What do Walmart, the small local grocery store down the block, and all decent retail stores out there have in common?
All of them rely on an inventory management system to keep track of their whole product list.
In this article...
Why is it so important to keep track of your goods?
Without a way to track inventory status, businesses will have no way to know when it’s time to restock shelves, or correct inventory mishaps as they occur and prevent them from happening again.
For every $1 sale a U.S. retailer makes, they “sit on” approximately $1.43 of inventory.
Seems like a huge waste, right?
This happens because they can’t solve their overstocking issue.
Without a proper inventory management system set in place, a business can not make intelligent decisions about reordering products or keep an updated list of items in their online store.
They might end up having too much or not enough product.
- If they have too much, they waste money on products that just sit there.
- If there’s not enough, they will lose customers.
It doesn’t matter whether you operate a brick-and-mortar shop or e-commerce site, an inventory management system is crucial if you want to succeed as a retailer.
So what exactly are inventory management systems?
The Basics You Need to Know
Inventory management is a process of supervising inventory or non-capital assets, such as finished goods or raw materials.
The process itself is systematic.
It simplifies purchasing, storing, and selling of inventory so that stock is always in the correct quantity, place and time, and at the right cost to produce a profit.
Inventory management is a part of your supply chain and will ensure efficiency and minimize costs only if properly understood and set up.
The core components of an inventory management system:
- Purchases from suppliers & customers.
- Storage control, which includes stocking items in the right place and at the right time.
- Pricing the inventory at the right costs to produce a profit.
- Fulfilling the final transaction.
If any of these components are in disarray, the whole supply chain will derail. The desired result, mainly producing a profit, will be compromised.
What’s Money Got To Do With It?
Bad inventory management often leads to over or under-stocking. Both online and in-store retailers lose around $1.75 trillion a year in overstocks, out-of-stocks, and returns.
Too Much Stock Scenario:
When you have too much stock, it will take up space, and cost you a lot more money since you have to store and maintain all those ‘extra’ items while you are waiting to sell them
If any items in your inventory sit there for too long, you may not even yield a profit once it’s finally sold because the costs of storage have eaten up most of, if not all the margins.
You may also have to sell your overstocked items at a steep discount just to make room for new inventory, which will only diminish your returns even further.
Not Enough Stock Scenario
If there’s not enough stock, you risk losing out on sales – if you don’t have the product, then you can’t sell it.
You are losing customer confidence. Sure, it can happen rarely that you don’t have an item in stock. But if this happens all the time, your customers won’t even bother trying to buy an item from you, they will skip you.
You might also lower your profit margins by missing out on discounts if you purchase too little. Usually, when you buy in bulk, you get a bigger discount, meaning you’ll have better margins.
These are just some issues businesses will have to deal with because of having a flawed inventory management system (or having no inventory management system at all). Additional issues they might encounter are:
Mispicks: picking the wrong items to stock.
Inventory Tracking Mistakes: usually caused by outdated inventory management methods.
Improper Training: this can include inadequate training or rushing through inventory management training methods to quickly fulfill orders.
How good management systems help?
The main benefit of a well-optimized and up-to-date inventory management system is that it will let you know when your stock is too low or too high. You’ll be able to stop ordering or order more just when you need to and therefore reduce inventory costs and increase profit margins.
The Right Inventory Management System will help you:
- Reduce costs
- Improve customer service
- Optimize order fulfillment
- Minimize theft, spoilage, and returns
- Gain better insights about financials, customer behavior and preferences
- Identify product trends and business opportunities
- Track damaged & lost items
- Spot shipping errors in real-time.
- Run reports on theft, trends, and opportunities
With the right system, you can get a better picture of what is currently going on with your inventory and what may happen with it in the future.
Learning the Warehouse Language
You’ll only be able to handle inventory right if you have a good grip on the basics.
You should know what your managers and employees are talking about when they come to you with a question, suggestion, or problem regarding your inventory.
This section will give an overview of the common inventory terms, and a few relevant formulas that help make decisions regarding your inventory.
Inventory Management Glossary
UNDERSTAND YOUR STOCKS:
Buffer Stock (or Safety Stock) – Additional inventory that safeguards against items going out of stock. It helps deal with an unexpected rise in demand, issues with suppliers, or delivery problems. Keeping it translates to extra costs but oftentimes they are lower than the price of stopping production or losing customers due to out-of-stock or undelivered items.
Deadstock – merchandise that has not been sold or used mostly because it’s outdated. It’s removed from sale but it can occasionally be sold for a large discount even if it has already been warehoused. If this is the case, it will remain within its original package and contain its original tags.
Decoupling Stock – Separately kept inventory used to minimize the risk of slowing down or halting the entire manufacturing process.
It’s used when:
One or more components of a product are currently unavailable
You have a case of equipment breakdown
There’s uneven machine production.
Pipeline Stock – Items within a business’s inventory that are either being produced or currently being shipped but have not reached their final destination yet.
Pipeline inventory remains within a business’s distribution chain until it’s purchased by the end consumer.
KEEP YOUR COSTS IN CHECK:
Cost of Goods Sold (a.k.a COGS) – All of the costs associated with production, including the storage costs of each product. COGS combines the following to come up with an accurate number for final expenditure:
Cost of material used to create the product.
Labor cost associated with the product.
Storage cost to store and maintain the product.
Does not include indirect costs such as sales and distribution costs.
