacles by incorporating simple inventory management processes and tools into your business plan.
Inventory management in 7 steps
If you find that inventory-related tasks are taking up a large portion of your day, it's probably time to evaluate and restart. Good inventory management is more than just increasing inventory accuracy, it makes your day more efficient. When you have good processes and procedures in place, you will quickly find more time for business building activities.
Here's a seven-step approach to creating an inventory management plan with processes, controls and tools tailored to your company's unique needs.
1. Determine methods for purchasing and storing products
How you source and store the various products you sell determines how you manage your inventory. If you store all products in your own facility, your inventory management and processes are handled internally.
But if you store goods remotely in fulfillment centers or supplier warehouses, or if you use dropship suppliers, you need to connect your warehouse processes and data tools to their systems.
2. Define how you want to track inventory data
Whether you stock items yourself, use a fulfillment partner, or focus on dropship suppliers, tracking inventory data is critical to inventory management. Spreadsheets and inventory management systems are invaluable tools for this.
The inventory data you want to record and track generally includes:
- Domestic and Supplier Product Numbers:Product numbers are called stock-keeping units (SKUs), and many suppliers also use Universal Product Codes (UPCs).
- Quantities Available (QOH):the current stock amount per item in your store or facility
- Product storage location:allocated areas where goods are stored or displayed
- Supplier information:contact information, minimum order quantities, number of boxes and delivery times, also known as delivery times
- Product price:wholesale price per supplier and volume discounts
- Retail prices:current and promotional sales prices on goods
You can use a spreadsheet for simple inventory management needs, such as less than 100 items. However, integrated inventory management systems such as Square POS, Lightspeed or Clover are very affordable and make inventory management in small businesses easy from day one.
These systems streamline customer orders, inventory management, supplier information, purchase orders and warehouse receipts into a single system. Additionally, most connect seamlessly with retail point-of-sale (POS) systems, online sales channels, fulfillment centers and dropship partners for real-time inventory updates.
3. Create an internal SKU system
Creating an internal product SKU system is useful for quickly locating and tracking products during day-to-day operations. SKUs generally use a combination of letters and numbers arranged to represent the most important details about an item at a glance.
For example,BW066-3201_RASPis an internal SKU coded to communicate specific information about a home goods company.
- BW:is the internal vendor code for the BentleyWare vendor
- 066:is the internal category code of an array
- 3:is the internal material code for plastics to control appearance, handling and packaging
- 201:attached to the last four digits of the supplier's UPC to verify orders and warehouse receipts
- FIL:is the internal color code for the Raspberry
So with a glance at the SKU, employees know exactly what an item is and other important details like where it's stored and how it's displayed or shipped.
4. Organize storage areas
Having a place for everything and everything in its place makes all your storage-related tasks fast and efficient. If you manage inventory in your own facility or store, first organize and identify storage areas such as shelves, racks, and bins, then assign each product to a specific room.
This is where internal SKUs come in very handy. You can easily link specific areas of the shop floor, warehouse or warehouse using your SKU's supplier or category codes.
5. Use forecasts to order inventory
Forecasting predicts how much inventory you will need to meet upcoming demand. Of course, there are many factors involved such as the rate of product sales, upcoming promotions, market trends, seasonality and business growth to name a few.
The goal of forecasting is to have enough inventory on hand to meet expected sales for a specific period of time, such as 15, 30, or 60 days. Understanding product sales velocity is critical to forecasting, and inventory management systems help tremendously with forecasting tools built into purchase orders.
Understanding supplier lead times also plays a key role in forecasting. Reliable suppliers who ship quickly means you have less inventory and order more often, which helps cash flow. With suppliers that ship more slowly or buy seasonally, you have fewer and larger purchases, leaving more cash in inventory.
6. Set up procedures for stock receipt
Getting inventory shipped quickly is another important element in learning how to manage inventory. You may not sell or ship inventory that has not been properly inspected, displayed or displayed. Therefore, it makes sense to make inventory receipts a priority in your inventory management plan.
