When you have a successful business, it’s important to be able to track and manage your physical goods, and an inventory management system will help you with that. Whether you’re just starting out or have been in the game for a while, good inventory management features will maximize your profits and minimize expenses.
The goal of inventory management is to ensure that you have the products that your customers want and are able to deliver them without any trouble. If you don’t have proper inventory management, you’re running the risk of incurring unnecessary costs (just think of all those extra shipping and handling fees) and disappointing your customers.
So how do you deal with inventory management? The first step is to find out what’s in and out of stock with an accurate inventory management system. You can’t manage what you don’t understand! This article will teach you how to track inventory and avoid overstocks or understocks.
- Types of inventory
- Inventory management vs inventory control
- What is the meaning of SKU tags in inventory management?
Introduction: What is inventory management?
Whether you have a retail store, an online store, or both, you need to understand inventory management. It’s crucial for businesses of any size to keep track of their goods and merchandise so that they can keep them on hand and meet the needs of their customers.
Inventory management refers to the idle stock of physical goods that contain economic value, and are held in any form (such as raw materials, components, and finished goods) by an organization waiting to be packed, transported, or sold. Once sold, the inventory becomes businesses’ revenue.
Inventory management for small business works by tracking products, components and other items across all channels to ensure that the stock is used as efficiently as possible.
Most companies underestimate how much they could be making every year if they just had a better inventory management system. But once you have a clear idea of what you have and what you need to stock up on, you can track your orders better and get paid on time, which is great for your bottom line.
Types of inventory
Inventory comes in different forms. It can be raw materials that you buy from others to make something new, or just the products you’ve bought in bulk and now are selling individually. Let’s take a look at the most common types of inventory:
- Finished goods – final products that are ready for sale.
- Raw materials – the inventory that you use to produce your finished goods.
- Work-in-progress – the inventory that is going through the manufacturing process.
- MRO goods – the inventory you use to support the manufacturing process (maintenance, repair, operating).
- Safety stock – the additional inventory you keep in store in case of shortages.
Inventory management vs inventory control
In order to operate a company efficiently and keep track of stock levels, it’s necessary for companies to have accurate records of their inventory levels. The higher the inventory levels, the more you’ll earn as a business. The main difference is that an inventory control system is responsible for how you manage the inventory you currently have on hand – in storage – how much is available, where it is and in what condition it is. So, basically, inventory control is part of inventory management.
If you’re running an e-commerce business or planning to start one soon, it’s important to assign unique identifiers to each of your products so that you can track them efficiently when they sell online. Inventories aren’t only essential for businesses which sell wholesale or retail; they also help reduce wastage and improve efficiency across supply chains by letting buyers know how much stock sellers have available at any given time.
The Stock Keeping Units (SKUs) are the labels that are assigned to a product when it’s being stocked in inventory. Having a universal identifier makes tracking items much simpler and prevents you from keeping track of all the different variations in your head or by hand. It’s used to track inventory details such as:
- Stock available;
- Product locations and types;
- Sell rates, margins, profitability, etc.
Importance of inventory management
Why is inventory management important? Do you remember that feeling when:
- you wanted to sell your goods but didn’t have the stock to replace it?
- you had at least $200 worth of inventory in your warehouse that your business couldn’t make use of?
- you’re out of stock and losing money?
An efficient small business inventory management system gives you time to promote your products, which increases margin, and keeps you from missing sales.
As a business owner, you need to know where you stand in order to make smart business decisions. Fortunately, inventory management is the key. You can use it to keep track of your inventory and even maximize sales so that you can skyrocket your profit.
As large inventory carries the risk of spoilage, theft, damage, or shifts in demand, it’s essential to have an accurate inventory management system.
What is an inventory management system?
An inventory management system is a set of procedures, algorithms, and software that is used to track, manage, and report all items in stock or on order. It’s an essential tool for any company that wishes to keep track of its inventory, especially those businesses that deal in high-volume or perishables. Whether you’re running a small business or a large corporation, you’ll find that inventory management is a necessity to ensure that your company’s stocks remain accurate and up-to-date.
An effective inventory management system will help to facilitate e-commerce inventory management by enabling businesses to track and analyze stock levels. It’ll help a company understand the demand for its inventory, manage the risk of having too much or too little stock, and stay organized and compliant with its accounting requirements.
Periodic inventory management system
Periodic inventory management is a type of system that records item details as the items move in and move out of stock. A database contains the records of stock levels and locations.
