Table of Contents
What Is Inventory Management?
Inventory management assists businesses in determining which and how much stock to order at what time. It keeps track of inventory from purchase to sale. The practice identifies and responds to trends to ensure that there is always enough stock to fulfill customer orders and that a shortage is properly announced.
Inventory becomes revenue once it is sold. Inventory (despite being reported as an asset on the balance sheet) ties up cash before it is sold. As a result, having too much stock costs money and reduces cash flow
Inventory turnover is one indicator of good inventory management. Inventory turnover is an accounting metric that reflects how frequently stock is sold in a given period. A company does not want more inventory than sales. Inadequate inventory turnover can result in deadstock, or unsold stock.
Why Is Inventory Management Important?
Inventory management is critical to the health of a business because it ensures that there is rarely too much or too little stock on hand, reducing the risk of stockouts and inaccurate records.
Inventory tracking is required for public companies to comply with Securities and Exchange Commission (SEC) rules and the Sarbanes-Oxley (SOX) Act. Companies must document their management processes in order to demonstrate compliance.
Benefits of Inventory Management
Inventory management has two primary benefits: it ensures that you can fulfill incoming or open orders and it increases profits. Inventory management also includes:
- Saves Money:
Understanding stock trends means knowing how much and where you have something in stock so you can make better use of what you have. This also allows you to keep less stock at each location (store, warehouse) because you can pull from anywhere to fulfill orders — all of this reduces inventory costs and the amount of stock that goes unsold before it becomes obsolete.
- Improves Cash Flow:
You spend money on inventory that sells when you use proper inventory management, so cash is always moving through the business.
- Satisfies Customers:
One aspect of developing loyal customers is ensuring that they receive the items they desire without having to wait.
Inventory Management Challenges
The primary inventory management challenges are having too much inventory and not being able to sell it, not having enough inventory to fulfill orders, and not knowing what items you have in inventory and where they are located. Other challenges include:
- Getting Accurate Stock Details:
There is no way to know when to refill stock or which stock moves well unless you have accurate stock details.
- Poor Processes:
Outdated or manual processes can lead to errors and slow operations.
- Changing Customer Demand:
Customer preferences and needs are constantly shifting. How will you know when and why their preferences change if your system cannot track trends?
- Using Warehouse Space Well:
If similar products are difficult to find, employees waste time. Mastering inventory management can help you overcome this difficulty.
What Is Inventory?
The raw materials, components, and finished goods that a company sells or uses in production are referred to as inventory. Inventory is classified as an asset in accounting. Accountants use stock level information to record accurate valuations on the balance sheet.
Inventory vs. Stock
In retail, inventory is frequently referred to as stock: Managers frequently use the term “stock on hand” to refer to products such as apparel and housewares. Across industries, “inventory” refers to both stored sales goods and raw materials and parts used in manufacturing.
Some argue that the term “stock” is more commonly used in the United Kingdom to refer to inventory. While there is a distinction between the two, the terms inventory and stock are frequently used interchangeably.
What Are the Different Types of Inventory?
There are 12 different types of inventory:
- Raw materials
- work-in-progress (WIP)
- finished goods
- decoupling inventory
- safety stock
- packing materials
- cycle inventory
- service inventory
- excess and maintenance
- repair and operations (MRO). Some people do not consider MRO to be inventory.
Inventory Management Process
When a company produces on demand, the inventory management process begins when a customer order is received and continues until the order is shipped. Otherwise, the process starts with forecasting your demand and then placing POs for the necessary raw materials or components. Other aspects of the process include analyzing sales trends and organizing product storage in warehouses.
How Inventory Management Works
Inventory management’s goal is to understand stock levels and stock location in warehouses. Inventory management software tracks the flow of products from the supplier to the customer through the manufacturing process. Inventory management in the warehouse keeps track of stock receipt, picking, packing, and shipping.
Inventory Management Techniques and Terms
Formulas and analysis are used in some inventory management techniques to plan stock. Others rely on protocols. All methods are designed to improve accuracy. The techniques used by a company are determined by its needs and stock.
Read the guide to inventory management techniques to determine which technique is best for your company. Here’s a rundown of what they are:
- ABC Analysis:
This method determines the most and least popular types of stock.
- Batch Tracking:
This method groups similar items together in order to track expiration dates and locate defective items.
- Bulk Shipments:
This method takes into account unpacked materials that suppliers directly load onto ships or trucks. It entails purchasing, storing, and shipping inventory in bulk.
When using consignment inventory management, your company will not pay its supplier until a specific product is sold. That supplier also retains ownership of the inventory until it is sold by your company.
You will unload items directly from a supplier truck to a delivery truck using this method. Warehousing is largely eliminated.
- Demand Forecasting:
This type of predictive analytics aids in forecasting customer demand.
