A Beginner’s Guide to Inventory Management

If you’re an entrepreneur starting a business that requires inventory, you probably already know that the majority of your business budget will likely be going toward stocking up on product. As a product-based business, it’s essential to have a reliable, regularly updated inventory management system in place to help keep your costs down without sacrificing your quality control, fulfillment times, and overall customer satisfaction. Let’s get into why you need a thorough understanding of inventory control, and how you can implement what you learn into your new business.

What is inventory control and why does it matter?

Sometimes referred to as stock control, inventory control is all about managing the amount of stock that you have on hand in your warehouse or storage facility. Successful inventory management means striking the balance between having enough inventory on hand to fulfill your customer orders in a timely manner without sinking most of your budget into paying for stock that isn’t flying off of your warehouse shelves.

No matter what industry you’re in, if your business sells products, then you’re going to have inventory and you’ll need some way of tracking what you have in stock. Inventory control helps you learn how to make use of customer data extracted from previous sales records in order to inform how you manage your inventory, restocking, and related processes. Inventory management refers to the entire process of making the product (including sourcing materials and labour), storing your inventory, and selling it for a profit.

Having a functional inventory management system in place is integral to running a successful, scalable business. An effective system will help you understand how to make the most profit in return for the lowest possible investment, while still satisfying your customers. Inventory control can reduce the risk of going out of stock and missing out on potential sales, which could have a negative impact on customer relations. Other risks of a poorly managed inventory include overspending on storage or stock and spoilage, especially if your product is perishable.

Common terms in inventory management

Inventory control: a system for managing the stock that you currently have in your warehouse.

Inventory management: the entire process that your product goes through, from creation to storage to sales and shipment, and the costs related to this process.

Inventory management system: a system, manual or automated, of tracking your inventory and using past purchases and customer behaviour to predict future demand, so that you always have a well-balanced inventory.

Critical stock: product that sells consistently that you always need to have available in your inventory.

Periodic inventory management: an inventory management system where physical stock is counted by employees at certain intervals. The downside to this system is that it requires ongoing manual labour and time, meaning you may have to close down your business or take inventory after regular work hours and can be prone to human error.

Perpetual inventory management: an automated system that is linked directly to your point of sale (POS) system that constantly updates your inventory numbers to accurately reflect what you have in stock. With this inventory management system, you will need to be counting and tracking your inventory as it arrives at your facility. You will still need to occasionally check in on your inventory for issues like food spoilage, breakage, leaks, or theft. 

Barcodes: scannable images stuck on your product to eliminate manual errors and ensure that your inventory tracking is accurate. QR codes can also be used, and they are able to contain more information than traditional barcodes.

Inventory management techniques

Now that you have a solid understanding of what an inventory management system is and why your business needs one, you’re ready to dive deep into some inventory management techniques that you can implement in your business right away. Inventory management is an ongoing process, and it’s about a lot more than just using inventory tracking software. You’ll always need to be checking on new customer reports and updating your system to reflect current data, trends, and forecasts.

Your inventory management needs will vary greatly depending on the size of your organization. When your business is a small online shop with a relatively limited inventory, you can easily get by using simpler strategies and systems than if you’re running a multi-level corporation. With that said, here are some common inventory management systems and what kinds of businesses they work best for:

–    Ledger: This is the most basic, old fashioned option available when it comes to tracking your inventory. A ledger refers to a handwritten inventory tracking system, and it is a completely valid option for small-sized businesses. However, the downside to the ledger system is that the only thing it does is track your inventory numbers, so you can’t get as in-depth with the data you collect, negatively affecting your ability to predict product demand and sales based on past performance.

–    Spreadsheets: One step up from the ledger system, spreadsheets still involve manually inputting sales numbers, but they can also be automated to calculate important inventory tracking metrics based on the data you input.

–    Basic software: For small to medium businesses that want to streamline their inventory management and introduce more automation, basic inventory control software is ideal. Many of these types of software are cloud-based and can be linked directly to your sales system so that your records are updated automatically as each sale is made. They also may include analytics capabilities, cost comparisons, and customer shopping pattern tracking, so that you can get even more specific about understanding your business’s target audience and the way that your customers shop for your product.

–    Advanced software: If you’re a business operating on a global level with a high volume of inventory, you’ll need to invest in an advanced inventory control software designed for scalable businesses.

Once you’ve figured out which inventory management system is best suited to your company’s specific needs, you’ll want to turn your attention to the variety of metrics and formulas that you can use to more accurately predict future sales. Forecasting sales is very difficult to get right, but by examining past sales data, growth rate, trends in the market, seasonality, and the general state of the economy, you’ll be able to estimate your expected sales and prepare your inventory adequately. 

