What is Inventory Management? | Top 10 Guides for Stock Management

Table of Contents

Inventory Management Basics

Methods of Inventory Management

Popular Processes of Managing Inventory

Challenges in Inventory Management

Best Practices for Inventory Management

Important Inventory Management Terms

What is Inventory?

Well, inventory represents one of the most important assets for a company because its turnover represents revenue for the company. Therefore, it is essential to understand inventory management properly.

In layman’s terms, “inventory” stands for a complete list of goods owned or stored either to resell or as a raw material for producing the final product and then, in turn, sell the final product.

However, to understand it in a more formal way, let’s look at some of the widely accepted standard definitions of inventory.

Standard Definitions:

As per the APICS (American Production and Inventory Control Society) Dictionary,

“Inventory is defined as those stocks used to support production, such as raw material and Work in Process, supporting activities, such as maintenance, repair, and operating supplies, and finally Customer Service in the form of finished goods and spare parts.”

According to the Author of Operations Management, Lee J. Krajewski,

“Inventory is created when the receipt of materials, parts, or finished goods exceeds their disbursement; it is depleted when their disbursement exceeds their receipt.”

Types of Inventory

Inventory can be classified into three main categories, namely,

Raw Materials

Raw materials or purchased parts are the raw products that are going to be used for making finished products. However, there are many other facets to raw materials such as different types of raw materials, why are they important, how to calculate how much raw material you need. To know all about this follow the link below.

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‘Work in Process’ Goods

‘Work in process’ goods are the goods that are partially completed are in the process of becoming finished goods.

Read more about ‘Work in Process’…

Finished Goods

The final product manufactured by the industries or companies that is ready to be sold by wholesalers, retailers, etc.

Read more about ‘Finished Goods’…

Transit Inventory, aka Pipeline Inventory

The inventory that is in transit from the manufacturer’s place to the retailer/wholesaler shop is called Transit inventory. At times, the transportation of inventory takes days or even weeks in transit.

It is the inventory that is continuously moving from one point into another in the supply chain. It consists of the orders that have been placed but have not been received yet, and therefore, it is also to be counted as an inventory.

Read more about ‘Transit Inventory’…

Buffer Inventory, aka Safety Stock

Safety stock is used to avoid customer service problems and the cost associated with this. It protects against uncertainties in demand, lead time, and supply variations. The higher the service level you want to provide, the higher the safety stock will be. In the same way, the higher the lead time and the higher the demand variations are, the higher the safety stock will be.

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Anticipation Inventory

It is inventory used to absorb uneven consumer demand during a certain period of time. Some companies that have a predictable seasonal demand, build up inventory during low demand periods so that when high demand periods come production rate is not affected.

Read more about ‘Anticipation Inventory’…

Decoupling Inventory

This is the inventory kept in the manufacturing units, wherein the stock of one part of the product is kept in some quantity so that it doesn’t hinder processing the other part of the product. It is something like safety stock, but the only difference is that this is safety stock for internal purposes so that the demand for a particular spare part is fulfilled while making the finished product.

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Cycle Inventory

Cycle inventory is also called a lot-sized inventory. It varies directly with the lot size. The quantity varies with the elapsed time between orders, the longer the time, the larger the cycle stock. For example, if you order every two weeks, your cycle stock will be equivalent to two weeks’ demand.

Read more about ‘Cycle Inventory’…

Maintenance, Repair, and Operating Supplies (MRO) Inventory

These are the products that support the production process of the finished goods such as lubricants, screws and ball-bearings, gloves, packing materials, etc.

Office stationery items like staples, pens, and pencils, papers, etc. are also part of the operating supplies.

Read more about ‘MRO Inventory’…

What is Inventory Management?

“Inventory management is a well-developed science, not a simple common sense,” says the author Tony Wild in his book ‘Best Practice in Inventory Management.’

In other words, it is all about ordering the right quantity of products and keeping track of all the company’s goods, and storing them in an appropriate facility for easy retrieval while selling them.

The very first traces of Inventory management dates back to some 50,000 years when people used to manually count the items with the help of ‘tally sticks’. However, once the industrial revolution started incredible breakthroughs were done in this field and hence evolved modern inventory management and its tools.

So why is inventory management so important? let’s try to understand.

Why is Inventory Management important?

“The motto of inventory management is to minimize holding costs while optimizing inventory.”