Holding Costs (a.k.a. Carrying Cost) – The cost of storing and maintaining stock in a warehouse until it’s sold. Holding costs are a crucial part of the EOQ equation. They help determine optimal time in which to reorder new items. Holding costs include:
Costs associated with storage space.
Costs associated with security.
Inventory insurance and costs associated with the protection of items against damage, loss, or theft.
Landing Costs – Total cost associated with transporting and shipping inventory. These are important for establishing a sales price that gives an adequate profit margin. Landing costs are the sum of the original price of the product along with some or all of the following:
Transportation Fees (inland & ocean)
Handling & Payment Fees
KNOW YOUR PRODUCTS:
Variant – A distinguishable product based on its unique attributes. A specific set or bundle of products may be the same according to definition but each product’s variants is what sets them apart. The most common variants are color, size, and price.
Bundles – Groups of items which are combined and sold as a single item.
The process of bundling is also referred to as ‘kitting’ and is used in inventory management to attribute each item within the bundle to the final sale helping to keep better track of grouped stock.
Order Management – The process of receiving, processing, and fulfilling orders. It begins with a customer placing an order and ends once the customer has received the order and is fully satisfied with it.
Order Fulfillment (a.k.a. Order Processing) – The complete lifecycle of an order:
Start: Point of Sale > Picking and Packing > Shipping > Delivery > Inventory Adjustments (may include returns, if needed)
Lead Time – The time it takes a supplier to deliver an order placed by a business, plus the time it takes that business to reorder the needed goods. Businesses must always consider keeping some measure of needed goods in stock just in case a supplier cannot deliver new inventory on time. The longer the lead time, the more goods a business will have to keep in their inventory.
Purchase Order (a.k.a. PO) – A commercial business to business (B2B) document outlining the specifics for transactions of products and services between a purchaser (buyer) and a supplier. The specific details of a PO include:
Items a buyer has agreed to purchase.
The number of items the buyer intends to purchase.
The specific price of the items.
The delivery date of the items.
The buyer’s mode of payment for the items.
Sales Order – A document issued by the seller signifying that a customer has purchased an item. it’s always made before the order is fulfilled and guarantees that there will be no additional charges for that item unless stated otherwise within the sales order form.
Barcode Scanner – An electronic device that decodes and captures information within barcodes. it’s used to check incoming and outgoing stock items at fulfillment centers and warehouses.
Stock Keeping Unit (a.k.a. SKU) – Barcodes assigned to products that streamline the scanning and tracking of inventory. Usually, an SKU will include alphanumeric characters that can easily be read by barcode scanners.
The most common reference points they have are product style, product color, and product size. SKUs are used strictly for inventory tracking purposes and have nothing to do with a product’s model number.
Third-Party Logistics (a.k.a. 3PL) – An external logistics provider that offers procurement and fulfillment services. 3PL provider offers range from a single company, service, or location (such as a warehouse), systems that serve a broad spectrum of a company’s supply chain and inventory-related activities (storage, shipping, and fulfillment of goods).
Aside from 3PL, there are also Fourth-party logistics providers (4PL) that offer additional supply chain management services like technology, management, and infrastructure.
The Math Behind Inventory Management
Inventory formulas help keep stock at optimal levels. These formulas are necessary for uncovering the current status of your inventory levels and alerting you to either slow down or speed up your ordering process.
In this section, we will list the most commonly used ones.
Don’t worry if you have never encountered them before. They might seem a bit confusing at the start but will become second nature to you and your inventory management team.
Formula 1: Economic Order Quantity (EOQ) Formula
This formula specifies how much inventory should be reordered given current demands and inventory holding costs. The main purpose is limiting holding costs and costs related to reordering an item.
It uses storage, ordering and shortage costs to calculate the number of items needed. The EOQ equation gives you the most optimized number of products to keep in your inventory if you want to minimize ordering and holding costs.
EOQ = √(2DK / H)
You can also break it down as: The square root of (2 x D x K / H)
D = The setup costs including shipping & handling.
K = The demand rate or the actual quantities sold each year.
H = The holding costs on a per year & per unit basis.
Formula 2: Reorder Point Formula
This formula determines when and how many items should be reordered. It’s calculated based on average daily sales and delivery lead times.
Ideally, the new inventory will arrive just as the current inventory is being sold or used up. It helps achieve continuous production, has an uninterrupted fulfillment process and a minimal on-hand inventory which lowers holding costs.
Reorder Point = (Daily Unit Sales x Delivery Lead Time) + Safety Stock
Formula 3: Days Sales of Inventory (DSI) Formula
This formula is used to find the average number of days needed to turn inventory (and work in progress items) into sales.
The formula gives a clear picture on how efficient your sales are. Here is how to calculate your DSI:
DSI = Costs of Average Inventory / Cost of Goods Sold x 365 days
To put it in words: Take your average inventory cost and divide it by your cost of goods sold (COGS) and then multiply that number by 365.
The lower the number, the better. High numbers mean that inventory is hard to sell.
Formula 4: Inventory Equation Formula (Safety Stock calculation)
This formula helps find the right amount of safety stock to meet current demands but not so much that it’s going to increase your holding costs and decrease your profits.
Safety Stock = (Maximum Daily Usage X Maximum Lead Time in Days) – (Average Daily Usage X Average Lead Time in Days)
- The maximum daily usage is the number of items sold at best times.
- The average daily usage is the average number of items sold per day.
- Maximum lead time is the longest it takes to make the item and deliver it.
- Average lead time is the average time it takes to make the item and deliver it.
