26 June, 2023

What is inventory management? The complete guide

Inventory management is the systematic processes of ordering, counting, storing, and tracking product supply.

Did you know that 43% of small businesses don’t track their inventory for one reason or another? Furthermore, only 63% of retail businesses report accurate supply chain and inventory levels. These alarming inventory management statistics cost businesses millions of dollars every year.

Inventory management refers to the theories, processes, and tools involved in controlling inventory at each stage, from sourcing to storing to selling. The core purpose of inventory management is to ensure you have the right amount of stock on hand at the right time — at the right cost and price. So what is an inventory management system?

 

An inventory management system describes the processes and tools businesses use (physical and digital) to track, record, and analyze inventory movements and sales performance across the supply chain. Cin7 Core and Cin7 Omni are examples of cloud-based inventory management software (IMS) solutions using an integrated software platform to perform all of these tasks efficiently.

Follow along as we unpack inventory management, why it’s important, and how to optimize your inventory management system.

 

Key takeaways:

  • Inventory management is the holistic process of forecasting, planning, and executing a series of inventory-related tasks for a company. It covers tracking goods during manufacturing and sourcing until the final product is in the customer’s hands.
  • Inventory turnover ratio is one way to gauge a business’s inventory management success. It measures the rate at which goods are purchased, used, and sold. Inventory turn is a primary KPI for overall supply chain management.
  • Excellent inventory management strives to enhance planning and forecasting, improve delivery times, control inventory costs, and boost efficiency.
  • Common inventory management challenges are inventory shrinkage, deadstock, out-of-stock inventory, demand changes, and poor use of warehouse space.

Why is inventory management important?

You must have enough inventory to run a successful product-focused business with satisfied customers and meet market demand. Therefore, systematic and transparent inventory management is critical to a business’s bottom line. For instance, it costs money to store inventory, so inventory managers or other stakeholders try to determine the minimum space required to store the appropriate amount of inventory.

Businesses will use many metrics to determine whether or not they’re managing inventory well. One of these metrics is the inventory turnover ratio. Generally, the higher the ratio, the better it is for the company because it means that inventory isn’t sitting idle on warehouse shelves, where it doesn’t make money. In fact, it costs money. Rather, a good inventory turnover ratio indicates that it is being used in production or sold.

Types of inventory

There are three main types of inventory — raw materials, work-in-progress goods, and finished goods. However, labeling with further classifications can help anyone understand the status of a product at any time. Below, we’ll cover the nine most common types of inventory in inventory management.

Inventory Types
Raw materials Materials or purchased parts that make up finished products.
Work-in-progress (WIP) goods Partially completed goods in the process of becoming finished goods.
Finished goods The final product manufactured by the industries or companies that is ready to be sold by wholesalers, retailers, etc.
Transit inventory Inventory that is in transit from the manufacturer’s place to the retailer/wholesaler shop. Sometimes known as pipeline inventory.
Safety stock Extra inventory that can avoid customer service problems, backorders and stockouts and the cost associated with them. It protects against uncertainties in demand, lead time, and supply variations.
Anticipation inventory Stock that is set aside and used to absorb uneven consumer demand during a certain period.
Decoupling inventory Extra raw materials or WIP goods that are set aside out of the way to avoid production interruptions.
Cycle inventory The portion of total inventory that is constantly turned over and replaced with new stock. It’s also considered the minimum stock needed to maintain quotas.
MRO inventory The products that support the production process of the finished goods, such as lubricants, screws and ball bearings, gloves, packing materials, etc.

Benefits of inventory management

As a small business owner, it’s important for you to be in the know about your day-to-day and overall performance at any time. Inventory management for small businesses is a critical component of how you can stay involved.

However, the benefits of inventory management go beyond this. Effective inventory management can curb profit loss through efficient planning and forecasting. It also improves workflow and delivery times. Let’s dive deeper into how inventory management can help your business thrive.