Inventory control must also be accurate, as errors directly affect your product quality data and lead to overorders, false orders, and unsold inventory. All this affects the final result.
The best procedure is to take inventory against your purchase order and open and check all boxes and containers to make sure everything is correct. Do not rely on box labels and packing slips from suppliers, as their staff can also make mistakes.
After receipt, the inventory must be stored quickly in the designated area. Alternatively, if it's excess inventory or seasonal items, you can record temporary locations in your inventory management system so you can find it when needed.
When placing or storing new inventory, you can use methods such as "last in, first out" (LIFO) or "first in, first out" (FIFO). In general, it is smart to use the FIFO method, which stores new products behind older inventory, so that you sell older products first. This is especially important for perishable foods and items with an expiration date, such as cosmetics.
7. Monitor inventory levels
Most inventory-based businesses perform an annual inventory count, called an audit, for tax purposes. This compares a physical count of all items in stock with the on-hand (QOH) shown in the data files. However, discrepancies found in annual censuses are almost impossible to detect and explain, as it can take months for the errors to become apparent.
This is where intermediate metrics like cycle counts and random checks fill the gap. These help you detect and correct small inventory inaccuracies before they become major problems.
- Number of cycles:Divide your entire inventory into units that count on a rotating schedule. Cycle counts can be performed by supplier, product category, warehouse location or whatever suits your business.
- Control samples:Periodic counts of some items help identify random errors in inventory, ordering, storage, or theft.
In short, when in doubt, measure. Keeping a close eye on inventory is key to improving your cash flow, detecting theft or other loss issues, and improving your bottom line.
The best tools for inventory management
There are many financial inventory management tools on the market. Some are even free, like Square POS. Most of these systems provide everything you need to manage inventory. Plus, they seamlessly connect sales channels and fulfillment sources into one system, so you're prepared for growth.
Here are some of the best inventory management tools to consider:
- Square POS:free basic POS system with a full suite of inventory tools
- Serie:advanced storage system, ideal for multi-warehouse and manufacturing operations
- Shopify point of sale:POS system for Shopify online, retailers and multi-channel sellers
- Speed of light:advanced POS system for large merchants in several stores
- Piano:online checkout and warehouse system that integrates with many e-commerce solutions
- eHopper:designed for restaurants with inventory management at the ingredient level
- Monday. dk:a step up from spreadsheets with inventory tools and reorder alerts
It boils down
It's easy for startups and small business owners to buy and sell products without an inventory management plan. But if it goes on too long, inventory management deficiencies quickly become headaches that cost you both customers and profits. By putting these seven essentials in place, you'll be well on your way to learning how to manage inventory and—best of all—making money from day one.
Frequently Asked Questions (FAQ)
What is the difference between inventory management and asset tracking?
Inventory management keeps track of the goods a company buys to sell. Inventory is only an asset until it is sold, then it becomes a "cost of goods sold" (COGS) expense. Asset tracking takes into account the cost and depreciation of equipment and supplies that a business buys to operate.
What is the 80/20 rule for inventory?
The 80/20 productivity rule states that 80% of your profit comes from 20% of your effort. Applied to inventory, this means that 20% of your total product line accounts for 80% of your profit.
What are storage types?
Inventory formulas are equations that give you insight into the health and profitability of your inventory. Useful formulas to know are inventory turnover, cost of goods sold ÷ average inventory, and sales percentage, which is units sold ÷ units received over a period.
What are the different types of shares?
There are several types of stocks that companies track. Raw materials include materials, parts and components used to manufacture or repair finished products. Fixing units are made-to-order only. Pending units are unfinished items. Finished goods are finished goods that are ready for sale. Product packaging and shipping materials can also be tracked as stock items.
How does the retail supply chain work?
The retail supply chain starts with the manufacturer, who creates and manufactures the product. This can be done by one person or by several people in a factory setting. From there the product goes to suppliers or distributors who buy the products from the manufacturer with the intention of distributing them directly to the customer or more commonly to retailers. When resellers are involved, they take the product from the suppliers with the intention of selling the product to customers who buy the products from the resellers.
