Inventory management is key to running a successful business because it helps control your stock by following your products’ purchase orders, delivery schedules, and shipment tracking. Furthermore, inventory management can help you to avoid overstock and out-of-stock situations for your products.
It will play a massive role in shaping your business’ future. In other words, managing inventory can make or break you. This piece will highlight the importance of inventory management, the different types, and their importance to businesses.
What is Inventory Management?
An inventory management system is a tool that helps small business owners and managers maintain a steady stock of goods and products. Moreover, it provides a record of all the items in storage, from raw materials to finished products.
For example, suppose you have an inventory management system for your clothing store. In that case, you’ll know immediately if one of your suppliers fails to deliver an order on time, so you can reorder from another company or get it elsewhere while supplies last.
Inventory management is the process of managing inventory levels, physical location, pricing, and movement to ensure that all items are available for sale at the proper time. As a result, it is a vital part of every business. An effective inventory management system will track critical information about your products, including availability, price, quantity on hand, cost value, and product lifecycle status.
- Inventory management is the entire process of managing inventory from raw materials to finished goods.
- Inventory management attempts to efficiently rationalize inventory to avoid both surpluses and shortages.
- The lifecycle of the inventory management process consists of; purchasing, storing, using, tracking, reordering and forecasting.
Retail Inventory Management
Retail inventory management refers to the act of monitoring the supply and demand of products in stock. Businesses in retail, such as grocery stores and clothing shops, must maintain accurate records of their product inventories so that they may adequately replenish stock when needed. The success or failure of a retail organization depends significantly on its ability to manage its inventory effectively.
Wholesale Inventory Management
Wholesale inventory management is a tedious process that involves keeping track of the movement of goods, ensuring that warehouses are well-stocked, and managing product returns. What’s more, you have to manage your stock across multiple locations. Because of these challenges, many retailers rely on wholesale supply chain management software to simplify their processes.
Inventory Management Process
The process of inventory management applies to both B2C and B2B consumers. The lifecycle in the inventory management process is as follows;
Businesses make purchases of inventories, relying on the need for the goods. However, when starting, it’s just okay for companies to overstock targets rather than under stocking; they can measure their needs as time goes by.
This is a stage where businesses ensure that all the goods or inventory in their records are stored and easily accessible by their customers. Companies may incur storage costs for the best practices. The process should include convenient stock checking and retrieval.
In this process, businesses take the stock items from the inventory for all individual purposes, either for production or use.
Being able to follow up on goods helps businesses keep track of what is at what stage. If anything is running low on stock, this is the best way to know what to order.
Under reorder, companies can make orders of what is needed automatically through the system. One can even monitor and know what has not been adequately delivered to reorder the stock from another supplier.
After several inventory life cycles, businesses can be able to predict or budget for their inventory. It creates a good working environment by estimating the amount of stock they might need in every process.
Important Inventory Management KPIs
A Key Performance Indicator (KPI) is a metric that measures the performance of a business process. KPIs are used to evaluate a business process and its outcomes and help identify areas for improvement. In the context of inventory management, key performance indicators are used to analyse inventory data from several perspectives.
Sales KPIs in Inventory Management are important metrics that measure the effectiveness of sales strategy. These are the numbers that show the performance of the sales team in achieving its goals.
Though there are many sales KPIs, such as orders or revenue generated, companies are looking for ways to differentiate themselves in today’s increasingly competitive markets. One way to do this is by improving performance metrics in critical business areas.
Receiving KPIs are focused on the process of getting in, receiving, and managing merchandise right away.
It helps avoid over-and under-production, which ensures smooth operations and timely delivery to customers. Several operational metrics can help you measure the performance of your inventory management system.
Employee KPIs are used to assess employee performance. The higher your employee KPIs score, the greater your organization generally performs. You can carry on savings to consumers if your employees are more productive and competent.