As an example:
A retailer based in London is selling branded coffee roasts made in NY.
- It takes on average 45 days to prepare, pack, ship and deliver the roasts from NY to London (average lead time in days).
- The retailer sells 25 packages on average (average daily usage).
- It soars up to 60 per day on good times (maximum daily usage).
- Sometimes, the supplier in NY has to wait for specific coffee beans and might take longer to prepare and pack roasts – up to 55 days (maximum lead time in days).
The safety stock of roasts should be:
- Safety Stock = (60 x 55) – (25 x 45)
- Safety Stock = 3,300 – 1,125
- Safety Stock = 2,175
The retailers should always have at least 2,175 packages as safety stock.
What Kind of Inventory Are You Dealing With?
Inventory is widely different across industries. From manufacturing to retailing to software development, every industry will have its own specific inventory.
The categories listed in this section are common to all types of industries, niches, and verticals, which means no matter what your business type, you will more than likely use one or more of them.
There are five main inventory types:
Are Your Materials Raw?
Raw materials are basic materials used to make a finished product. They can be purchased by a business from a supplier or produced by the business itself.
Some examples of basic materials used by different businesses to make their finished products can be seen below:
- Aluminum scraps are raw materials used by businesses that make bike frames.
- Flour is the raw material used by restaurants and other companies that make or distribute food items like bread and muffins.
- Manufactured metal parts are the raw materials used by automotive companies who make cars, trucks, and motorcycles.
- Wax is the raw material used by companies who make candles.
One company’s finished goods can be used as a raw material for another company’s finished product. For example, drilling companies produce crude oil as their final product. Refining companies purchase it to produce gasoline.
Carrying too much raw material can incur a hefty holding cost and increase the risk of it becoming spoiled, damaged, or obsolete.
Raw food storage is a good example: If stored for a very long time it could spoil before it can be used.
This is why it’s important to streamline the storage of raw materials through an inventory management system.
By using formulas like EOQ, reorder point and safety stock you’ll always have enough raw materials are ordered, held, and used without risking them going bad.
This will ultimately maximize inventory input and output.
Are You Stocking Semi-finished Goods?
Work-in-progress inventory (a.k.a. WIP Inventory, semi-finished goods) are partially finished goods that are not yet ready for customer consumption. You’ll encounter such unfinished items on the production floor of a manufacturing plant.
WIP inventory example:
A company that creates plastic products will consider plastic they have in their inventory raw material. Once it’s in the production process, for example when it’s being molded, it’s considered WIP inventory. It will remain WIP until it’s infused into the finished product.
From a monetary standpoint, companies often consider their WIP inventory useless because they can’t sell them – can’t make money while it’s undergoing production. Therefore, a lower WIP inventory number is always preferred.
Companies who wish to decrease their WIP inventory to make money on it need to consider decreasing their cycle time – the time it takes to complete the manufacturing process.
Is Your Product A Final Version That’s Ready For The End User?
A finished good is the final product after production is finished.
Raw materials that have undergone the manufacturing process and are ready to be sold to customers are called finished goods.
Because finished goods can be sold, they have immense financial value. Not all finished goods are the same, however.
Specifically, there are two types of finished goods that you should distinguish, depending on your industry:
Mass-Produced Goods: With mass-produced goods, the sale happens after the production process so it’s important to keep raw material inventory levels close to finished goods inventory levels to meet the demand of the market.
Industries dealing in mass-produced goods include:
Fast-Moving Consumer Goods(FMCG) Industry
On-Demand Goods: With on-demand goods, production starts only when the order is received. No finished goods should be kept in stock as they may never be sold if no orders are coming in or the new orders have variations that differ from the finished product.
Industries dealing in on-demand goods include:
- Capital Goods Industry
- Customized Goods Industry
Does Your Inventory Include Additional Supporting Materials?
Maintenance, repair, and operation goods (MROs) are supporting materials and supplies that are used in the production process.
MROs aid in the production of finished goods but are not part of the finished product. If they play a part in the finished product, then their role is minimal.
MRO inventory management is one of the most overlooked inventory management areas.
Maintenance and repair supplies are used mostly to keep machines and machine parts operating during the production process.
A few examples of maintenance & repair supplies include various nuts, bolts or lubricating oil.
Operation supplies are mostly made of office supplies, such as pencils, paper or staplers.
Without keeping track of your most common MRO items you might reduce restocking costs, production expenditures, and downtime.
Today, there are plenty of MRO tracking systems and software that can streamline your entire MRO inventory management activities so that you can always have them available and ready when you need them.
Don’t Forget To Pack
Packing inventory is just that, material a company uses to pack their goods. Packing material can be divided into two categories:
Primary Packing Inventory – Contains and uses the finished product.
Example: The toothpaste tube is the primary packing and is needed to hold and dispense the toothpaste.
Secondary packing inventory – Protects the finished product and in some cases makes it look more appealing..
Example: The toothpaste box is the secondary packing which contains the primary packing and finished product (i.e., toothpaste tube & toothpaste).
Why should you track packing materials?
Because you need to make sure that your packing supplies do not go to waste or become a source of extra expenses as with extra boxes and other packing supplies like crates and shrinkwraps that don’t get used.
The good news is that tracking packing supply inventory is rather simple as your shipping supply orders are handled, tracked, and monitored separately from the rest of your inventory (i.e., raw materials and MRO inventory).
The most common ways to track packing inventory are:
Annual Figures – Take your beginning year packing stock and compare it to your end-of-year stock.