Dropshipping is a practice in which the supplier ships items directly from its warehouse to the customer.
- Economic Order Quantity (EOQ):
This formula determines how much inventory a business should order in order to reduce holding and other costs.
- FIFO and LIFO:
First in, first out (FIFO) refers to the practice of moving the oldest stock first. Because prices always rise, the most recently purchased inventory is the most expensive and thus sold first, according to the last in, first out (LIFO) principle.
- Just-In-Time Inventory (JIT):
Companies use this method to keep stock levels as low as possible before restocking.
- Lean Manufacturing:
This methodology focuses on removing waste or any item from the manufacturing system that does not provide value to the customer.
- MRP (Materials Requirements Planning):
This system handles manufacturing planning, scheduling, and inventory control.
- Minimum Order Quantity:
To keep costs low, a company that relies on minimum order quantity will order small amounts of inventory from wholesalers in each order.
- Reorder Point Formula:
Businesses use this formula to determine the bare minimum of stock required before reordering and then manage their inventory accordingly.
- Perpetual Inventory Management:
This method involves tracking stock sales and usage in real time.
- Safety Stock:
An inventory management philosophy that prioritizes safety stock ensures that there is always extra stock on hand in case the company is unable to replenish those items.
- Six Sigma:
This is a data-driven method for eliminating inventory waste in businesses.
- Lean Six Sigma:
To eliminate waste and increase efficiency, this method combines lean management and Six Sigma practices.
Inventory vs. Cycle Counting
“Taking inventory” refers to the process of physically counting all stock, which is typically done once a year. The practice of counting a specific set of stock more frequently is known as cycle counting. Cycle counting is an important means of ensuring that the amount of inventory represented in the inventory management system corresponds to what is on the shelf.
A cycle counting best practice is to count specific SKUs on a regular basis and incorporate it into warehouse staff’s daily tasks. Companies may set different standards for different types of inventory, such as performing a cycle count of the most popular SKUs or higher-value items.
Demand Planning and Inventory Management
Demand planning is an essential component of effective inventory management. It is the process of determining how much of each item you expect to sell and when you expect to sell it. Once demand is established, inventory management tracks the flow of goods from the supplier to production and, finally, to the fulfillment of customer orders.
Inventory Management Formulas
It is critical to understand inventory management formulas in order to optimize stock levels. Several inventory and accounting professionals have tested formulas to simplify inventory calculations.
Inventory Management KPIs
Effective inventory management is critical throughout the supply chain. There are numerous key performance indicators for measuring inventory management success across the various business organizations. It is critical to understand which calculations provide the most insight into your business processes.
How Is Inventory Management Different From Other Processes?
Inventory management is frequently confused with related practices. Inventory management is in charge of all stock in a company. Supply chain management oversees the entire process, from supplier to customer delivery. Inventory control includes warehouse management, which focuses on stock in a specific location.
Inventory Management vs. Inventory Control
Inventory control is a component of the inventory management process. Inventory control oversees the movement of items throughout the warehouse.
Inventory Management vs. Inventory Optimization
Inventory optimization is the process of using inventory in the most efficient way possible, thereby reducing the amount of money spent on stock and storage.
Inventory optimization can also be defined as seeing inventory across all locations and selling channels and being able to use any of it to fulfill customer orders, allowing you to hold less stock overall.
Inventory Management vs. Order Management
Inventory management is in charge of placing orders and tracking stock as it arrives at the warehouse. The process of receiving and tracking customer orders is known as order management. Both tasks are frequently combined by software.
Inventory management is critical in order management. As orders are received, inventory can be allocated to specific orders, and the status of the inventory record can be changed to essentially put it “on hold” for that order. Furthermore, when the order management system and inventory system are integrated, the inventory system can recommend which location should fulfill the order based on the availability of all the items in the order—this eliminates multiple shipments for a single order.
Inventory Management vs. Supply Chain Management
Supply chain management is the process of managing external supply relationships as well as the flow of stock into and out of a company. Inventory management may concentrate on trends and orders for the entire company or a portion of it.
Inventory management is critical for a well-functioning supply chain. Inventory management is concerned with the movement of goods into, through, and out of the warehouse. Demand planning, procurement, production, quality, fulfillment, warehousing, and customer service are all components of the supply chain that require inventory visibility.
Inventory Management vs. Warehouse Management
Inventory management is supplemented by warehouse management. Warehouse management is in charge of organizing stock in a warehouse. Inventory management oversees stock and trends across multiple warehouses or an entire organization.
A well-planned and meticulously organized facility is essential for streamlining your warehouse operations. When each product has its own location in the warehouse, it keeps employees from moving around inefficiently and maximizes labor efficiency. These processes, however, are only as good as the inventory records that power them.