In other words, to reduce the stock levels while achieving higher availability of the products at the same time. This motive can be achieved only when inventory is managed systematically.

Here are some other salient reasons for the importance of inventory management

Enables you to do the planning and forecasting accurately

Managing your inventory brings sense to all those data around you. Inventory management can help you analyze and distinguish the products between well-performers and shelf-eaters. This improves revenue generation and frees up cash flows.

Also, it would be great if you can 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, based on previous inventory statistics, your forecasted product “x” is going to 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 stocks again based on the daily sales pattern of your customers.

Improves your delivery time

Nowadays, customers demand no less than the best in the market, whether it may be regarding 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 cannot once be the cause of one sales loss because it affects your brand reputation.

Properly arranged and tracked inventory helps to locate when the order arrives and hence enables you to deliver the product quickly.

Opting for inventory management can protect you from mismanagement of inventory and also enables you to increase customer satisfaction by a speedy delivery.

Controls your inventory costs

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

Due to accurate forecasting done with the help of inventory management systems, you can order the products in the right amount and hence 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 need to be reordered and how frequently from your suppliers. This can help you crack deals with your supplier, thus saving money.

Increases your business efficiency and productivity

If you are spending a lot of time searching for the products your customers order, then maybe it’s time to invest time into inventory management. Inventory management includes allocating specific locations to specific products, and therefore, you can track the products and their quantities in no time!

Systematically managing products not only saves time and efforts but also lets you divert your human resources towards more pressing matters regarding your business, hence, improving 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. And inventory management and control helps in doing just that; that’s why it is crucial.

As you witness growth in your business, you need to prioritize your inventory management accordingly but how do you select an appropriate method?

The ‘One size fits all’ rule cannot be applied for selecting inventory management methods. There are various ways in which inventory can be managed, and it is up to an organization to choose the inventory management technique that best suits their business.

However, to select the best approach for your business, you need to know all of them in detail so that you can make a wise choice.

Let us look at some of the commonly used inventory management techniques in detail:

Just In Time Inventory

Just-in-time fulfillment (JIT) is an inventory management practice to enhance returns on investments while improving product quality. The method also helps in cutting down the wastages since the receiving goods are obtained only when they are needed in the production process.

Hence, as the name suggests, 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 overstock it creating a deadstock.

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FIFO & LIFO

FIFO or LIFO are the methods that companies use to assess their inventory and calculate profit. The amount of profit a company generates affects its income taxes.

FIFO, the acronym stands for First-In-First-Out. It is an inventory accounting method where the oldest stock or the inventory that entered the warehouse first is recorded as sold first. FIFO is one of the most popularly used inventory valuation methods.

LIFO, the acronym stands for Last-In-First-Out. It is an inventory accounting method where goods produced or purchased most recently are recorded as sold first.

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Economic Order Quantity (EOQ) Formula

The Economic Order Quantity is a quantity designed to assist companies to not over-or under-stock their inventories and minimize their capital investments on the products that they are selling. The cost of ordering an inventory touches down with an increase in ordering in bulk. However, as the seller wishes to grow the size of the inventory, the carrying costs also increase.

The EOQ is exactly the point that optimizes both of these costs i.e. cost of ordering and the carrying costs which are inversely related.

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Vendor Managed Inventory

Vendor Managed Inventory is one of the most popular business models for managing inventory and there’s no wonder that the world’s largest corporations like Walmart, Tesco, and Amazon use this method.

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

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Two Bin Inventory Control

As the name suggests, this method comprises two identical plastic bins that are utilized alternately. Both of them are filled with components that are fitted onto the final product.

The workers on the production line shall use the first bin until it is emptied. Once the first bin is wholly utilized, they will start utilizing the second bin. The empty one will act as a signal for replenishment.

Thus, the manufacturing is continued without stopping the line to fetch the required components. In most cases, these items are used in semi-finished goods which are in the final stage of production.

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A good process provides you good results. It is primarily the process that makes you end right where you are meant to be at the right time. So is true for the inventory management process.

A right and modern approach will enable you to manage your inventory, orders, shipping, returns in such a way that you will be able to track your items easily and efficiently at any given point.

There are primarily two popular processes for managing inventory. Gone are the days when everything was handled on pen and paper! Technology has allowed us to record all the important data in easy-to-access digital ways.