If you have more packing supplies at the end of the year than at the beginning and have not shipped any more products than usual, you are ordering too much packing supplies.
Invoices – Use packing supply vendor invoices to see how many supplies you have been ordering over the year. Compare your current year’s invoices to the previous year’s invoices to gauge your packing supply trends.
Distribution-Center Bundling – An automated inventory-tracking system, usually located in the main distribution center.
It can track current packing stock, packing stock that has been shipped, and packing stock that has been reordered out of various centers.
The best method for companies who ship from several locations.
Purchasing-Group Records – Using the invoices of a purchasing group that supplies several similar businesses with packing items. Purchase-group records can serve as your inventory tracking just as long as you have already made sure that you received the packing supplies stated on their invoices.
Finding The Best Management Strategy
While there are different inventory management techniques, the ones we mention here have proven to work in all kinds of businesses, no matter what their size or their level of inventory management experience is.
It starts with ABC…
ABC inventory management technique helps segment item values into separate categories so company resources can be allocated wisely.
If your business offers multiple products, then you probably know that not all of them are of equal value to your company.
Make an order of importance for each product.
The basic rule of ABC Inventory management is to allocate more resources to the inventory that produces the highest value products, and fewer towards inventory that produces the lowest value products.
Categorize your inventory based on the value
To assess the value of an item, companies must first know its consumption value.
An item’s consumption value equals its total value over a period, i.e. how much money it brings to a business in over a year, for example.
Based on consumption value, you’ll put items into:
A Category – Items that have the highest consumption value per annum. They bring the company the most financial gain and therefore get the most attention and resources for inventory analysis, tracking, and ordering of items.
Keeping a close eye on ‘A’ class inventory can help reduce the potential for losses and reduce the number of inventory costs.
B Category – Middle-class items that have the second-highest consumption value. They are primarily used in stock management as intermediary points between class ‘A’ items and class ‘C’ items. They help control inventory management costs, which is why they are monitored regularly.
Managing B-class stock items not only helps in moving stock items but also assists in shifting inventory management policies as consumer demand changes.
C Category – They have the lowest consumption value but comprise the largest number of stock items within a company. Stringent inventory controls are unnecessary with this class of items as the cost-effectiveness of doing so is not warranted – the risk of loss is low and increasing inventory analysis will typically not bring higher returns but only more inventory costs.
Key Points of the ABC Management:
Class A items may not sell more than class C items but their value may be higher as keeping these items at healthy stock levels yield higher returns for the company than do B or C inventory.
Consumption value can include units sold, inventory value, and holding costs. There are no set rules for upper and lower limits regarding ABC inventory as businesses differ and have varying inventory needs and risk factors specific to them.
Factors determining a company’s A, B, & C inventory categories can change over time in response to demand.
The main benefits of ABC inventory management include:
- Accurate consumer demand forecasts.
- Optimal inventory resource allocation.
- Higher inventory optimization levels.
- Accurate product pricing.
- Controlled high-value inventory, which reduces inventory costs and losses.
- Higher levels of buffer stock items for B and C inventory reducing the possibility of out-of-stock products.
- Increased production cycle time, which increases customer satisfaction.
The disadvantages of using an ABC inventory management system include:
- You need large amounts of human resources and time to apply it correctly.
- Does not work well with other inventory management systems.
- Recent trending products may fall through the cracks’ and get ignored for some time – usually gets noticed after a year within the ABC inventory management system.
Sell Now, Order Later: How Backordering Works
What happens when you have more demand than supply for a particular item that’s become the hottest purchase you have?
You might think the logical thing to do is to stop selling and let customers know that you don’t have it anymore.
You can do that, but you risk losing customers and money. But how can you sell if you don’t have it anymore?
Backordering is a process where business takes orders and receives money for an item even if it’s out-of-stock at the moment. It will fulfill the orders once the item is back in stock.
Every time Apple comes out with an iPhone, they have a ton of backorders because they have created a demand for their product over the years that far exceeds their ability to meet it all at once.
Who should use this?
Whether backordering is a good choice depends on how many backorders you have to deal with and whether you have the time, resources, and staff in place to deal with all of them.
Apple has the capability to fulfill all the backorders promptly to keep customer satisfaction levels high.
You may not have the same backordering inventory capabilities as Apple, especially if you are a small business owner.
Should you even consider backordering then?
Handling one out-of-stock item is simple but handling hundreds of different backorders every day can be a nightmare even for large companies.
This is because you have to:
- Record all of your backorders properly.
- Place purchasing orders related to those backorders with suppliers.
- Search through sales orders once the product arrives at your business.
- Match the sales orders to the appropriate purchase order.
If this sounds too complicated, then the potential of increased sales through backorders may be offset by the disappointed customers who do not get their products when they were promised them.
Another key metric to consider is how valuable the item is to your customers.
The higher the value of an item in the customer’s mind, the longer they will wait for it.
Many customers will happily wait for days and weeks to get their new iPhone. If the item is not valued as much, then you may be risking dropping customer satisfaction levels and the potential increase in sales is not worth it.
How To Manage Backorders
Even if you don’t have an item that your customers will wait for ages to receive, open some backorders to keep customers happy.
Out-of-stock items can cause customer angst just as much as delayed backorders can.
So, how can you keep selling items that you don’t have on hand without upsetting your customers with later delivery times?
