7 Essential Insights into Inventory Management: Types, Techniques & Benefits

What Is Inventory Management?

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.

Why Is Inventory Management Important?

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.

Public companies must track inventory as a requirement for compliance with Securities and Exchange Commission (SEC) rules and the Sarbanes-Oxley (SOX) Act. Companies must document their management processes to prove compliance.

Benefits of Inventory Management

Inventory management offers two primary benefits: ensuring prompt fulfillment of incoming orders and boosting profitability. Additionally, it:

1. Saves Money:
Understanding stock trends enables efficient utilization of existing inventory, reducing the need for excessive stock levels at different locations. This decreases inventory costs and minimizes the risk of unsold stock becoming obsolete.

2. Enhances Cash Flow:
Effective inventory management ensures that investments are made in inventory that generates sales, facilitating continuous cash flow within the business.

3. Delights Customers:
Timely order fulfillment contributes to customer satisfaction and loyalty by ensuring customers receive desired items promptly, without delays.

Inventory Management Challenges

Inventory management presents several key challenges, including excessive inventory leading to stagnant stock, inadequate inventory resulting in unfulfilled orders, and a lack of visibility into inventory details and locations. Additional obstacles include:

1. Accurate Stock Information:
Without precise stock data, it’s challenging to determine restocking needs or identify fast-moving items accurately.

2. Inefficient Processes:
Obsolete or manual processes can introduce errors and inefficiencies, slowing down operations and hindering productivity.

3. Shifting Customer Demands:
Constantly changing customer preferences require robust systems to track trends and adapt to evolving demands effectively.

4. Warehouse Space Optimization:
Disorganized inventory can lead to wasted time and resources as staff struggle to locate similar products within the warehouse.

Understanding and addressing these challenges is crucial for businesses to optimize inventory management processes and reap the associated benefits.

What Is Inventory?

Inventory is the raw materials, components and finished goods a company sells or uses in production. Accounting considers inventory an asset. Accountants use the information about stock levels to record the correct valuations on the balance sheet.

Learn more about inventory in the article “What is Inventory?”.

Inventory vs. Stock

Inventory is often called stock in retail businesses: Managers frequently use the term “stock on hand” to refer to products like apparel and housewares. Across industries, “inventory” more broadly refers to stored sales goods and raw materials and parts used in production.

Some people also say that the word “stock” is used more commonly in the U.K. to refer to inventory. While there is a difference between the two, the terms inventory and stock are often interchangeable.

What Are the Different Types of Inventory?

There are 12 different types of inventory: raw materials, work-in-progress (WIP), finished goods, decoupling inventory, safety stock, packing materials, cycle inventory, service inventory, transit, theoretical, excess and maintenance, repair and operations (MRO). Some people do not recognize MRO as a type of inventory.

Learn more about the 12 different types of inventory.

Inventory Management Process

If you produce on demand, the inventory management process starts when a company receives a customer order and continues until the order ships. Otherwise, the process begins when you forecast your demand and then place POs for the required raw materials or components. Other parts of the process include analyzing sales trends and organizing the storage of products in warehouses.

How Inventory Management Works

The goal of inventory management is to understand stock levels and stock’s location in warehouses. Inventory management software tracks the flow of products from supplier through the production process to the customer. In the warehouse, inventory management tracks stock receipt, picking, packing and shipping.

Inventory Management Techniques and Terms

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:
  This method works by identifying the most and least popular types of stock.

• Batch Tracking:
  This method groups similar items to track expiration dates and trace defective items.

• Bulk Shipments:
  This method considers unpacked materials that suppliers load directly into ships or trucks. It involves buying, storing and shipping inventory in bulk.

• Consignment:
  When practicing consignment inventory management, your business won’t pay its supplier until a given product is sold. That supplier also retains ownership of the inventory until your company sells it.

• Cross-Docking:
  Using this method, you’ll unload items directly from a supplier truck to the delivery truck. Warehousing is essentially eliminated.

• Demand Forecasting:
  This form of predictive analytics helps predict customer demand.

• Dropshipping:
  In the practice of dropshipping, the supplier ships items directly from its warehouse to the customer.

• Economic Order Quantity (EOQ):
  This formula shows exactly how much inventory a company should order to reduce holding and other costs.

• FIFO and LIFO:
  First in, first out (FIFO) means you move the oldest stock first. Last in, first out (LIFO) considers that prices always rise, so the most recently-purchased inventory is the most expensive and thus sold first.

• Just-In-Time Inventory (JIT):
  Companies use this method in an effort to maintain the lowest stock levels possible before a refill.

• Lean Manufacturing:
  This methodology focuses on removing waste or any item that does not provide value to the customer from the manufacturing system.

• Materials Requirements Planning (MRP):
  This system handles planning, scheduling and inventory control for manufacturing.

• Minimum Order Quantity:
  A company that relies on minimum order quantity will order minimum amounts of inventory from wholesalers in each order to keep costs low.

• Reorder Point Formula:
  Businesses use this formula to find the minimum amount of stock they should have before reordering, then manage their inventory accordingly.

• Perpetual Inventory Management:
  This technique entails recording stock sales and usage in real-time. Read “The Definitive Guide to Perpetual Inventory” to learn more about this practice.

• Safety Stock:
  An inventory management ethos that prioritizes safety stock will ensure there’s always extra stock set aside in case the company can’t replenish those items.

• Six Sigma:
  This is a data-based method for removing waste from businesses as it relates to inventory.

• Lean Six Sigma:
  This method combines lean management and Six Sigma practices to remove waste and raise efficiency.

Inventory vs. Cycle Counting

“Taking inventory” is the process of physically counting all stock, once a year in most cases. Cycle counting is the practice of counting a selected set of stock more often. Cycle counting serves as an important means of checks and balances to ensure the amount of inventory represented in the inventory management system is what you have on the shelf.

A cycle counting best practice is to count specific SKUs regularly and integrate it into the daily tasks of warehouse staff. Companies may determine different standards for different types of inventory, such as performing a cycle count of top-moving SKUs or higher-value items. Learn more about the benefits of cycle couting.

FAQs on Inventory Management

Navigating the complexities of inventory management often raises numerous questions. Here are concise answers to some of the common queries:

What Are the Goals of Inventory Management?

Inventory management aims to meet customer demand effectively while minimizing investment in stock to maximize profits.

What Are the Different Types of Inventory Management Systems?

• Manual Inventory System: Involves physical counting and record-keeping, suitable for small businesses.
• Periodic Inventory System: Combines manual counts with periodic tracking using barcodes and databases.
• Perpetual Inventory System: Utilizes RFID technology for real-time stock updates and accurate data management.

How Does ERP Benefit Inventory Management?

ERP systems track and consolidate supply chain operations, accounting, and purchasing data, providing comprehensive insights and visibility into inventory management processes.

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