Let us take a look at them in detail here…

Managing Inventory on Excel Sheet

“Tracking your inventory can become a complicated task if it’s not managed properly with a proper tool.”

Spreadsheets are the simplest way to manage your inventory and related data like stock, sales, purchases, orders, suppliers, and basic level reports for free!

With the help of advanced mathematical capacity, excel sheets can comfortably be used to organize and operate different aspects of inventory and business management with ease. You can also use excel with other apps to get through challenging situations in business that require exceptional calculation skills.

Create group sheets, use filter search results, and get the information on the changes in inventory instantly. It’s pretty much easy to figure out the flaws and correct them quickly without wasting much time and money.

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Inventory Management Software

As mentioned earlier, inventory is the backbone of any commodity business, and therefore, managing it properly becomes important.

Using excel sheets for inventory management is a fair process for small businesses with limited products but what when you expand your business and start selling online?

You need a better tool for obtaining accurate inventory count, stock taking, tracking the inventory in real-time, locating inventory, managing orders, shipping and receiving the orders, etc. that’s when it is crucial to use inventory management software.

Inventory management software is efficient in not just handling inventory-related tasks but can automate the entire eCommerce operations process. You can conveniently manage back-end operations of selling your products across multiple channels, multiple locations, and in multi-currency by using one single software.

To learn more about Inventory Management Software sign up here.

As discussed earlier inventory management is an essential task while running a manufacturing or a retail unit. There are a certain set of practices that a successful wholesaler or retail house practices across the borders and these very profitable practices are discussed in detail in our best practices for inventory management guide.

For optimizing your inventory and minimizing your holding costs, you should practice some of the best industry practices.

Here are some useful ones for you to follow. Please click on the bullet points given below to read a detailed guide on them.

Maintaining Safety Stock

Every retailer stocks inventory according to its customer’s average demand. Now, sometimes there can be a rush of sales. Meaning, you are soon going to 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 in preventing stock-outs when there is a high variation in demand and supply. For instance, in this current situation of the Coronavirus pandemic, the suppliers are not able to provide the required product in the given time frame or in the right quantity expected by the retailer. Now in such situations, if the retailer has kept safety stock then it will help him to make sales and keep his customers happy.

However, there are various facets to safety stock such as how much safety stock to keep? How to calculate the amount of stock required? To know all this and much more follow our link given below.

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Demand Forecasting and Planning

Demand Forecasting is the scientific process of estimating the future demand for products in terms of quality, quantity, and driving factors. The use of end results generated from forecasting is done to calibrate the business processes and set targets for the sales teams.

Here are some of the most significant reasons to include demand forecasting as a core business process:

It helps in devising sales and marketing plans along with their respective budgets.
They also lay down the foundation for the master budget of the company.
The data available from these exercises will give insights to the required plant capacity to meet the targets.
It also contributes to the pricing strategy.
It suggests the type of equipment required, production processes, types of products, and components along with the volume of production.
It also helps in devising procurement strategy by understanding the consumption of various raw materials and supply chain management.

To learn more about the methods and strategies on demand forecasting, please refer to the link given below.

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Merchandise Planning

Retailers of modern times might not ask this question because they know how vital merchandise planning is; however, for the beginners or the ones who think that it is not that important, here are some of the 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 as there is less unwanted inventory in the warehouse and hence less labor, less maintenance cost, less loss through obsolescence as most of the stock is sold, less depreciation of inventory, etc.

Brings value addition to the company as your customer very rarely goes empty-handed and has enough options to compare products to make a purchase.

However, these are just a few benefits, to know the detailed benefits of merchandise planning, please click the link below.

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Retail Visual Merchandising

Simply put, visual merchandising means a visual display of the store. When you enter the store, you’ll most likely first get attracted to visual displays at the store. This can include aspects like window displays, décor style, fixtures, and many others that give a visual identity to the store.

Visual Merchandising always attracts more customers. So, showcase your best products, make them attractive and beautiful, bring in those people who are window shopping, and show them your store!

You can increase your Brand Value with appropriate visual merchandising. The more attractive your store looks, the more customers prefer visiting the store. This way, your brand value increases as well as awareness. No wonder, in a short time, people have started knowing your name!

You know, right, when customers walk-in, it clearly shows that they have an inclination towards your products. Well, when your brand is increasing its value and customers are increasing, there is no surprise that your sales will also grow.