Create a ‘backorder page’ on your website where only backordered items are listed. In this way, the customers who want a particular item from your store will know that it’s out-of-stock at the moment but can still order it if they are willing to wait a bit longer to get it.
Ask your suppliers if they will drop ship for you so that your customers can get their products faster than if they had to come to you first before shipping to them. The only caveat with the ‘dropshipping backorder’ method is to be sure that if a supplier agrees to do this, they will deliver the product to your customers without a hitch.
It’s all about informing your customers beforehand that they are ordering backordered products so they can decide whether they will wait for a particular item before they order it.
To make a more informed decision about whether or not backordering inventory is right for your business, consider the following benefits:
- Increased Sales
- Little to No Holding Costs
- Lower Risk of Out-of-Stock Inventory
- Higher Customer Satisfaction (if done correctly)
There are risks involved too: The longer wait times could produce customer dissatisfaction.
Ship It In Bulk
The concept of bulk shipping is rather simple: it’s better to buy in bulk because the cost of ordering and shipping goods in large quantities is usually cheaper than doing so one item at a time.
This usually holds true for businesses that sell goods in high demand. Large quantities can be ordered without risking increasing holding costs since the inventory moves fast.
The problem arises when you don’t sell items that move quickly.
Here, buying in bulk may not save you money because you will have to contend with the added costs of storing items that just sit there, especially if you have to rent a warehouse to hold them until they are shipped out to you.
Bulk shipping is easy to manage and track and it decreases the actual costs of ordering and shipping items but will only work if you work with fast-selling products & a warehouse that can deliver your shipment quickly.
If you do not meet these factors, bulk shipping can end up costing you more than it can save you.
Here is how:
Holding Costs: You’ll need a warehouse to store items until they are collected together and ready to be shipped. This is usually an unavoidable circumstance of bulk shipping and depending on the time spent at the warehouse, it can drastically reduce your ‘bulk savings’.
Large Capital Investment: You might need to provide a high initial cash injection to receive and ship bulk items. You must cover transportation costs, warehouse storage costs, packaging costs, plus tax, insurance, and documentation costs sometimes.
Improper Distribution & Damaged Goods: Warehouses that store bulk items but do not have adequate tracking software and inventory management systems can make distribution of bulk goods a nightmare.
Poor sorting and distribution might cause delays, and you must deal with an increased likelihood of damaged products. Unless you have insurance, you won’t be able to recover those costs.
When buying in bulk a business must also consider what type of items they are buying to reduce the likelihood of product waste. Produce, for instance, while having a high turnaround will not last too long if it’s stuck in a warehouse because of poor sorting and distribution procedures.
To recap, bulk shipping can:
- Increase profit margins as long as the savings outweigh the added costs.
- Make it easier to track items as they all arrive under a single bulk order.
- Work well for businesses that have high-demand products with long shelf lives.
Bulk shipping can also:
- Increase the number of damaged goods and spoiled goods because of warehouses who use poor distribution and storing systems.
- Increase holding costs and offset the savings of buying and shipping in bulk.
- Make it hard to adjust inventory levels when demand changes abruptly.
Meet Halfway With The Retailer and Make a Contract
Consignment inventory is an agreement between a wholesaler and a retailer stating that the wholesaler agrees to give their goods for free to the retailer who only needs to pay for the goods that are actually sold.
This is a great deal for the retailer. They can stock up on items without worrying about selling or not because they did not have to purchase them upfront.
Retailers also get the following benefits from this inventory arrangement:
- They can return goods that do not sell at no cost.
- They can restock consignment items quickly.
- They can offer more items to their customers and test them out, risk-free.
But what about the wholesaler? What benefits do they derive from allowing such a deal?
There are three ways wholesalers benefit:
- They do not have to worry about marketing their products because the retailer bears the responsibility for doing so.
- They can gather data from the retailer which of their products sell the best and which ones don’t sell at all.
- They can test out new products for free without having to hire a marketing team to do so.
Wholesalers also bear the highest risk with this arrangement – aside from having to take back all unsold inventory for free, they also have to deal with not knowing when they will get paid, if at all, or how much they will get paid.
The retailer also faces potential risks because they do, mostly:
If the consigned inventory gets damaged while they hold it, they must buy it.
They need to have a separate consignment inventory management system or risk that they will mix their consigned with their other inventory and have to deal with shipping delays and inventory counting errors.
To minimize risks and increase their profit potential of a consignment agreement setup, both parties should adhere to the following consignment principles:
Only enter consignment agreements with parties you know – Have a previous positive relationship with your partner before accepting such agreements.
Create a detailed contract that includes all the necessary information. Most important things to include are:
Inventory holding time
The selling price of each good
Customer data collection information
Retailer’s sales commission
Damaged goods stipulations
Use an inventory management software designed for consignment inventory. The software should be able to track the inventory sent from the wholesaler to the retailer and track inventory that needs to be restocked on both the wholesaler and retailer’s end.
Cyclic Inventory Counting for Continuous Operations
Cycle counting is an inventory management procedure where a small part of a company’s inventory is counted on a specific day. It helps measure the accuracy of current inventory records against the actual current inventory count.
In case there are inventory errors, they will be adjusted and recorded immediately within the company’s inventory records, and investigated to find the cause and mitigate similar errors in the future.
The most common form of cycle counting is to begin in one area of inventory storage and slowly work your way throughout their entire storage facility aisle by aisle or bin by bin until the entire inventory has been counted and verified.
You can choose how often you’ll do this – each day, every other day, or every week, depending on the current needs of the company.