Inventory Management formulas
Economic order quantity
The Economic Order Quantity (EOQ) is an essential concept in manufacturing. EOQ helps the manufacturer figure out how much of a product should be produced to minimize costs associated with production, holding stock, and accounting.
The formula for EOQ is:
Q = √ 2DS / H
D=Demand in units (annual basis)
S=Order cost (per purchase order)
H=Holding costs (per unit, per year)
Days inventory outstanding
The days’ inventory outstanding (DIO) is the number of days of sales that are not yet invoiced. It can be calculated by dividing current liabilities (accounts payable and accrued expenses payable) by average daily sales for the year. The DIO indicates how long it will take to turn performances receivable into cash, or in other words, how long a company waits before collecting money owed to it. A high DIO is an indication that accounts receivable are high.
The Formula for DIO is:
DIO = (Average or ending Inventory/Costs of goods sold) x 365 days
Reorder point formula
Reorder point (ROP) is the minimum inventory level that stock should maintain at all times. The reorder point formula is used to calculate the correct quantity of inventory that needs to be ordered at a given time, always to be adequate stock.
A company can choose to order its products based on either periodic or perpetual inventory systems. A periodic system calculates the reorder point by dividing average consumption by lead time. In contrast, a perpetual system calculates the reorder point using last period usage as a base.
The reorder point formula is as follows:
Reorder Point (ROP) = Demand during lead time + safety stock
Safety stock formula
Safety stock is the portion of inventory that a company holds to protect itself from fluctuations in production and sales. Furthermore, it is also referred to as buffer stock or safety margin. Simply put, safety stock helps ensure that products are available when customers need them.
Safety stock = (maximum daily use x maximum lead time) – (average daily use x average lead time)
What are the different types of Inventory Management systems?
The four most common inventory management systems are;
- Raw materials.
- Works-in-progress inventory.
- Maintenance, repair, and operations (MRO) goods.
- Finished goods.
Raw materials are any objects that a company uses to manufacture or produce any finished product. It can either be bought from another supplier or be produced by your company.
Works-in-progress inventory refers to incomplete goods that are being manufactured and are not yet ready to be sold.
Maintenance, repair, and operations (MRO) are objects used to help and support the manufacture of finished goods. These products are typically consumed in manufacturing, although they are not a direct component of the final product.
Finished goods are items that have finished the manufacturing process and therefore are ready for sale.
Inventory Management techniques
Several techniques are used in inventory management, though the popularity may vary from one organization to another. Always watch out for what works best for you.
1. Bulk shipments
The bulk shipment has always been considered the cheapest way to purchase goods. It is ideal for a business that always has high demand from customers. Bulk shipping also provides the best opportunity for profitability with ready goods to hit the market. With bulk shipments, you have decreased the number of trips taken in shipping and have been reduced and thus less shipping cost.
The flip side of it is that with the entry of bulk goods to your store, you’ll need to invest more in your storage, like warehouses, to fit all your inventory. Keep in mind that there might be difficulty in adjusting in case the market demand flips.
2. ABC Inventory Management
An ABC inventory system (A = high value, B = medium value, C = low value) is a management technique for prioritizing and tracking inventory. This method can also help you prioritize repetitive or bulk orders of products that don’t require much attention, as those with higher profit margins.
One of the most important things for business owners is to make sure they are running as efficiently as possible. This will help ensure that you can deliver the best product or service at a competitive price without needing to cut corners.
One of its biggest challenges is that some products or goods may be overlooked, especially if they are just starting to get accepted into the market( new trends).
Backordering is a technique used in forecasting as well as inventory management. It is also known as optioned ordering or optioned backorders. Backordering involves placing an order for an item that has already been sold to a customer but has not yet arrived at the seller’s premises.
Backordering is a technique used for creating an external demand. However, it is also known as backfilling or back-filling to satisfy the internal demand with external resources.
4. Just in Time (JIT)
Just In Time (JIT) is the concept of manufacturing and delivering a product only when a customer orders it. The goal is to eliminate production waste and improve quality. Toyota Motor Corporation developed it during the 1950s and 1960s by Taiichi Ohno. With JIT, all inventories are kept at a bare minimum level, with most products being manufactured or assembled to order, resulting in faster delivery.