 

1. Enhances planning and forecasting

Managing your inventory brings sense to the data around you. Inventory management can help you analyze and distinguish the products between well-performers and shelf-eaters. Using inventory management tools to identify these products can:

  • Improve revenue generation
  • Free up cash flow

Also, it would be great if you could forecast your customer’s purchasing pattern and restock your inventory based on that data. Inventory management grants you access to do stuff like this, too.

For example, say your forecasted product “x” will be in massive demand during the sales season. You stockpiled product “x” in your inventory, and it paid off. You will not only generate revenue but can also stockpile your supply again based on the daily sales pattern of your customers.

2. Improves delivery time

Nowadays, customers demand no less than the best in the market, whether it’s the quality of the product delivered or the time taken to ship the product to its end customer. Late delivery due to out-of-stock or inventory mismanagement can affect your brand reputation.

Properly arranged and tracked inventory helps:

  • Protect you from mismanagement of inventory
  • Increase customer satisfaction by expedited delivery

3. Controls your inventory costs

Inventory management is about overseeing the flow of inventory through your organization. Stock management helps you better understand which stocks are doing well and which stocks are eating up your shelf space. The key is to order the inventory as much as needed — not too little or too much.

Due to accurate forecasting done with the help of inventory management systems, you can order the products in the right amount and save the costs involved in purchasing extra products and storing them.

This also protects you from keeping a less demanding inventory, backorders, excessive inventory, etc. Also, better inventory management helps you understand which products you must reorder and how frequently you must reorder them from your suppliers. This can help you crack deals with your supplier, thus saving money.

4. Boosts efficiency

If you are spending a lot of time searching for the products your customers order, it may be time to invest in inventory management. Inventory management includes allocating specific locations to specific products, so you can track the products and their quantities efficiently.

Systematically managing products:

  • Saves time and efforts
  • Fosters better employee allocation towards more pressing matters
  • Improves overall productivity

In short, companies need inventories to operate, and having the right products available at the right time in the right quantities to meet customer requirements is the key to achieving the company’s objectives. Inventory management and control help do just that; that’s why it is crucial to business operations.

Inventory management methods

Selecting an inventory management method isn’t one-size-fits-all — you’ll need to pick the method that suits your business best. There are various ways in which you can manage inventory, and it is up to your organization to choose the inventory management technique that best suits your business.

  • Perpetual inventory method: As the name suggests, the perpetual inventory method of accounting inventory is about tracking inventory ‘perpetually’ as it moves throughout the supply chain.
  • Periodic inventory management: Inventory is monitored at the beginning and end of the accounting period.
  • ABC analysis: ABC analysis typically separates inventory into three categories based on its revenue and control measures required.
  • Just-in-time inventory: The just-in-time inventory method refers to having the inventory readily available at the right time and in the right place as per the demand but not overstocking it, creating a deadstock.
  • First-in-first-out (FIFO): FIFO is an inventory accounting method where the oldest stock or the inventory that entered the warehouse first gets sold first. FIFO is one of the most popularly used inventory valuation methods.
  • Last-in-first-out (LIFO): Compared to FIFO, LIFO is an inventory accounting method where goods produced or purchased most recently get sold first.
  • Economic order quantity (EOQ) formula: The economic order quantity is a formula designed to assist companies to not over-or under-stock their inventories and minimize their capital investments in the products they are selling.
  • Vendor-managed inventory: Vendor-managed inventory (VMI) is a business model in which the buyer of a product provides certain information to a vendor or the supplier of that product, and the supplier takes full responsibility for maintaining agreed inventory levels of the material, usually at the buyer’s preferred location or store
  • Two-bin inventory control: The two-bin method comprises two identical plastic bins that get utilized alternately. Both of them get filled with components fitted onto the final product. The workers on the production line use the first bin until it empties. Once the first bin gets wholly utilized, they will start utilizing the second bin. The empty one will act as a signal for replenishment.
  • Fast, slow, non-moving (FSN) inventory: This method separates products based on their consumption rate, quantity, and the rate at which the inventory gets used.

