What Is Inventory Management - Indepth Guide With Examples

Understanding Inventory Management

Inventory management is a part of the supply chain management, which includes various aspects such as the process of ordering, storing and using the company’s inventory like raw materials, its components, and the finished products.

It is also used for controlling the number of products for sale. It helps to manage the inventory and stock of the company.

Inventory management has been defined quite simply as having the right inventory of the right quantity and place to be sold at the right time with the right cost.

Having effective inventory management helps to ensure that there is a sufficient amount of stock available at hand to meet the customer demands.

Mishandling of inventory management could result in enormous losses for businesses due to the unfulfillment of potential sales or overstocking. Inventory management ensures that such mistakes are avoided.

Methods of Inventory Management

Here are some of the widely used inventory management techniques that are used by traders and online sellers.

Economic Order Quantity (EOQ)

EOQ is the least amount of inventory that should be ordered for meeting peak customer demands without running out of stock or producing obsolete inventory. The purpose of EOQ is to reduce inventory to the minimum and lower the cost of inventory to the least possible amount. EOQ uses the three variables, viz.,

Demand
Relevant Ordering Cost
Relevant Carrying Cost

Minimum Order Quantity (MOQ)

It is the least set amount of stock that a supplier is prepared to sell. In case the buyer does not agree to purchase the MOQ of a product, then the supplier will not agree to execute the order.

The purpose of MOQ is to ensure suppliers can increase their profits while selling more inventory quicker and eliminating “bargain shoppers.”

MOQ is fixed depending on the total cost of inventory including other expenses to be paid before making a profit. This ensures MOQs help the wholesalers in maintaining profitability with healthy cash flow.

ABC Analysis

The analysis is a sorting method depending on the demand for the product and the expenses that will be incurred to hold the particular stock.

A Goods – Bestsellers and taking the least amount of storage space
B Goods – Mid-range but in regular demand and more expensive to store as compared to ‘A’ items
C Goods – The rest of the inventory which contributes the least but takes up the bulk of inventory costs.

Just-in-Time Inventory

This inventory is making goods that are needed, when they are required, in the amount they are required. Many companies hold a small stockpile in case of unexpected demand for commodities.

Just-in-time Inventory establishes a “zero inventory” system. The goods are manufactured by order and operate on a “pull” system. The system triggers a sequence of activities once an order comes through.

The staff gets into the process of either organizing the stock or manufacturing them.

Safety Stock Inventory

Safety Stock Inventory is keeping aside a small amount of stock as a safeguard against the variability of the product in market demand. It helps in preventing loss of revenue, customers, and market share. The reason behind this is:

Protection against a sudden spike in demands
Prevention against incorrect market forecasts
Safety from stockout
Buffer against unexpectedly longer lead times

FIFO / LIFO

This accounting method helps in valuing your inventory and calculating profitability.

First In, First Out – In the FIFO system, the oldest items in the inventory are sent out first.

Last In, First Out – In the LIFO system, the newest items in the inventory are sent out first.

Drop Shipping

In this method, you sell and ship products that are neither owned nor stocked by you. The benefits of this system are:

Low cost of start-up and inventory
A low cost incurred for fulfilling the order
More scope in testing newer products with minimum risk

Maintaining Reorder Level

This method ensures that you know exactly when you need to order more stock. This method protects you from market slumps and spikes and ensures that you have the required amount of stock in hand every month.

Sometimes, there is a high demand for a specific product, which is great for businesses as it means that you are making profits with each sale, but it also says that your inventories are coming down at an equally fast pace.

Reordering before running out of stock also means an additional charge for storage and delay in ordering means stockout and losing your customers to your competitors.

For calculating the reorder point: –

Calculate lead time in days
Account for safety stock in days
Add lead time with safety stock for determining the reorder point

Learn how to calculate reorder point.

Batch Tracking

Batch tracking is using the batch number to track goods along the distribution chain. It is a highly efficient method as it helps to monitor every aspect of the manufacturing process from raw materials to finished products, where and how much was shipped and their expiry date.