To read more about the visual merchandising techniques, Do’s and Don’ts, please click the link below.

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Stock Replenishment

In layman’s terms, stock replenishment is a general practice to make sure that the right quantity of the products is available at the right time with the vendor or shopkeeper on the picking shelves.

Did you know that as per a study conducted by Harvard Business Review, “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.”

Such an alarming percentage indicates that inventory replenishment must be conducted in a timely fashion as well as in a systematic way.

In short, a properly done Stock replenishment helps in eliminating stock-outs and overstocking – both of which can prove to be very costly in Supply Chain Management.

To learn more about the replenishment or restocking strategies click on the link below.

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Product Bundling

Retailers combine several products in one package and make it a better deal via several types of attractive offers. This is called product bundling.

Usually, a retailer will bundle a slow-moving item with the corresponding fast-moving item so that he can minimize his loss of stocking the slow-moving item. When product bundling is used correctly, it can boost your sales and improve your conversions.

You can combine it with other marketing strategies, and it’s not actually costly.

Since it’s an effective strategy on so many levels, it’s worth trying. You can read more about the bundling strategy, how you can benefit from it, and the examples to help you understand the difference between a well-combined product bundle and a bad one by clicking the link below.

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Cost of Goods Sold

Cost of Goods Sold (COGS) is a direct cost of the production of the goods or products sold from an inventory. This amount includes the additional material charges as well which are used for the delivery and packaging of the goods.

Methodically,
COGS = Beginning Inventory + Purchases during the period – Ending Inventory

As inventory is an asset, till the time the product remains a part of that inventory, the amount of that product remains in the asset account. As soon as the product is sold, that amount (along with all the additional charges) goes into the expense account which is also called the ‘cost of goods sold.’

COGS always appears on the profit and loss statement and is also used for inventory measurements.

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Bullwhip Effect

The Bullwhip Effect is a phenomenon in the supply chain and distribution channels in which forecasts reveal supply chain inefficiencies. This mostly occurs when retailers become highly reactive to consumer demand, and in turn, intensify expectations around it, causing a domino effect along the chain.

The bullwhip effect was named for the way the amplitude of a whip increases down its length. Here, the end customers have the whip handle, and as they create a little movement, the whip amplifies traveling up, increasing the buffer between the customer and the manufacturer. On average, there are 6 to 7 inventory points between the end customer and raw material supplier.

Better communication among supply chain partners, better forecasting methods, and a highly demand-driven approach can help reduce inventory waste or over-stocking that results from the bullwhip effect.

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Reorder Point

The ‘reorder point’ or ‘replenishment order quantity’ is the inventory level used to determine the need for stock replenishment. As stock reaches the reorder point, the seller can release fresh purchase orders to the supplier for replenishment. The total time between PO creation and receipt of stock ready to be sold is called ‘lead time’. Anything below the reorder point is safety stock.

Methodically,
(Average daily units sold x Delivery Lead time) + Safety stock

It is always advisable for sellers to set a re-order point considering lead times, sales forecasts, and safety stock quantity at any given point of time; hence avoiding any low-stock or out-of-stock situations; an expert seller approach!

Learn more about “how to calculate Reorder point“…

ABC / Pareto Analysis

ABC / Pareto analysis is an inventory control technique based on the Pareto principle named after an Italian economist Vilfredo Pareto. Also called 80 / 20 rule, this principle suggests that 80% of the total output is generated only by 20% of valuable efforts. ABC analysis typically segregates inventory into three categories based on its value and control measures required: ‘A’ is 20% of inventory with 15% value; ‘B’ is 30% inventory with 15% value; whereas ‘C’ is 50% inventory with 5% value and hence treated as most liberal.

These are only suggestive numbers and vary from company to company but tend to follow a similar pattern. This analysis helps business managers to draw more attention to the critical few (A) and less on the trivial many (C) and focusing inventory control efforts where it will have the greatest effect.

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Lead Time

The time taken by the supplier to supply the required order after the purchase order is placed is called Lead Time. Also called the time between the placing of a purchase order and the receiving of the goods ordered.

If the supplier is not able to supply the required ordered goods on time, the seller must keep a backup stock to avoid any sort of hamper to the business reputation. The longer the lead time, the larger the number of goods that must be kept as a backup from the very beginning.