The consignment technique is a sales and marketing strategy commonly used in the retail industry. Because it’s such an effective method for increasing sales, businesses of all sizes can benefit from using it to boost revenue.
As its name suggests, the consignment technique involves selling products on a consignment basis. Instead of purchasing inventory upfront, you pay suppliers only when your customers buy the products you sell. This arrangement reduces the risk that you’ll end up with unsold merchandise and helps keep your books out of losses.
6. Dropshipping and cross-docking technique
Dropshipping is the future of ecommerce. At least, that’s what many experts are saying. The dropshipping and cross-docking technique can provide you with a cost-effective way to sell your products online. It has even been referred to as “the holy grail” for people who want to start their own business but don’t have the funds to create an inventory. Just provide your customer’s address to the manufacturer, and the manufacturer will send the goods to them directly — no cost to you.
7. Inventory cycle counting technique
The inventory cycle counting technique is applied to counting the physical inventory of a business. The importance of this process is that it helps in maintaining the accuracy and integrity of financial information. In other words, it supports the trustworthiness of data regarding an organization’s assets and liabilities, which are revealed through balance sheet accounts such as inventory, cash, etc.
Inventory Management vs. Inventory Control
Management and control of inventory are two different things, although they do overlap. Inventory management refers to the overall administration of a company’s inventory. In contrast, inventory control is a subset of the management function that monitors and tracks stock levels and sales over time.
What to consider when choosing an Inventory Management System
- The business size determines the complexity of your inventory system.
- What are the challenges you are facing in running your business? What are you aiming at?
- Your budget can also help you decide on the system to buy.
- Who will need to run the system?
- What are the most important features for you to have in your system?
- Do you have skills in operating the system you want to buy, or you must have some training?
Why a centralized system for Inventory Management?
A centralized inventory model is the best form of inventory management. It involves keeping all the products in one place and distributing them to various stores etc. designing a centralized system of inventory will help you:
- Get better control over your stock and reduce shrinkage.
- Keep track of stock movements quickly and easily.
- Spend less time on physical work like counting, monitoring, etc.
Importance of Inventory Management
The point of inventory management software is to help companies in making the most of their available resources. For example, it helps analyse the current stock and suggests when to order more or less from a particular supplier or manufacturer.
Benefits of Inventory Management:
- An inventory management system reduces your risk by helping you reduce costs through better planning and forecasting.
- Keep track of your goods, from purchasing raw materials to selling final products.
- It increases efficiency by taking care of all your ordering and receiving needs.
- Good inventory management software will allow you to keep track.
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Inventory management helps you by keeping tabs on your stock and focusing on other important duties in running a business.
You have to make sure that you have enough products in stock, but not too many. There’s also the issue of keeping track of how many items you have left from each order and each supplier so that when it comes time to reorder or replenish your stock, you know just how much product to get. And except for some commodity items, there are no two products that are exactly alike. Assume you are the warehouse manager for a large company. The first thing you see when you arrive at work is that there are reams of paper taped to the walls, detailing every single item in inventory. It takes hours to sift through the information and make sense of it all, but what do you do? Get an inventory management system.
Raw materials, works-in-progress inventory, MRO and finished goods.
Inventory management aims to minimize the excess or shortage of materials needed for production by ensuring that inventory items are available when they are required. When raw material arrives at the warehouse, it’s counted and placed on a shelf for future use.
As a business, it is best to be updated on what trend is up to every step of the way, as well as to have a deep understanding of your customers. Do regular surveys to know what they need most and at what time, to avoid the issue of being understocked when there is high demand. Start slow, and you wouldn’t want to have much in stock that isn’t moving. Having a good inventory management system is essential to the success of your business. An inventory management system will determine whether you sell more, save money, and ensure that your business runs smoothly and efficiently.