Lean Manufacturing

In this system, it is ensured that the consumer is given the maximum value of the product with the minimum waste and maximum productivity.

Six Sigma

It is a data-driven process and helps to reduce and finally eliminate product defects. The aim is to ensure that the final product which reaches the consumers is almost perfect.

In addition to that, the combination of Six Sigma with Lean Manufacturing i.e. Lean Six Sigma ensures that the waste is removed and there is a reduction in the process variation.

This method ensures that there is an organized manufacturing and flawless product output.

Perpetual Management Inventory

This system tracks the stocked and sold inventory in real time. The accounting system is updated every time there is an arrival of new inventory, execution of sale, and inventory used.

Consignment Inventory

This is an agreement between the vendor and the vendee, wherein the vendor owns the goods, and the vendee pays only after the products are sold.

Demand Forecasting

This is a method of forecasting customer demand for goods about what, when and how much they will buy.

Managing SKUs (Stock Keeping Units)

For businesses that sell products, managing inventory through SKU is very crucial. SKU is a product code, which is unique to the product. It helps in identifying, tracking or searching it in the invoices, order forms, etc.

SKU can also be used for tracking intangible products which are billed, such as warranties or repair time of units. The benefits of using SKU are:

Monitoring inventories
Stocktaking
Identifying stock shrinkage
Replenishing inventory
Profit calculation

Manage The Inventory Lifecycle

Following are some fundamental techniques for controlling inventory:

Annual Stock Policy

The company management decides the maximum and minimum amount to be maintained, reorder level, safety stock, etc., at a given period across its various warehouses.

Inventory Budget

It helps in an advance preparation before the inventory is acquired. The budget includes the total cost of keeping the inventory for the financial period. It includes materials cost, carrying costs, operational costs, logistics costs, redistribution costs, and any other miscellaneous costs.

Automatic Inventory System

It helps to keep track of the quantity and price of each item in stock.

Inventory Turnover

It is calculated for determining the speed at which the inventory is being used. The higher the turnover ratio, the higher is the sales volume and profitability. It is mandatory to track every single item in the warehouse for determining the turnover ratio.

Optimizing Purchase Procedure

All inventory items left unsold in the warehouses over a period of one year should be removed from the inventory to eliminate excessive storage costs. Low customer demand products should also be excluded from the inventory.

Why You Must Systemize Inventory Management

Tracking of inventory, regularly updating it, using the available data for tracking profits, demands and sales are essential for any company. For small businesses, an inventory software can help in building or breaking the business, depending on its ability to keep up with the sales and demands.

For managing online businesses or selling on online portals like Shopify or Amazon, inventory management software helps in keeping track of the various consignments, sales, etc.

It enables you to track your stock and control the supply, thus ensuring that you can manage your stock supply without overspending time and money.

If you are dealing with inventory, you should start implementing an inventory management system. Your business will benefit in multiple ways, like:

There is an increase in the sale of goods.
There is an increase in information transparency.
There is almost a 50 per cent reduction in lead times.
Lower costs due to accuracy in planning
High improvement in delivery performance
Increase in employee productivity
Up to 10-25 per cent decrease in stockout
Increase in customer loyalty
Increase in inventory turnover by optimizing the value of goods

Check out the top inventory management solutions.

The Bottom Line

The inventory management system prevents situations where you are either running out of stock or left with idling capital in warehouses or unable to track your goods. It is best suited for monitoring stock in real time.

Small businesses usually use MS Excel as a means of managing inventory, but its scope becomes very restricted to a growing business.

If you are a trader, wholesaler or a small manufacturer, you should consider investing in a good inventory management software.

ProfitBooks Inventory management helps keep an updated record of stock movement, ensuring that you can track every single piece of goods that you have or handle.

Try ProfitBooks FREE Today

Also Read:
12 Inventory Management Techniques To Cut Losses
How to Deal With Surplus inventory