 

Inventory management challenges

You can minimize or even solve many inventory management challenges with proper inventory management systems. But, if demand changes or sudden inventory shrinkages come out of nowhere, you need a plan to curb the issue.

Implement the following solutions to prevent issues — and meet them head-on.

Inventory shrinkage

Inventory shrinkage is a phenomenon where there is less inventory available due to unforeseen circumstances such as shoplifting or employee theft, damaged or expired products, and vendor error. This is one of the biggest problems a company must plan for since the exact causes are typically left unidentified.

Solutions:

  • Safeguard expensive inventory.
  • Build trusting vendor relationships.
  • Install warehouse security systems.
  • Implement employee training and incentives.
  • Tighten the process to avoid overlooked inventory shrinkage.

Deadstock

Deadstock, or obsolete inventory, is stock that never sells for one reason or another over a long period without any near future indications of selling. This stock occupies warehouse space, clutters inventory systems, and blocks cash flow. The most common causes of deadstock are incorrect forecasting and lack of demand.

Solutions:

  • Prioritize customer relationships to understand what they want.
  • Understand market trends.
  • Track sales history and demand.
  • Communicate with your supplier regularly to learn trends.
  • Sell time-sensitive products at discounted prices or donate for tax deductions (if applicable).

Out-of-stock inventory

Harvard Business Review states, “72% of stock-outs were due to faulty in-store ordering and replenishing practices — retailers ordering too little or too late, generating inaccurate demand forecasts, or otherwise mismanaging inventory.”

It’s one of the worst nightmares for any retailer to be out of stock of a particular item, especially when it is in great demand. Being out of stock when the product is in great demand means loss of revenue earning for the company and also decreasing the credibility of your company.

Solutions:

  • Create a re-ordering threshold to alert you when it’s time to restock.
  • Implement demand forecasting.
  • Offer a reserve option to clients when the product is back in stock.
  • Indicate online when products are out of stock and show alternatives available to purchase instead.

Demand changes

Unexpected changes in demand can wreak havoc on a company’s inventory. While high demand means a business may profit, they could sell out, unable to keep up with consumers’ needs. On the other hand, low demand results in deadstock and wasted dollars.

Accurate forecasting allows companies to recognize market trends and improve supply chain management. Though forecasts can’t predict all scenarios, it’s the best approach to managing demand changes alongside remaining flexible.

Try the following tips if you’re in the thick of demand changes.

Solutions:

  • Analyze your current inventory and supplier needs.
  • Build a safety stock.
  • Restructure fulfillment processes relevant to the moment.
  • Implement a strategic demand management system to plan for future challenges.

Poor use of warehouse space

An inefficient warehouse layout negatively impacts workflows, supply chain performance, and shipping times. Optimizing the space you have from the start can save headaches later.

Warehouse design covers much more than building the physical facility. Think about the zoning of each task — like packaging and shipping — and how much space they’ll truly encompass. What’s the best way to store your goods, and what shelving should you use? One frequently forgotten aspect is planning for future growth — will you likely outgrow your warehouse in a year?

Solutions:

  • Utilize an inventory organization system that best suits your business — what products should be most accessible?
  • Map out the workflow between warehouse departments to determine what functions you should place and where.
  • Revamp the picking process in a way that best fits your sales.
  • Optimize for accessibility to cut cross-department interference.

How to manage inventory

You now understand the importance of inventory management, but how do you get started? Here are a few tips and best practices for inventory management to remember as you revitalize your processes.

1. Keep safety stock

Every retailer stocks inventory according to its customer’s average demand. Now, sometimes there can be a rush of sales. You will soon be out of stock faster than you can replenish your inventory. It is during such situations that we need a safety stock.