A steady supply of goods and services not only keeps your business running smoothly, but it also prevents wastage and excess stock. So, by maintaining a periodic inventory management system, you’ll be able to focus on your core business rather than worry about maintaining stock levels.
Note: For e-commerce inventory management it’s recommended to implement a periodic inventory so that you can have an accurate and complete view of what you have in stock. Once you know exactly what’s in and out of stock, you may try to expand your inventory.
Perpetual inventory management system
Perpetual inventory management is a business discipline that requires continuous and sustained efforts to reduce costs, increase accuracy and stay ahead of demand. This inventory management system provides real-time stock data. It might rely on active radio-frequency identification (RFID) tags that are always on and sending updates on item movements.
The system ensures that inventory levels are checked on a regular basis and the excess or shortage of goods is measured. The main advantage of using such a system is that it can help businesses save money, time, and resources.
Manual inventory management system
A manual inventory management system relies on manual processes to keep track of the inventory levels in each location or storage unit. This can be a time-consuming process that requires frequent data entry. Such a system requires you to manually record inventory on paper or in a spreadsheet.
If you have limited resources or simply don’t want to invest in an automated system, manual inventory management might be right for you. Manual inventory management systems generally suit small businesses that don’t have much inventory yet.
Supply chain management: What is the first step of inventory management?
Supply chain management (SCM) is the planning and execution of activities that help your company transform its products from raw materials into the final items that are delivered to customers. This includes everything from procuring raw materials, storage and distribution, inventory management systems, and shipping and tracking packages.
The most common inventory management process includes five main steps:
- Delivery of the materials or items;
- Receiving them;
- Putting them away;
- Manufacturing (if raw materials were delivered) or Distribution (if items were delivered);
Throughout all these steps you also need to keep in mind all the important information (lot and serial number, cost, quantity, production/expiration/shipment dates) and timely update it to keep everything in order and save your money.
What are the techniques for inventory management?
Just-in-time inventory management
Just-in-time inventory management is a manufacturing process that eliminates excess inventory so that the company operates with a minimal stock of inventory. It’s one of the many inventory management techniques that help a company keep its supply chain lean and avoid excess stock.
ABC inventory analysis
This type of analysis looks at your inventory in order to determine how much of what you have on hand is selling at a profit by classifying goods into different tiers. Inventory analysis can help your company better understand what’s selling well and what needs to be sold at a higher profit margin in order to offset the fixed and operational costs of maintaining the inventory.
One more trending technique in the inventory management strategy is to sell products on dropshipping platforms that are focused on specific niches. They usually handle all aspects of running an online store, such as product listings, payment processing, inventory management and customer service.
They also offer a variety of services from software and consulting to managing inventory and shipping. This means you don’t have to invest your time and money in setting everything up yourself.
Bulk shipments take place when an exporter sells goods in bulk quantities rather than individually. This way, the exporter doesn’t have to worry about a customer coming by to buy just one thing — they can sell the entire batch wholesale at a cheaper price.
Instead of a shipment being sent from one location to another, bulk shipments are sent from one place to another in a different kind of shipping container, known as a bulk carrier.
The cycle count is an inventory management technique used to keep track of how many times an item has been used during the course of a day’s operation. The count starts with the first time the item is used for its intended purpose. The count then increments every time the item is used for any other purpose.
The cycle count technique is a method that can help you keep tabs on your inventory and reduce the cost of maintaining it.
FIFO and LIFO
First In First Out (FIFO) is a way of accounting for inventory that assumes the oldest inventory is sold first. FIFO is commonly used to track costs which are commonly referred to as Cost of Goods Sold (COGS). Businesses use this method to track costs, make better decisions about restocking inventory, and reduce taxes by recognizing the most favorable costs for their financial statement.
Last In First Out (LIFO) is the opposite of FIFO. It’s a method of inventory accounting that considers that the prices always rise, so the most recently-purchased inventory is the most expensive and thus is sold first. This is done to avoid artificially inflating profits during periods with high supply costs by ensuring that older inventory costs aren’t included as part of cost of goods sold.
Demand planning is an important part of successful inventory management which can be done with the help of calculating inventory management formulas and setting the proper inventory management KPIs – we’ll talk about them in the next block.
Such a technique is used to analyze past data, trends, and inventory levels to identify what to expect in the future. This also helps you optimize stocking levels of each item without the risk of running out.
E-commerce inventory management
Do e-commerce businesses need an inventory management solution?