You might need to count some sections or items more frequently if the company feels that a particular section or group of items are necessary to complete production.
The actual steps comprising a routine inventory cycle counting procedure include:
The inventory database is referenced to gather inventory information.
Then, you must create a counting report from this information.
This report will also define which inventory should be counted and who will do the counting.
Cycle counters (staff members in charge of counting) then check the report information with the actual items that appear on the inventory shelves or bins.
Any items on the shelves that do not appear on the report are immediately included in the report by the cycle counters.
Any mismatches, omissions, or other inventory errors found in the report are reported to inventory managers who check these problems to see if further investigation is warranted.
If a pattern of errors occurs during the cycle count, then the managers may tackle them through further inventory training, updated inventory procedures, re-staffing, or any other solution that is deemed necessary to eliminate future problems.
Finally, the current inventory records are adjusted to reflect the actual inventory count.
Cycle counting brings the following benefits:
- It’s time-saving and saves money when compared to full-stock inventory count
- It Improves inventory record accuracy.
- It helps decrease holding costs.
- There are no interferences to day-to-day business operations, unlike other inventory counting methods where certain operations need to be halted.
There are also drawbacks to consider:
- Inaccurate counts because of items stored in multiple locations.
- Overlooking inventory errors because of seasonality.
Transition From Physical To Virtual And Eliminate Inventory Altogether
Dropshipping allows an online retail store to fulfill customer orders through a wholesaler or manufacturer who is ultimately responsible for processing, packing, and delivering customer orders.
Dropshipping is a practical inventory management solution for e-commerce businesses that do not wish to hold any inventory.
This is ideal for e-commerce stores because the online ordering process can be easily set up and automated with suppliers and manufacturers who specialize in this inventory management system.
A typical dropship inventory management system usually comprises the following steps:
The business opens a reseller account with a supplier.
The supplier provides the business with pertinent information regarding their dropshipping method. They explain how they accept orders from their resellers.
The supplier provides the reseller with their inventory data through a data feed file (e.g., CSV, TXT, XML, or EDI), which is then used to upload the supplier’s inventory stock into the reseller’s online store.
The reseller markets their store and the supplier’s items displayed and convert visitors to their site into sales.
These sales orders are then automatically accepted into the supplier’s order system and from there the supplier takes care of the processing and shipping themselves.
Dropship suppliers and resellers usually use an automated system to transfer orders from their store to the supplier’s order system.
The most common ways a dropship supplier will accept an order from a reseller are by email, phone, supplier website API, EDI applications FTP folders.
Cross-docking, which is similar to dropshipping, can also be used by online retailers to get items to customers without having to store them.
This particular method incorporates suppliers or manufacturers who use railroad cars or semi-trailer trucks to unload partial items and deliver finished products to customers.
No warehouse is needed as inventory is transferred from the manufacturer to a transport vehicle and then onto another one until it reaches the customer.
If you like holding no inventory, then consider the following pros and cons of using a dropshipping or cross-docking inventory method before you make your final decision.
- Little to No Inventory Costs
- Low Order Costs
- Testing and Selling New Products with Little to No Risk
- Little to No Order Fulfillment Control
- Lower Profit Margins
- Higher Possibility of Poor Customer Service
Stock Only What You Need, at the Right Time
Imagine being able to lower the number of items you needed in your inventory stock to only those that were in demand at the moment. You’d be able to reduce your holding costs and eliminate perishable stock that becomes outdated.
You can do that if you use just-in-time (JIT).
The JIT technique allows a business to purchase only those items that are needed, in most cases, only a few days before production completion.
The trick to using JIT, however, is to make sure that production levels are predictable enough to order accurately – too much or too little will diminish all of the benefits of using it.
Meet the following criteria to make JIT work:
- Steady & Predictable Production
- Little to No Machine Breakdowns
- Reliable Suppliers
Without these, the company risks running out of stock and not being able to fulfill orders on time. This option is best for companies running on a short and predictable production, order, and fulfillment cycle.
Multiple products can be churned out quickly, which means more cash flow for your business.
Reduces holding costs because items are ordered only when they are needed.
Less dead stock to contend with as items are immediately used and replenished.
Not having stock on hand can cause a potential supply-chain disruption.
Suppliers may have trouble delivering items on time and thus cause a delay in your production cycle.
An error in demand forecasting can cause you to experience inventory stock-outs, which can diminish customer satisfaction levels.
3 Strategies to Optimize Your Inventory Management
Not one inventory management strategy can fit all businesses.
One thing is for sure though: manually managing inventory is much harder than learning how to work with digital and automated inventory management solutions.
Good management software can monitor and update your stock in real-time, and your forecasting, production process, reordering, and fulfillment processes will also be optimized.
The crucial task here is to find out what strategy best suits your inventory management needs and will help you streamline the whole process.
There are three common strategies that can help any business optimize their inventory management system:
1: Keep a Good Eye On Your Stock
Inventory visibility is knowing the exact amount of inventory you have and where it is.
A more accurate name for inventory visibility would be ‘real-time inventory visibility’ as businesses aware of how much stock they have and where it is right now are in a better position to accurately reorder stock, use current items for production, and fulfill orders on time.
Real-time inventory visibility is crucial now that retailers are utilizing a multi-channel inventory system to meet the demands of omnichannel order fulfillment and distribution models.
Today’s retailers often have many areas where they hold inventory so they can fulfill orders as fast as possible.