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Big Data

Big Data represents massive amounts of human-generated data, in structured or unstructured form, as a result of a variety of sources – social media, online transactions, enterprise content, emails, mobile devices, applications, databases, servers, and other means.

The importance of big data doesn’t revolve around how much data you have, but what you do with it. Big Data, when captured, formatted, manipulated, and analyzed, can help a company gain useful insights and take critical and better organizational decisions.

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Bundling and Kitting

Bundling and Kitting is a sales technique of grouping separate but related products / SKUs into sets that can be sold, packed, or shipped as a single unit or order, hence helping sellers to increase the total order value.

Say, for example, kitting of shampoo and conditioner, or PC with drives or software, or a pack of t-shirts. Sometimes, sellers also use kitting/bundling to introduce a new product along with existing products for promotions or soft-launch.

This technique is highly used by brick & mortar stores, malls, as well as online sellers for its benefits in abundance.

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Last-In-First-Out (LIFO)

Last-in-First-out (LIFO) is a method used to account for inventory where the most recently produced products are considered as sold first. It is a cost flow assumption technique used only by the U.S. Companies in moving the cost of products most recently purchased, from inventory to cost of goods sold (COGS). This means that the cost of the oldest products will be reported as inventory.

The LIFO inventory control method has gained popularity in the U.S. because due to inflation and the fact that companies can associate their most recent inflated costs with sales, thereby reporting less taxable income.

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Backflush

Backflush is an accounting approach, used in a Just-in-Time (JIT) environment, in which costing is delayed until goods are finished. Costs are then ‘flushed’ back at the end of the production process and assigned to the goods. This approach helps in eliminating all work-in-process accounts and manual assignments of costs to products during the various production stages.

Backflush accounting is entirely automated, with a computer handling all transactions. Backflush costing may not always conform to generally accepted accounting principles (GAAP) and also lacks consideration of sequential audit trail.

Backflushing is not suitable for long production processes, neither for the production of customized products.

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Moving Average

Moving average is a demand forecasting method that uses the most recent actual past data to calculate the average demand over a fixed time period. It removes the effect of random fluctuations and is most useful when the demand has pronounced trends or seasonal fluctuations.

Moving average = Demand in previous ‘n’ periods ÷ ‘n’

It’s called ‘moving’ because as a new demand number is calculated; the oldest number in the set falls off, keeping the time period locked. For example, if you want to calculate a three-month moving average on 1st August, you will calculate the average demand for May, June, and July. Subsequently, on 1st September, you would use May, June, and July demand for the calculation.

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Kanban

Kanban (‘visual signal’ or ‘card’ in Japanese) is a visual scheduling system related to Just-in-Time (JIT) production that tells you ‘what – when – how much to produce. The first Kanban system was developed by Taiichi Ohno of Toyota Automotive, the aim of which was to tackle inadequate & inefficient production; and to control inventory optimally.

Kanban system visualizes both – the workflow and the actual work passing through the flow. In this way, it helps avoid supply disruption and overstocking of stock or raw materials at any stage in the value chain. So there is no incoming of the stock unless & until there is space for it.

Kanban gradually improves the existing process – whether it is software development, recruitment, sales, procurement, etc., rather than changing everything from the core.

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Cycle Count

Cycle count is an efficient and cost-effective inventory auditing practice where a small subset of inventory, in a specific location, is counted on a specified day. This is to ensure the accuracy of inventory without having to count the entire inventory and the result of which can be used to infer the results of total inventory. So, any accuracy or error found could be assumed to be occurring for the whole inventory.

Cycle count is usually conducted on an ongoing basis, often weekly or monthly, hence is less unsettling than a full physical count which requires the shutdown of day-to-day functioning. Fast-moving and more expensive items typically are counted more often than slower-moving and less expensive ones.

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Consignment Inventory

A consignment inventory is a quantity of stock that is in possession of the customer, yet owned by the supplier. In this scenario, the supplier allocates some of his inventory to the seller, which remains in the supplier’s warehouse only. The seller has the right to sell those products on his behalf to his end-customer, either through a physical store or an online marketplace. Only when the seller sells or consumes that part of the inventory, it’s considered to be purchased from the supplier.

Example:
A gym and a supplier of protein supplements. There is no inventory in the gym, but with the supplier. As soon as the customer purchases from the gym, the item from the consignment inventory with the supplier is considered to be sold. Till there is no purchase, the owner of that inventory is the supplier, and not the gym.

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