They sure do!
The days of buying items in bulk to have an extensive inventory on hand are over. Consumers expect fast deliveries, and they expect to see a full assortment of items in the store.
Having an e-commerce store can help you meet these expectations. Especially if you’re running your store from home.
E-commerce inventory management is an important part of running your business, but there are a few ways to look at it. Inventory is broken down into product, stock and profit. The ratio between these will give you an idea of how successful your business is.
The two main formulas for e-commerce inventory management will be your Cost of Goods Sold (COGS) and Gross Profit:
|COGS = Beginning Inventory + Purchases – Ending Inventory|
COGS – the metric that reflects the direct costs of producing the goods sold by the business. Cost of Goods Sold is also known as Cost Of Sales. It refers to all costs associated with procuring raw materials and manufacturing finished goods for resale. These costs include direct materials, direct labor, and all other related costs such as indirect labor, depreciation on production equipment, etc.
👉 To learn more about COGS and how to calculate it, check our article “What is COGS in Accounting and How to Calculate It? Examples and Formula”.
|Gross Profit = Revenue during a Particular Period – COGS|
Gross Profit – is a measure of how profitable your business is once you account for the costs of acquiring your inventory. In other words, gross profit is the revenue left from selling products and services before accounting for any COGS. It’s a measure of how much profit you’re making on each product or service sold.
Other important formulas for inventory management
1. Economic order quantity (EOQ)
– is a measure of an optimum number of products that you should keep on hand in order to optimize production and distribution. It helps businesses make sure they have the right amount of raw materials on hand. This way they ensure the materials don’t run out mid-production or they don’t get stuck with too much inventory, which can lead to a waste of money, time and other resources.
|EOQ = √(2 x Setup or Order Cost x Demand Rate (Quantity Sold per Year) / Holding or Carrying Costs)|
2. Safety Stock
– is the quantity of an item kept in stock in excess of the lead time plus minimum stock level. In other words, safety stocks are the amount of inventory that a company maintains to mitigate the risk of running out of stock and missing sales opportunities. This practice helps companies avoid a minor disruption in operations, resulting from unforeseeable supply chain disruptions.
|Safety Stock = (Max. Daily Usage x Max. Lead Time in Days) – (Average Daily Usage x Average Lead Time in Days)|
Lead time in days in this formula reflects the time it takes for a purchase order to arrive.
3. Reorder point
– is a target stock level for a specific product or SKU that is determined based on the lead time from the vendor, lead time between vendors, demand forecast and safety stock. Reorder point helps businesses understand how much time will pass before an item runs out and initiate a restocking process to avoid stock-out situations.
|Reorder Point = Lead Time Demand + Safety Stock|
We’ve discussed how to calculate Safety Stock above, but what about Lead Time Demand? To find out this metric you need to multiply the Lead Time in Days by Average Daily Usage. The formula looks like this:
|Lead Time Demand = Lead Time in Days x Average Daily Usage|
Benefits of inventory and warehouse management
Inventory management is an indispensable part of any business that produces and/or sells goods. Warehouse management systems help you gain control over your stock, reduce excess inventory, and save money by reducing storage space and operational costs.
Let’s look at the specific aspects the inventory management systems help you with.
Plan your money investment
As your business grows and you begin to add new inventory, you might be worried about inventory issues. The key to good small business inventory management is to keep track of your stock so you know exactly when it’s needed, how much you have, and whether it’s available for purchase. If you know which products are selling best, you can invest in them in the future instead of spending money on unpopular products.
Identify issues quickly
When things get busy and you have no time to check stock manually, it’s easy for mistakes and oversights to creep in. But with a proper inventory management system you’ll be able to keep an eye on your inventory levels, and identify errors or issues inside your warehouse. The earlier the problem is identified, the better – you have more time and can take action to resolve it.
Be ready for high demand during peak seasons
Forewarned is forearmed. When you already know which products sell best during the holiday season, you can order them beforehand and never worry about running out of stock and messing up your inventory management.
Make reordering as simple as possible
When you manage your inventory efficiently, you can implement some additional triggers that help customers reorder their previous purchase. Plus, this trigger may automatically replenish the sold items with new ones so you never have to worry about being understocked.
4 common mistakes in e-commerce inventory management
There are a number of common mistakes you can make when integrating an inventory management system into your e-commerce business.