As mentioned earlier, retailers are sometimes left out of the process and distributors or warehouse may even be eliminated, which is known as a direct-to-consumer business model.
What are the types of warehouse management software?
There are many types of warehouse-based businesses, and each has unique warehouse management needs. Custom built inventory management software includes manufacturing inventory management systems, e-commerce and multi-channel online inventory systems, retail inventory systems with point-of-sale capabilities, restaurant inventory software, and asset tracking systems for service businesses.
- Fine-tune your forecasting. ...
- Use the FIFO approach (first in, first out). ...
- Identify low-turn stock. ...
- Audit your stock. ...
- Use cloud-based inventory management software. ...
- Track your stock levels at all times. ...
- Reduce equipment repair times.
Four major inventory management methods include just-in-time management (JIT), materials requirement planning (MRP), economic order quantity (EOQ) , and days sales of inventory (DSI).What is your method for monitoring inventory levels answer? ›
An inventory review can be done using one of two common methods. One is a “cycle count.” This means physically counting a small sample of your inventory to make sure the information in your system is accurate. This is typically done daily or weekly. A second, more time-consuming approach is a physical count.What are the 3 major inventory management techniques? ›
In this article we'll dive into the three most common inventory management strategies that most manufacturers operate by: the pull strategy, the push strategy, and the just in time (JIT) strategy.What is the most effective inventory method? ›
1. FIFO — first in, first out. FIFO is one of the most common Inventory management techniques used in manufacturing. This system helps ensure that the oldest products are used first and reduces the chance of spoilage or obsolescence.What is the 5S method for inventory? ›
The 5S system consist of: sort, set in order, shine, standardize and sustain. Repeat it to yourself multiple times and write it down — go ahead, do it now! Have your employees and technicians do the same.What are the basic questions in inventory management? ›
- Who owns the inventory until it's sold?
- What WMS (warehouse management system) and OMS (order management system) does the provider use?
- What type of reporting is available to you about your inventory? ...
- Who manages vendor/manufacturer relationships?
- Centralized Tracking: Consider upgrading to tracking software that provides automated features for re-ordering and procurement. ...
- Transparent Performance: ...
- Stock Auditing: ...
- Demand Forecasting: ...
- Add Imagery: ...
- Go Paperless: ...
- Preventive Control: ...
- Measure Service Levels:
- Designate someone to be responsible for your inventory management. ...
- Select an inventory management system. ...
- Determine how often you need to run inventory. ...
- Roll out your inventory tracking equipment. ...
- Audit your inventory tracking on a regular basis.
- Avoid pitfalls and mistakes with Excel inventory. ...
- Update immediately. ...
- Use the cloud. ...
- Take the time to consolidate data. ...
- Review your data. ...
- Audit and review. ...
- Know when to upgrade.
ABC analysis is an inventory classification strategy that categorizes the goods into three categories, A, B, and C, based on their revenue. 'A' in ABC analysis signifies the most important goods, 'B' indicates moderately necessary goods, and 'C' indicates the least essential inventory.What are the three most common inventory control models? ›
Three of the most popular inventory control models are Economic Order Quantity (EOQ), Inventory Production Quantity, and ABC Analysis. Each inventory model has a different approach to help you know how much inventory you should have in stock.What are the 3 types of inventory examples? ›
- Raw Materials (raw material for making finished goods)
- Work-In-Progress (items in the process of making finished goods for sales)
- Finished Goods (available for selling to customers)
- Choose inventory management software. ...
- Identify all locations for inventory. ...
- Identify each unique item. ...
- Categorize items. ...
- Describe items. ...
- Create barcodes or QR codes. ...
- Apply barcodes or QR codes and scan as you go.