Trying to manually keep track of such distributed inventory is impossible.
Software solutions can help keep it visible and accounted for and thereby lower inventory costs, increase production output and maintain good customer satisfaction levels.
Clear and visible inventory records provide the following benefits:
- Time Efficiency
- Cost Savings
- Predictable Inventory Levels
- Fewer Stock-Outs
- Optimized Inventory Reordering
- Quicker Order Fulfillment
- Better Quality Control
- Smarter Stock Allocation
You can improve inventory transparency with an inventory technology like RFID, warehouse inventory software, or barcode scanners to digitally keep track and record your inventory levels.
If budget permits, you can also consult professionals specializing in inventory systems integration to see what custom inventory visibility solutions you can get.
2: Use Data Analysis, not Guesstimates
Smart inventory management uses analytical-based technology to locate and discard old or damaged stock, check current inventory levels, propose logical stock ordering levels to meet current demands, and price products according to fluctuating costs and demands.
An effective smart inventory strategy will address three core aspects affecting inventory management
- Historical Sales
- Current Market Demand
- Market Forces Affecting Demand
Armed with this data, not only will you be able to make more predictable decisions about your inventory but the system itself will offer a practical analysis that can be used as stand-alone solutions or as a complement to your inventory team’s planning process.
Most of today’s cloud-based inventory management systems will collect the information mentioned above along with other pertinent data regarding the inventory processes, such as:
The ability to collect, record, analyze, and even advise on almost every facet of your stock is what smart inventory management and smart insights are all about.
3: Automate Your Supply Chain and Eliminate Human Errors
Approximately 43% of businesses use old-fashioned manual methods to track and manage their inventory.
The problem with manually copying and inputting inventory data across your entire supply chain is that it takes up way too much time and resources.
It produces a host of errors along the supply chain which can slow down production and delivery cycles.
Supply chain automation is comprised of technology that manages all or some of your supply chain processes including your inventory on its own.
Having a fully automated supply chain reduces the need to do mundane tasks, increases productivity levels and helps increase the accuracy of data.
What does such an automation offer in regards to inventory management?
Some of the most beneficial things it brings to the table include:
- Real-Time Backorder Information
- Automated Stock Reordering
- Multi-Location Inventory Tracking & Routing
- Automated Customer Order Confirmation Emails
These integrated and automated inventory functions help your business by improving:
Operational Efficiency: Automated inventory processes are much faster and more cost-effective than manual supply chain systems.
Inventory Management: Inventory automation improves stock tracking, stock ordering, stock reporting, and demand forecasting.
Transparency: Automated ordering systems and customer communication interfaces help keep customers in the loop and so helps to increase trust between them and your business.
When you determine the optimal strategy for your needs, you must purchase and implement relevant inventory software and cloud-based systems.
Proven Methodologies for Better Inventory Management
Now we’ll give you solid advice on how to best manage your inventory levels.
We can’t provide detailed instructions on how to go about implementing them – this is best left to you as you know your business’s inventory needs better than anyone else.
Still, these tips are specific enough to help you optimize your inventory management systems, processes, techniques, and strategies.
So without further adieu, here are 10 inventory management best practices for stock optimization and organization:
Know Which Inventory Review System You Need
There are two systems on how to review your inventory:
Continuous Inventory Review – this system lets you order the same number of items with each order, monitor your inventory continuously and have a set level of items in inventory that will trigger a reorder.
Periodic Inventory Review – you can order products during a set period, with the number of items to be ordered at the end of a period based on the current levels. There is no set reorder levels forecasted with this system.
Knowing how much inventory you need and when to order that inventory will keep your inventory at optimal levels at all times.
This means you’ll never order too much to incur higher holding costs and never too little to halt production and delivery.
OnlyYour Data is Good Enough
This used to be impossible for small businesses as they did not have enough inventory to calculate predictable inventory behaviors. The workaround was to learnm from other successful companies and rely on their data to better manage and predict future inventory needs and demands.
Inventory management software and technology leveled the playing field.
Inventory management software helps small businesses track their inventory levels, order levels, and deliveries while collecting and aggregating supply chain data that offers practical insights.
Your data is the only true data – no other company or business can accurately predict what type of inventory level, process, system, or strategy your business works best with.
Implement a Cycle Counting Program
Choose how many times you will count your inventory levels. Here the questions you need to ask yourself:
- How many times can my workers count inventory during a one-year cycle?
- How will the counting cycle affect the ordering, manufacturing, and delivery processes of my business?
- Is it best to divide my inventory between locations, items, or categories?
- Which one will make tracking my inventory easier?
- Who will manage the inventory count?
Hint: it should be a trusted and experienced inventory manager or team.
Analyze Your Turnover Times
Calculating inventory turnover is easy: Just take the cost of goods sold and divide it by your average inventory levels.
After that, divide your inventory turnover rate by 365 to get a number representing how many times each product was ordered and sold over a year.
You will be in a better position to decide which items hold the most value for your business and concentrate most of your inventory management resources on them.
Control the Quality of Your Inventory
Ensuring that your items in stock are of good quality is necessary for keeping your customers happy and coming back for me.
Small businesses may not have all of the logistics set in place to run advanced quality control systems, but such systems may not be needed in the first place.
A simple checklist outlining all the things to look for when checking inventory may be all your workers need to keep your current stock up to par.
