- Inventory management is the process by which products are ordered, tracked, stored, managed and shipped.
- Inventory management prevents the loss of items, improves your ability to track products, streamlines order fulfillment and helps you maintain appropriate inventory levels.
- There are many methods of inventory management; the right one for you depends on the nature of your business and the products you sell.
- This article is for business owners who store inventory, either in a warehouse or their physical store, and need to develop an effective way of managing it.
Any business that sells physical goods needs a place to store items, whether that's a warehouse or your own store. Inventory management is crucial to prevent loss of items, quickly fulfill customer orders and know when you need to buy more of a given product. It contributes directly to profitability, and no business can successfully scale without an inventory management process in place.
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What is inventory management?
Inventory management is the process by which an organization manages its physical stock, controlling the inflow and outflow of products from the point of procurement to the final sale. This includes tracking inventory by location, choosing when to submit purchase orders, and fulfilling sales in an efficient manner.
"Inventory management is the process to manage physical stock or products that you buy for sale," said Mohammed Ali, CEO of Primaseller. "[Inventory management includes] procuring, storing, managing and ensuring that product is there when customer is ready to buy it."
"Being able to know where your pieces are at all times is pretty much the key," added David Singletary, founder and CEO of DJS Digital.
Inventory management is important to a wide range of businesses, including retail companies, shipping and logistics operations, and manufacturing businesses. The exact nature of a business's inventory management process is dictated by the type of inventory it requires. For example, a retail business only needs to track the location and quantities of the finished goods it is selling, while a manufacturer needs to account for both raw materials and finished products.
"Say you're selling jeans," Ali said. "The first thing you start with is predicting how much you're going to sell per quarter. Place an order for those items."
Then, Ali said, there are three major questions to answer.
- Where will you store the product? Consider whether you need a warehouse or if you can store your inventory in a physical retail environment. If you are an online business selling on an e-commerce platform, ask yourself whether you need a separate location to store product or if you have enough room in your main office.
- How much are you going to store at one time? Accurate sales projections will help you better understand how much product you need to purchase and maintain at any given time, a process known as inventory control. Balance is key; you never want to hold too much inventory at once – known as "dead stock" – but you also want to always have enough units on hand to fulfill sales quickly.
- How do you store your inventory? Storage is a lot more than holding space for items awaiting sale. It includes setting up aisles and bins, ensuring storage locations are clean and free of moisture or contaminants, and establishing a quality assurance process to guarantee that products delivered by suppliers are in saleable condition.
Key takeaway: Inventory management is the process of creating an organized system for purchasing, tracking and reordering products.
7 inventory management techniques
If you are establishing a new inventory management process or looking to improve your existing one, here are seven inventory management techniques that you may find helpful.
1. FIFO vs. LIFO
First in, first out (FIFO) and last in, first out (LIFO) are accounting methods (also known as "costing") based on how products move through your warehouse.
FIFO is a useful system for businesses that sell the oldest inventory first. If it was first into the warehouse, it should also be first out the door when someone orders that product. This keeps inventory as fresh as possible, which is essential for perishable or expiring goods.
LIFO is the opposite of FIFO, ensuring that the most recently received inventory is the first out the door. FIFO is the default costing method, but LIFO makes sense for businesses that don't ship perishable goods, because the way this accounting method reports income has potential tax advantages.
2. Demand forecasting
Demand forecasting (or sales projections) helps you understand how much of each product you need to have on hand at all times to meet customer demand.
For established businesses, demand forecasting should be based on historical sales data. Newer businesses might need to rely on assumptions and industry data until they have a sales history of their own.
Demand forecasting is essential to inventory management, because it helps you determine the minimum amount of a product you should have on hand and set reorder targets when you reach that number. You should revisit your demand forecast quarterly to adjust your minimum quantities and reordering targets.
3. Minimum order quantity vs. economic order quantity
Minimum order quantity (MOQ) and economic order quantity (EOQ) are two different methods a business can use to determine when to reorder products.
MOQ focuses on maintaining the minimum possible amount of each product type a seller is willing to fulfill. High-ticket items tend to have a lower MOQ, while low-cost items often have a higher MOQ. It is important to take this into account when reordering products from suppliers; consider a supplier's MOQ for a particular product against your own sales projections.
The EOQ method is more common for manufacturers, which have to account for variable costs like raw materials, production and fluctuating demand. It is designed for companies to keep costs down by purchasing the greatest amount possible of multiple product units to minimize the need to reorder items individually.
4. ABC analysis
An ABC analysis helps you understand what products are most profitable and which are most costly. As the name suggests, it breaks products down into three categories.
- A: These products are the most valuable and cost the least to store long-term. These products contribute greatly to a business's profitability.
- B: These are midrange products that are important sales to make, but not as big tickets as products in the A category.
- C: These tend to be small-ticket items with high turnover. Individual sales of these products are not as important to a business as items in the A or B categories, but high volumes of C product sales are critical to profitability.
5. Safety stock inventory
Safety stock inventory is tied to your sales projections and influences your reorder quantities. It is especially important to your bestselling or essential products.
Safety stock is the extra inventory you order beyond your expected demand. While over-ordering is never advisable, it is useful to have a few more units than you expect you'll need, especially if you anticipate that item will continue to be a hot seller.
Dropshipping is the process of receiving an order from a customer and having your supplier ship the products directly to the customer. This cuts out the need for a storage facility or for keeping any inventory on hand. It is best reserved for rare orders or items you cannot accommodate in your warehouse, because it means your customer's satisfaction is in the hands of your supplier, rather than your own business.