Safety stocks thus help prevent stock-outs when there is a high variation in demand and supply. For instance, during the Coronavirus pandemic, suppliers couldn’t provide products in the given time frame or the quantity retailers expected. Now in such situations, if the retailer has kept safety stock, it will help make sales and keep customers happy.

2. Emphasize merchandise planning

Retailers of modern times might not question the importance of merchandise planning, but for beginners, here are some reasons why you should plan your merchandise.

Merchandise planning can help you stock your warehouse in a way that increases the inventory turnover ratio. It decreases inventory carrying costs because of:

  • Fewer unwanted inventory in the warehouse
  • Less labor and maintenance costs
  • Loss through obsolescence as most of the stock gets sold
  • Less depreciation of inventory

3. Track your products

The bread and butter of inventory management is tracking products at all times. You should be able to track a single item from when you order raw materials until the finished goods are in customers’ hands. Create a tracking system for each step by identifying responsible parties, selecting a tracking method, and training employees.

4. Invest in automation with connected inventory performance

It’s been said before — manually tracking inventory is a process that you’ll likely outgrow fast. As your business expands to bigger or multiple locations or online selling, a more robust system is needed. This is where connected inventory performance and inventory management software come into play.

Connected inventory performance uses automation and integrations to drive visibility, traceability, and efficiency throughout the inventory lifecycle. It offers software solutions for understanding real-time insights and analytics on stock levels, sales trends, and more. Cloud-based technologies allow connections between point-of-sale bases that update inventory levels automatically after each transaction or new receiving shipment. It’s also easy to set up alerts for low inventory to avoid selling out of your high-demand items.

5. Audit regularly

Though inventory management software offers endless benefits, you should still periodically count your inventory levels to ensure your stock reflects the software’s levels. Depending on your stock size, it may be best to schedule a thorough inventory review annually or even quarterly.

Regular audits paired with systematic spot-checking may catch unexpected inventory shrinkage, improperly stored items, and more.

Frequently asked questions (FAQ)

Still have inventory management questions? Let us answer them.

What is meant by inventory management?

Inventory management means tracking a company’s complete list of goods. It covers tracking raw materials from the original manufacturers to the warehouse to the point of sale.

What is the 80/20 rule in inventory?

The 80/20 inventory rule states that 20% of your inventory and product range should deliver 80% of your sales. Outside of inventory, it suggests that 20% of customers should drive 80% of profits. You may hear this also be called the Pareto Principle.

Can Excel be used for inventory management?

Most businesses outgrow Excel as an inventory management solution very quickly. Tracking inventory through spreadsheets is a manual, time-consuming process. There’s a greater chance of human error and security breaches when relying on Excel spreadsheets for inventory management.

What is the difference between inventory management and inventory control?

Inventory control is a facet of inventory management that manages in-stock inventory, including the day-to-day processes of receiving stock, sending orders, and storing.

What is the difference between inventory management and order management?

Inventory management and order management work hand-in-hand. Whereas inventory management typically handles products before and while it’s in the warehouse, order management takes over once a customer purchases the product. Order management involves receiving, sending, and tracking orders once shipped.

What is the difference between inventory management and ERP?

Enterprise resource planning (ERP) is a multi-faceted system for managing and unifying all business functions within a company. It differs from inventory management as it can include operations, finances, supply chain, human resources, customer relationships, and inventory management.

What is the best way to manage inventory?

While it may come as a surprise, you’re likely not cutting any costs by manually tracking inventory on spreadsheets. Between time loss and human error, your business might be ready to move on to inventory management software.

With an automated, all-in-one system like Cin7 Core or Cin7 Omni, you’ll have real-time visibility on your inventory, allowing you to improve your supply chain, keep customers happy, and minimize inventory loss.

Core and Omni are efficient in handling inventory-related tasks and can automate the entire e-commerce operations process. You can conveniently manage back-end operations of selling your products across multiple channels, multiple locations, and multi-currency by using one software.

To learn more about inventory management software, try a Cin7 demo today.

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