Commonly used systems to effectively forecast for inventory control

ABC analysis: a system that divides your inventory into three different groups so that you can prioritize based on where your focus is needed. A is for the inventory that makes up the majority of your revenue, B is for your mid-level revenue stock, and C is for the low value, low payoff portion of your inventory.

MOQ (minimum order quantity): the smallest amount of stock that your manufacturer will sell.

JIT (just in time): an inventory management system where inventory is ordered as determined by production schedules. This method requires vigilance to ensure that you don’t go out of stock.

Safety stock inventory: extra stock that you purchase in addition to the inventory that fulfills your expected demand, to prevent stocking out in case your demand forecast turns out to be inaccurate.

FIFO (first in first out): older inventory is sold first, to account for changes in packaging and best before dates.

LIFO (last in first out): new inventory is sold first. This is useful when you sell seasonally relevant items.

ROP (reorder point) formula: helps you determine when you need to order more stock. This can be calculated using the expense of lead time demand, safety stock, and reorder lead time (if available). The ROP formula allows you to calculate your par levels.

Par levels: minimum amount of stock that you must always have available. When your inventory dips below your par levels, you know that you need to order more.

EOQ (economic order quantity): a method of tracking your inventory to minimize the cost of manufacturing and storage. It is particularly useful when your sales numbers are consistent over time.

Batch tracking: tracking groups of your stock that have similar attributes.

Bundling: offering sales or discounts when multiple products are bought in tandem. This is an effective method for clearing out older or less desirable stock.  

Rolling inventory: an inventory storage system where the stock is kept in a trailer or truck, which can then be driven to location when a new delivery is required. This helps save on storage costs.

Cross-docking: similar to rolling, one truck unloads the stock directly into another truck

Drop shipping: a sales fulfillment system that doesn’t require the seller to hold any physical stock. When a customer places an order, the retailer sends that order to be fulfilled by the manufacturer, who store and ship the product. This inventory management system is common for small online businesses, as it helps eliminate upfront costs. 

Consignment: when you give your products to a store to be displayed, and you only receive a previously agreed-upon percentage of sales if the item sells. If not, the product will be returned to you.

Backordering: accepting orders for items that not currently in stock, and producing inventory in order to fill the orders. This can be a risky sales technique, especially if you’re allowing for a high volume of backordering, as customers may lose trust in your company if the orders are not fulfilled quickly enough or there is a holdup with manufacturing.

KPIs (key performance indicators): metrics that show how your company is functioning. KPIs can be used to compare the success of your business to competitors in your industry, and to identify where in your supply chain you might be losing money. Here are some examples of KPIs that may come in handy when it comes to inventory control and management:

–   Stock-to-sales ratio: track how your stock amounts relate to product sales for monthly forecasting

–   STR (sell-through rate): how long your item is in stock before it is sold. You can use this KPI to determine if your pricing is too high and when you need to reorder stock.

–   Average inventory: this measurement is determined by comparing the amount of inventory you have this month with numbers from previous months to see how much you are storing at different times.

–   LIFR (line item fill rate): a calculation to determine how well you fulfilled your orders. This is calculated by comparing the number of line items you mailed out as compared to the number on the initial order. For example, if your shipment had to be separated into two shipments, the first of which contained 3 out of 4 line items, your fulfillment rate would be 75 per cent.

In order to choose the best inventory management system for your business, start by considering what type of products you sell. If your products are perishable, an inventory management system will probably only be useful to you if it includes capabilities for tracking expiry dates. This will ensure that you are always shipping out quality items and preventing food waste. You’ll also want your inventory management system to integrate with your current sales and accounting software and allow you to track communication with multiple shipment and fulfillment companies. There are plenty of low-cost inventory management systems that are perfect for small businesses in the early stages. When you’re working on your business plan, figure out how much you can afford to spend on inventory control without sacrificing any features that are integral to your inventory management.

When should you invest in an inventory management system?

No matter how big or small your business is right now, if you’re feeling overwhelmed by trying to keep track of your inventory, then you need to implement some kind of inventory management system. There are so many management options, from simple spreadsheets to advanced management software, that you can easily decide which type of inventory control practices are best suited to the stage that your business is in at the moment. Once you’ve introduced systems for tracking your customer and sales data, you’ll be able to clearly see what a big difference a good inventory management system can make to the success of your business. An effective inventory management system will help you reduce overhead costs, increase the profitability of your company, and analyze past sales data in order to accurately plan for the future.