Cross-docking is a method that prioritizes efficiency. A delivery truck will unload at your facility, directly into trucks shipping your sales out to customers. This eliminates the need to bring new items into your storage facility and bypasses your inventory management process. Instead, the items go right out as you receive them. This method is best for items planned for "just in time" shipping.
Key takeaway: There are several ways you can manage your inventory. Consider the circumstances of your operation and implement the inventory management process that makes sense for you.
How to improve your inventory management process
Here are several policies you should put in place to ensure the efficient and accurate management of your inventory.
1. Project accurate sales numbers.
The amount of inventory you keep on hand is directly related to how much you expect to sell and how quickly.
For new businesses, projections might be a challenge. Glean whatever data you can find online to establish a projected baseline, then adjust your expectations every 90 days based on real data.
If you're an established business, use your sales history and growth projections to determine how much inventory you should always have in stock and when you need to reorder each piece. Pay special attention to your bestselling items.
2. Appoint a warehouse manager.
A warehouse manager oversees the daily operations of a warehouse and ensures all onsite workers are regularly updating software systems and adhering to company policy. This includes scanning products in and out of the correct locations when they arrive for delivery, when moving products from one place in the warehouse to another, and when they go out for delivery to a customer. The warehouse manager also ensures quality assurance checks and regular inventory audits are performed as planned.
3. Establish regular inventory cycle counts.
While inventory is sitting in storage, it is important to regularly take stock of the products you have on hand. Without a recurring cyclical inventory process in place, Ali said, businesses could lose 2% to 10% of their product to loss or theft each year. Regular inventory auditing is critical to keep the percentage of vanished goods as low as possible.
4. Implement a tracking system
Tracking can be done manually, but today it is far more effective to use an inventory management system: sophisticated software that can help you automatically update your inventory in real time by scanning items and locations around your storage facility.
For example, Singletary said, when 10 items are delivered, you'd scan them at the loading bay door. The system updates to acknowledge these 10 items are waiting for pickup. When a worker moves those items from the loading bay to Aisle 1, Bin 13, for example, they scan the items in, and the system automatically updates. These scans should be performed every time a product is moved. Then, the warehouse manager can reference the software to understand precisely where everything should be in the warehouse and then verify the accuracy of that information.
These are the bare bones of an inventory management process. Your exact process should be influenced heavily by the unique circumstances of your business. For instance, manufacturers often have raw materials and goods to account for as well, so this consideration should be central to the development of their inventory management processes. [Read related article: 10 Essential Tips for Effective Inventory Management]
Key takeaway: Setting up a tracking system and regularly counting inventory can help your warehouse manager run an efficient, accurate inventory management system.
Benefits of inventory management for business
Inventory management is not the most glamorous aspect of business, but it is critical to a business's profitability and scalability. Without an efficient inventory management process, businesses could find themselves wasting money on products they can't sell, running out of stock and causing fulfillment delays that upset customers, and losing valuable items – which immediately eats into profit margins. An effective inventory management process can prevent these issues and offer the following benefits.
Traceability of inventory
Inventory management begins and ends with the simple goal of knowing where a product is at all times. This includes knowing when a supplier has shipped the goods, when the goods arrive at your storage facility, where the goods are moved to within your facility, and when the goods have been shipped out of your facility to a buyer.
"You need a system to tell you the exact place where a product lives," Singletary said. "You need to track it as it gets moved from its location all the way out the door to delivery to the customer."
Whatever system you use, it should be able to track items right down to the specific aisle and bin they are placed in within your warehouse or storage facility. Your warehouse manager should enforce this process; if a worker moves an item without updating your data – typically through an inventory management system – it will be difficult to locate the item when it comes time to send it out for delivery.
A major issue for warehouses is the loss or theft of products, known as inventory shrinkage, especially when inventory management controls are not in place. Without regular inventory audits, items could go missing for months, and you'll have no idea why. It could be a simple error, or it could be theft. Regardless, every missing item is a wasted investment.
"Cycle counts should be done routinely throughout the year," Singletary said. "Depending on the size of your warehouse or location, you'll want to do them frequently so you track your quantities and catch issues right away."
A regular cycle count should be baked into your inventory management process to help you confirm the accuracy of tracking information listed in your inventory management system. This prevents the loss or theft of items, allowing the warehouse manager to quickly confirm that all inventory is where it should be at any given time.
Higher customer satisfaction
Customers today expect rapid fulfillment of orders, especially when ordering products online. An effective inventory management process ensures that your products are always in stock and that pickers can quickly locate them and send them out for delivery. This, in turn, boosts customer satisfaction and increases the likelihood that you will gain repeat business.
"Your customers can be buying on a website or in-store, so you have to be sure you are stocked up," Ali said. "The whole goal is to make sure you have the products you're managing and that you can support fulfillment. Knowing where your demand is coming from and allocating your inventory to those orders is key."
Consistent inventory levels
An effective inventory management process also helps with inventory control, letting you know when it is time to reorder products. Again, this is largely based on how quickly you sell a particular item, but once you have this data, you can clearly determine when you should order more.
"If I have Widget A, whenever I get down to a quantity of two, I want to reorder it so that I always have 10 in stock," Singletary said, adding that these numbers are just examples and sales data should drive this determination. "That's something that a good warehouse manager would be able to determine by understanding the turnover of their products. Especially [for] your bestsellers, you want to have enough quantity on hand at all times."
Inventory management systems can be set up to automatically reorder products from suppliers when you're down to your minimum quantity. However, you might prefer to create purchase orders manually, especially if your organization is very small.
Key takeaway: Inventory management prevents loss or theft of items, helps businesses understand how much inventory they should have on hand, and improves customer satisfaction through rapid order fulfillment.