Inventory Management vs. Logistics
The practice of controlling processes in a warehouse as well as replenishment and delivery systems is known as logistics. Inventory management is in charge of stock levels and stock location.
Inventory management is a critical component of how businesses manage their logistics. Inventory management and logistics have a symbiotic relationship. Inventory management is required for logistics to carry out their functions. Excellent logistics systems enhance warehouse and operational activities.
Inventory Management vs. ERP
An ERP system is software that manages business processes such as accounting, purchasing, compliance, and supply chain operations. Inventory management, on the other hand, is a component of a modern ERP system that provides insight into stock levels, inventory en route, and the status of current inventory—making it visible across the organization in real time.
Inventory management aids in the proper planning of a company’s replenishment orders. ERP systems provide companies with accurate inventory data, ensuring that their inventory management strategy is up to date. ERP systems optimize data for effective inventory management.
Retail Inventory Management
The stocking of products that you sell to customers is referred to as retail inventory. Use the system to set profitable prices and ensure that you have enough stock to meet demand.
Manufacturing Inventory Management
Manufacturing inventory management is the practice of keeping sufficient stock on hand to allow production lines to fulfill orders. The process allows managers to see stock levels at a glance while also tracking raw materials, parts, work-in-process, and finished goods.
What Is Multi-Location Inventory Management?
The process of managing stock across multiple locations, warehouses, retail stores, or selling channels is known as multi-location inventory management. You can monitor stock levels in all locations and optimize your inventory to meet orders with multi-location management.
What Is an Inventory Management System?
An inventory management system integrates various software packages to track stock levels and movements. The solution is compatible with multichannel sales and shipping systems.
Inventory management systems optimize inventory levels while also ensuring product availability across multiple channels. It offers a centralized, real-time view of all items, inventory, and orders across all locations and selling channels. This allows businesses to stock less inventory and frees up cash for use in other areas of the business. An inventory management system assists in lowering inventory costs while meeting customer expectations.
How to Choose an Inventory Management System?
Choosing an inventory management system entails determining which features your company requires. Do you need to track stock movements and warehouse location, or plan inventory and track trends, or both?
Inventory Management FAQs
Inventory management is a broad and complicated topic with many questions. Here are some responses:
What Are the Objectives of Inventory Management?
One goal of inventory management is to keep enough inventory on hand to satisfy customers. Another strategy is to invest as little in stock as possible while still earning the most profit.
Why Inventory Management Is Important in the Supply Chain
Inventory management is essential in the supply chain because a business must balance customer demand with storage space and cash constraints. Inventory management provides managers with visibility into the supply chain (procurement, production, fulfillment, and so on), allowing them to coordinate delivery lead times with production timetables.
How Can Inventory Management Be Improved?
Keeping accurate accounting records and performing physical stock counts on a regular basis can help you improve your inventory management efforts. A system that provides your organization with real-time inventory visibility can assist stakeholders in making critical business decisions. You should also be aware of the condition of your stock, especially if you’re dealing with perishables.
How Inventory Management Affects the Working Capital
Warehoused goods consume working capital until they are sold. Making the supply chain more efficient keeps you from stockpiling. Improving inventory management processes helps you avoid mistakes in storing, picking, and shipping that reduce sales.
What Are Inventory Management Policies?
Inventory management policies are plans for how to use inventory to keep customers satisfied while lowering costs. Policies detail things like the company’s stock management method.
What Are the Types of Inventory Management Systems?
Businesses use various types of inventory management systems depending on how they operate. Manual inventory, periodic inventory, and perpetual inventory are three examples. Manual methods are the most primitive and inaccurate, while perpetual systems are the most sophisticated and precise.
- Manual Inventory System:
This entails counting items physically and recording them on paper or in a spreadsheet. Manual systems may be used by small businesses.
- Periodic Inventory System:
Manual and periodic counts are part of periodic inventory systems. Periodic counts capture item information as it moves in and out of stock. Barcodes make inventory management easier. A database stores information about stock levels and locations.
- Perpetual Inventory System:
Because they rely on active radio frequency identification (RFID) tags that are always on and sending updates on item movements, perpetual inventory systems provide real-time stock data. Meanwhile, passive RFID tags use a scanner to send stock information to a database.
What Is Service Level in Inventory Management?
A service level for inventory management is the amount of stock that a company believes it can successfully store. In other words, it is the likelihood that a company will avoid stockouts and maintain sales.
How Does ERP Help in Inventory Management?
ERP is useful for inventory management because it tracks and provides insights into supply chain operations, accounting, and purchasing, consolidating the information and making it visible in a single location.
What Is Poor Inventory Management?
Poor inventory management is characterized by an imbalance between stocking too much and too little. As demand changes, so does the definition of perfect balance: When trends or seasons change, so do sales. Poor stock management raises costs and, as a result, reduces profits.