The checklist can include items such as:
- Damages (tears, leaks, spoilage, etc…)
- Matching Items to Descriptions (colors, sizes, styles)
- Comparing Item Price to Terms of Sale
The quality controls don’t end by going over all individual items. Your warehouse environment also needs to be checked for hazards that could damage your stock. The key environmental issues you may want to inspect are temperature, humidity, and lighting.
If any of the items you purchased do not meet your standards, return them immediately to your supplier with a brief description of the problem.
By maintaining the health of your inventory through proper quality controls, you can expect to reap the rewards in the form of optimized stock levels, quality products, and happy customers.
Use Value Categories
Separate your inventory using the ABC technique to optimize inventory resources and time. Once you know your turnover rate, you can see which items sell the most and which ones need to be replenished more often.
You may also want to look at your company goals when deciding on value as some items, even if they don’t sell as much as others. They may be more in line with what your company wishes to accomplish and so will be of higher value to your business.
An example of how to breakdown your inventory into classes can be seen below:
- Class A Items: 70% value and 10% of total stock
- Class B Items: 20% value and 20% of total stock
- Class C Items: 10% value and 70% of total stock
Your highest value items will usually have the lowest number within your stock, while your least valued items will comprise of the highest number in your overall inventory levels.
Try to Forecast Trends and Keep Safety Stock
Demand forecasting is a process in which a business tries to predict how much of their products consumers will purchase over a period.
The process helps businesses figure out when and how much inventory they need to purchase to not only meet current customer demands but future ones as well.
To calculate such forecasts, you need historical sales data, consumer trends, and external market factors such as seasonality, weather, economy, and others.
Manual inventory management methods made it very difficult to predict future demand with any sense of consistent accuracy. It was most difficult for small businesses who often used spreadsheets and calculators to sift through a mound of files containing historical sales data which needed to be manually calculated and inputted.
The digital age has made intelligent demand forecasting systems and software available to companies of all sizes and made the process of sifting through large amounts of data an ‘automated walk in the park’.
Such systems are also able to offer insights that help management teams make more accurate predictions when it comes to future inventory needs.
One important point to note is that you will have to factor in lead time to get a more accurate prediction of your reorder point while using any type of demand forecasting system.
Make sure you have enough safety stock to mitigate undelivered items caused by stock-outs or halts in production due to missing components or entire products.
Use Smart Tracking Techniques
Tracking your inventory through batch and expiry dates. It will help you locate your stock, know how much of it remains, and when it will expire.
Tracking items by expiry date is rather self-explanatory.
Batch tracking is a bit more complex. It allows a business to monitor a group or set of stocks with similar characteristics and properties.
Batch tracking usually combines expiry date along with other similar qualities in a group of items to track both defective goods and expired items.
Batch and expiry date tracking help companies:
- Avoid spoilage due to expiration
- Maintain a measure of quality control as all items in stock are sold ‘in-date’.
- Identify soon-to-expire items to be sold before they expire.
- Remove batches of items all at once in the event of a product recall.
Pack and Sell Together as One to Increase Order Value
You can bundle products together and sell as a single unit.
The concept of kitting and bundling has only one difference: when you kit inventory you put together different combinations of an item and when you bundle inventory you put more of the same items together.
Kitting and bundling help increase average order value and makes your price per sale much higher.
It also gives more options to customers who wish to purchase goods in bulk. It will help reduce holding and shipping costs and optimize inventory levels.
It will reduce the potential of holding dead stock as items close to expiration can be combined and sold quickly.
Accounting Procedures Can Help You Decide What Goes First
FIFO and LIFO are accounting procedures that dictate which items in your inventory you should sell first.
FIFO (first-in, first-out) means that the oldest items in your inventory are sold first as they were purchased first. If you sell perishable items you will want to use the FIFO method as it will give you a better chance to sell your inventory before it gets spoiled or expires.
The following benefits can be derived from using the FIFO method:
Inventory costs are easy to figure because the last purchases are always sold first.
It’s easier to calculate net profits as the cost of goods increase because the first items sold can be quickly compared to the last items purchased.
Very easy to understand (i.e., inventory managers and teams do not need accounting education or experience to understand its principles).
LIFO (last-in, first-out) means that the newest items are sold or used for production first. It’s a great option if you sell non-perishable items because it makes it easier to manage your inventory (i.e., less rearranging of stock and the less likelihood of having to rotate items in batches).
The following benefits can be derived from using the LIFO method:
It decreases taxable income when inventory cost increases because it matches the recent higher cost of goods with recent revenue.
It minimizes the chances of write-down to market (i.e., when the value of assets are reduced to reflect current market prices) as items purchased at the most recent higher prices are sold first.
It gives a better depiction than the FIFO method when it comes to current earnings as the most recent cost of goods purchased is matched against the sale of the most recent goods sold.
If you sell both perishable and non-perishable items, use a mixed approach that accommodates both your perishable and nonperishable goods.
This mixed approach will also be useful for you if you sell both seasonal and non-seasonal products.
The above guide provides the basic concepts, techniques, processes, and best practices that are generally associated with successful inventory management systems.
Even the best inventory practices, methods, and systems will not work well without a central inventory management system that is tailored to the specifics of your particular business.
Therefore, use this guide as a starting point to begin your inventory management optimization process and then apply other ratios, key metrics, techniques, and technology that helps your inventory management process function more effectively and effortlessly.
An effective inventory management strategy and the system can help small businesses increase production and efficiency, minimize costs associated with purchasing, holding, and delivering items, maximize sales and profits, integrate and automate an entire supply chain, and keep customer satisfaction levels high.