Accounting convention provides two main ways to value inventory on the balance sheet: last-in, first-out, or LIFO, and first-in, first-out, or FIFO. They both have advantages, but in periods of rising prices, FIFO is the preferred method for balance sheet analysis, especially for capital-intensive companies.What is the most common method of inventory control? ›
Four popular inventory control methods include ABC analysis; Last In, First Out (LIFO) and First In, First Out (FIFO); batch tracking; and safety stock.What is the golden rule of stock control? ›
The golden rule of stock control is to get the quantity and the frequency of re-stocking activities right, keeping costs as low as possible without compromising profitability and growth.What is the difference between inventory and stock? ›
In summary, stock is the supply of finished goods available for sale, and inventory includes both finished goods and components that create a finished product. In other words, all stock is inventory, but not all inventory is stock.What are the two main methods in inventory controls? ›
There are two main inventory control systems: periodic and perpetual systems.What is Kaizen in warehouse? ›
In warehousing, Kaizen generally involves thinking with your team and fishing out creative ideas to solve problems. You can use this strategy with everyone, from managers to plant workers to make the most out of it. All ideas will have equal value, followed by testing to measure how effective an idea is.
Kaizen, or rapid improvement processes, often is considered to be the "building block" of all lean production methods. Kaizen focuses on eliminating waste, improving productivity, and achieving sustained continual improvement in targeted activities and processes of an organization.What does Gemba walk mean? ›
The word “Gemba,” sometimes written with an “n” as “Genba,” comes from the Japanese word meaning “the real place” or “the place where value is created.” The idea behind a Gemba Walk is to go to the actual place where the work is done, such as the production floor, to understand what goes on.What is an inventory checklist? ›
Inventory Checklist is a record of the items stored in a specific area or department of a company. It helps in tracking and controlling the goods in an organized way. This document can be also be used for inspection because all items in the inventory are recorded here.What are the 7 parameters of inventory? ›
It especially focuses on the assessment and modeling of basic inventory parameters, namely demand, procurement cost, cycle time, ordering cost, inventory carrying cost, inventory stock, stock out level, and stock out cost.What should be included on an inventory checklist? ›
- Item. You need to list every individual item on your inventory sheet, including variations. ...
- SKU or Serial Number. ...
- Amount of inventory in stock. ...
- Price per unit. ...
- Sale price (optional) ...
- Location (optional)
Rules of Inventory #1: Have Enough Inventory to Service Demand. In the past, when inventory ran out, companies would simply issue a backorder while they purchased or manufactured more items. Customers would simply wait for the item to be in stock again.What are the two most basic inventory questions? ›
We will build an inventory model in order to answer two basic questions: How much do we order? And when? - with the goal of minimizing the total inventory costs. In the most basic of all inventory models we are going to make several important assumptions in order to keep the model simple.What are three basic questions of inventory control? ›
When it comes to the supply chain, there are three questions to which knowing the answer is imperative: when, where, and how much? Luckily, there are inventory control solutions available to help businesses answer these important questions.What is one of the greatest challenges in managing inventory? ›
Knowing how much (or how little) of a product you need to meet demand is one of the central challenges of inventory management. Not properly ordering the right amount from suppliers can lead to stockouts or even stock surpluses. In either case, it leads to inefficiencies and reduced revenue for your business.What is the basic formula of inventory? ›
The first step to calculating beginning inventory is to figure out the cost of goods sold (COGS). Next, add the value of the most recent ending inventory and then subtract the money spent on new inventory purchases. The formula is (COGS + ending inventory) – purchases.
- Taking a physical count of inventory? ...
- Use inventory scanners or other types of stock counting technologies. ...
- Choose your “counters” wisely. ...
- If you must do a full physical inventory count, schedule it ahead of time. ...
- Communicate, communicate, communicate. ...
- Map your store.
- Choose an inventory management tool. ...
- Focus on forecasting. ...
- Sell goods chronologically. ...
- Consider the demand for goods. ...
- Perform inventory counts.