Let’s have a look at the top five errors that most business owners make:
Mistake #1. Not Using Long-Term Assets
Before you start getting a bunch of inventory, think about its life expectancy and how much of your inventory you should be keeping in store for future sales. A good way to determine this is by checking the minimum and maximum sales of your products, planning your inventories accordingly and keeping proper inventory management systems.
The last thing you want to do is start keeping inventory and find out that your products are outdated or out of stock.
Mistake #2. Buying Bad-Quality Goods
Although there’s a huge variety of quality goods and services available on today’s market, you should be careful in the choice of dependable vendors, especially when you’re a new or growing business. A company that has proper small business inventory management and positive feedback is a good choice for business purposes.
Purchasing bad-quality goods will significantly lower your profit margin and affect your reputation.
There’s one way to spot good quality goods: look for companies that have a track record of success and a long list of satisfied customers.
Mistake #3. A Lot of Storage Sites
Do you really need that many? Increasing space for inventory without facilitating your items themselves or the service won’t lead you anywhere.
Even if you’re able to fill all the shelves, this only means that you’ll have much more work to do. Therefore inventory management will become more difficult and may potentially lead to more errors.
Mistake #4. Trying to do everything by yourself
Most small businesses buy software for inventory management. Some set up their inventory on an Excel spreadsheet. What they probably don’t realize is that they’re losing quite a bit of the data they’ve been working so hard to build up.
To prevent all these mistakes and grow your business smoothly and successfully, it’s recommended to give some technologies a try. Specialized software will help you with all the inventory management processes and simplify your business workflow.
How to improve inventory management system
Now that you know the theory, let’s move to the actual actions and learn how to improve your inventory system. By creating efficient practices you’ll be able to enhance both your business performance and time management since checking your inventory won’t take as much time as it used to.
1. Maximize inventory turnover
Inventory turnover is a measure of how well a business manages its inventory. It answers the question of how fast a company sells its products once they’re purchased.
By maximizing your inventory turnover ratio, you’ll be able to determine the right reordering point and thereby reduce holding costs as well as spoilage.
👉 Find out more about inventory turnover and the way it works – check our article “What is a good inventory turnover ratio?”
For a better inventory turnover ratio, you’ll need to know what inventory to prioritize. Here comes the next improvement step – learning your ABC.
2. Focus on your needs with ABC analysis
With ABC analysis you can categorize your products by three groups:
- Items of high value (70%) but small in numbers (10%);
- Items of moderate value (20%) and moderate in number (20%);
- Items of small value (10%) but large in number (70%).
Always keep in mind that not all products are of equal value and more attention should be paid to more popular products: in this case these are products from group A since they’re the most valuable.
3. Choose the right inventory management software to utilize real-time data
Support your process with technology! The best way to ensure that you have a successful inventory management process is to use technology that works for you.
Not all of the software for inventory management can provide you with all the necessary information. That’s why you’re going to need to understand different features that your software has.
How to choose the right inventory management software for small businesses?
The best way to choose an inventory management tool is to ask yourself a few important questions. For example, Are you looking for a way to make your inventory costs lower? or Are you looking for a way to keep an accurate record of sales? Also remember that a good inventory management software needs to provide you with real-time data, analysis tools and reporting features.
Synder Sync is the easiest example of such software that has a suite of useful accounting features including inventory tracking. By creating a flow with the help of Smart Rules feature, you can create a condition based on which the recorded amount of inventory will be deducted from the existing product records in your accounting software. With Smart Rules, you’ll be able to keep track of your inventory on hand.
Need help? Try Synder Sync’s 7-day free trial now and create your own flow!
👉 To learn more about various software options facilitating inventory management for small businesses, check our blog post Top-7 small business inventory software solutions.
Although you might not think of inventory management as an essential part of running a business, it’s definitely affecting your workflow and the way you allocate your resources.
Keeping track of your inventory on a monthly basis is vital to your success as a business owner. Customers are buying products faster than ever, which makes it difficult for you to keep tabs on everything. Investing in a reliable inventory software is a good way to get a handle on what you have and what you need.
Here are three main reasons why you need to use a trustworthy software for inventory management:
- Inventory management software gives you a better understanding of your sales and profits.
- Inventory management software allows you to manage inventory more efficiently.
- You’ll be able to access your historical and current inventory data and manage it from one easy-to-use interface.
With the right inventory software, you’ll be able to get a clearer idea of what items are selling better, which will help you plan ahead and make strategic financial decisions. Keep your inventory accurate and precise and you’ll have a piece of mind and a plan of actions for the future!