Inventory Management
Inventory management is vital to a company’s health because it helps make sure there is rarely too much or too little stock on hand, limiting the risk of stockouts and inaccurate records
Inventory management helps companies identify which and how much stock to order at what time. It tracks inventory from purchase to the sale of goods. The practice identifies and responds to trends to ensure there’s always enough stock to fulfill customer orders and proper warning of a shortage.
Once sold, inventory becomes revenue. Before it sells, inventory (although reported as an asset on the balance sheet) ties up cash. Therefore, too much stock costs money and reduces cash flow.
One measurement of good inventory management is inventory turnover. An accounting measurement, inventory turnover reflects how often stock is sold in a period. A business does not want more stock than sales. Poor inventory turnover can lead to deadstock, or unsold stock
Inventory Management Challenges
The primary challenges of inventory management are having too much inventory and not being able to sell it, not having enough inventory to fulfill orders, and not understanding what items you have in inventory and where they’re located. Other obstacles include:
- Getting Accurate Stock Details
- Poor Processes
- Changing Customer Demand
- Using Warehouse Space Well
- Evolving Packaging
- Overstocking
- Inventory Loss
- Poor Production Planning
- Poor Communication
Types of Inventory
Inventory Management Techniques and Terms
Raw materials are the materials a company uses to create and finish products. When the product is completed, the raw materials are typically unrecognizable from their original form, such as oil used to create shampoo.
Components are like raw materials in that they are the materials a company uses to create and finish products, except that they remain recognizable when the product is completed, such as a screw.
WIP inventory refers to items in production and includes raw materials or components, labor, overhead and even packing materials.
Finished goods are items that are ready to sell.
MRO is inventory — often in the form of supplies — that supports making a product or the maintenance of a business.
There are three types of packing materials. Primary packing protects the product and makes it usable. Secondary packing is the packaging of the finished good and can include labels or SKU information. Tertiary packing is bulk packaging for transport.
Safety stock is the extra inventory a company buys and stores to cover unexpected events. Safety stock has carrying costs, but it supports customer satisfaction. Similarly, anticipation stock comprises of raw materials or finished items that a business purchases based on sales and production trends. If a raw material’s price is rising or peak sales time is approaching, a business may purchase safety stock.
Decoupling inventory is the term used for extra items or WIP kept at each production line station to prevent work stoppages. Whereas all companies may have safety stock, decoupling inventory is useful if parts of the line work at different speeds and only applies to companies that manufacture goods
Companies order cycle inventory in lots to get the right amount of stock for the lowest storage cost.
Service inventory is a management accounting concept that refers to how much service a business can provide in a given period. A hotel with 10 rooms, for example, has a service inventory of 70 one-night stays in each week
Also known as pipeline inventory, transit inventory is stock that’s moving between the manufacturer, warehouses and distribution centers. Transit inventory may take weeks to move between facilities.
Also called book inventory, theoretical inventory is the least amount of stock a company needs to complete a process without waiting. Theoretical inventory is used mostly in production and the food industry. It’s measured using the actual versus theoretical formula.
Also known as obsolete inventory, excess inventory is unsold or unused goods or raw materials that a company doesn’t expect to use or sell but must still pay to store.
Some inventory management techniques use formulas and analysis to plan stock. Others rely on procedures. All methods aim to improve accuracy. The techniques a company uses depend on its needs and stock
Find out which technique works best for your business by reading the guide to inventory management techniques. Here’s a summary of them:
- ABC Analysis
- Batch Tracking
- Bulk Shipments
- Consignment
- Cross-Docking
- Demand Forecasting
- Dropshipping
- Economic Order Quantity (EOQ):
- FIFO and LIFO
- Just-In-Time Inventory (JIT):
- Lean Manufacturing
- Materials Requirements Planning (MRP):
- Minimum Order Quantity
- Reorder Point Formula
- Perpetual Inventory Management
Inventory Management Systems
There are several types of inventory management systems that businesses use depending on how they operate. Three examples are manual inventory, periodic inventory and perpetual inventory. Manual methods are the least sophisticated and least accurate, and perpetual systems are the most sophisticated and most accurate.
Manual Inventory System:
This involves physically counting items and recording them on paper or in a spreadsheet. Small businesses may use manual systems.
Periodic Inventory System:
Periodic inventory systems include manual and periodic counts. Periodic counts record item details as items move in and out of stock. Barcodes simplify stocktaking. A database contains the records of stock levels and locations.
Perpetual Inventory System:
Perpetual inventory systems provide real-time stock data, as they rely on active radio frequency identification (RFID) tags that are always on and sending updates on item movements. Passive RFID tags, meanwhile, use a scanner to send stock information to the database.
Benefits of Inventory Management
Saves Money:
Understanding stock trends means you see how much of and where you have something in stock so you’re better able to use the stock you have. This also allows you to keep less stock at each location (store, warehouse), as you’re able to pull from anywhere to fulfill orders — all of this decreases costs tied up in inventory and decreases the amount of stock that goes unsold before it’s obsolete.
Improves Cash Flow:
With proper inventory management, you spend money on inventory that sells, so cash is always moving through the business.
Satisfies Customers:
One element of developing loyal customers is ensuring they receive the items they want without waiting.
Reduces Wasted Inventory :
Understanding what, when and how much people buy minimizes the need to store obsolete products, as well as when products expire so you can have a strategy behind using them.
Reduces Project Delays:
Learning about supplier lead times helps you understand when to reorder and how to avoid late shipments.
Improves Pricing From Suppliers and Vendors:
Inventory analysis can lead you to order high volumes of products regularly rather than small volumes on a less reliable schedule. This regularity can put you in a stronger position to negotiate discounts with suppliers.
Expands Your Understanding of the Business:
Reviewing inventory provides insights into your stock, customers and business.