Inventory tracking is the systems and methods a company uses to monitor how raw materials or finished goods move through the supply chain. Fundamental to generating revenue, the goal is to have the right amount of stock to meet customer demand.What is the goal of inventory management? ›
The goal of inventory management is to have the right products in the right place at the right time. This requires inventory visibility — knowing when to order, how much to order and where to store stock.What Excel formula is used for inventory? ›
Outgoing Stock: =SUMPRODUCT(($B5=item)*(movtype=”Outgoing”)*(quantity)) The outgoing stock formula works with the SUMPRODUCT function to help you easily calculate how much inventory has been sold and shipped. This formula can help you keep better, more accurate data and avoid overselling.How do I make an inventory list? ›
In general, an inventory list should include the product's name, SKU number, description, pricing, and quantity. Inventory lists help brands manage and monitor their stock levels, allowing for greater inventory control and a more streamlined approach to inventory management.What is XYZ analysis in inventory management? ›
What is an XYZ analysis? An XYZ analysis divides items into three categories. X items have the lowest demand variability. Y items have a moderate amount of demand variability, usually because of a known factor. Z items have the highest demand variability and are therefore the hardest to forecast.What does the EOQ stand for? ›
Economic Order Quantity (EOQ) is derived from a formula that consists of annual demand, holding cost, and order cost.Which of the following is not an inventory? ›
The answer is CNC Milling Machine. Raw Materials are machined or processed before they are ready to be used in the assembly of finished products.What are the 4 types of inventory? ›
There are four different top-level inventory types: raw materials, work-in-progress (WIP), merchandise and supplies, and finished goods. These four main categories help businesses classify and track items that are in stock or that they might need in the future.
The fixed order quantity, or Q system, operates through ordering a fixed quantity of materials when the stock on hand reaches a pre-determine reorder point.What is the difference between inventory control and inventory management? ›
Inventory management and inventory control are similar but have different focuses. Inventory management handles forecasting and ordering stock. Inventory control, also known as stock control, is a part of inventory management that handles the stock on-hand.What is the best example for inventory? ›
Inventory refers to all the items, goods, merchandise, and materials held by a business for selling in the market to earn a profit. Example: If a newspaper vendor uses a vehicle to deliver newspapers to the customers, only the newspaper will be considered inventory.What is inventory buffer? ›
An inventory buffer is additional inventory kept on-hand in case of emergencies, transportation delays or surges in demand. Buffer inventory takes up additional space and can be costly, especially with inventory that has a shelf-life.What are the 4 components of inventory? ›
There are four different top-level inventory types: raw materials, work-in-progress (WIP), merchandise and supplies, and finished goods. These four main categories help businesses classify and track items that are in stock or that they might need in the future.What are the four 4 elements of traditional inventory management? ›
- Maintaining Enough Inventory. ...
- Avoiding Excess Inventory. ...
- Inventory and Cash Flow. ...
- Tracking Inventory.
Four valuation methods are typically used: first in, first out (FIFO), last in, first out (LIFO), weighted average cost and specific assigned value.What are the four functions of inventory quizlet? ›
- Buffering against uncertainty in the marketplace. - Uncertainty in demand. ...
- Decoupling dependencies in the supply chain. - To achieve economies of scale in purchasing, manufacturing, transportation, etc..
- Balancing demand and supply. ...
The two sides are Inventory Control and Inventory Replenishment.What are the three components of inventory? ›
Manufacturers deal with three types of inventory. They are raw materials (which are waiting to be worked on), work-in-progress (which are being worked on), and finished goods (which are ready for shipping).
At a basic level, the cost of goods sold formula is: Starting inventory + purchases − ending inventory = cost of goods sold.What is the ABC method of inventory cycle count? ›
ABC analysis is an inventory management technique that determines the value of inventory items based on their importance to the business. ABC ranks items on demand, cost and risk data, and inventory mangers group items into classes based on those criteria.What is the most important function of inventory? ›
The main function of inventory is to provide operations with an ongoing supply of materials. To achieve this function effectively, your business should strive to find a sweet spot between too much and too little, without ever running out of stock.What is the main task of inventory? ›
An Inventory Clerk is responsible for tracking current production levels and recording purchases and products in a warehouse. They review purchase orders to ensure they're accurate before processing them with suppliers and checking stock status by performing physical counts on shelves or in trucks.