How does inventory management work?At a basic level, inventory management works by tracking products, components and ingredients across suppliers, stock on hand, production and sales to ensure that stock is used as efficiently and effectively as possible. It can go as deep as you need it to: for example, by examining the difference between dependent and independent demand, or forecasting sales to plan ahead. But at the end of the day, it all goes back to your stock. Show
Example: Sam’s chairsSam decides to set up a business selling her handcrafted dining chairs. Each chair she makes requires 6 different sizes of wood, plus a cushion. She goes to her supplier and buys 10 planks of each size of wood she needs, plus 10 cushions. These are all now included in her business’ inventory. As she turns raw materials into chairs, then sells them, Sam’s inventory levels will change. She’ll need to keep track how much of each material she has at any one time, how many chairs she can make, how fast she can make them, where her materials are, how many chairs she is selling and much more. This is all inventory management. Don’t worry if that seems daunting — inventory management is much easier to digest once you break it down into the 5 key stages that your goods will go through. Inventory management process:5 key stagesThe inventory management process involves tracking and controlling stock as it moves from your suppliers to your warehouse to your customers. There are five main stages to follow:
Continuing with our example from earlier, here’s how Sam’s company utilizes each stage of the process: Inventory management vs. inventory controlWhile they may sound similar, inventory control is a key part of inventory management, but it isn’t the same thing. What is inventory control?Inventory control is how you manage the stock you currently have in storage. This involves knowing your stock inside and out — how much is available, where it is and what condition it is in. It’s also about ensuring that you are storing stock efficiently, keeping inventory costs down and minimising the time spent counting and controlling inventory. Learn more about inventory control. Which comes first — management or control?Inventory management is much broader than control: it takes your supply chain, manufacturing, fulfilment, sales and reporting into account. Almost any business will have to get an inventory management system in place before they drill down to control. Otherwise, you’ll have no way of managing suppliers, production or sales. After that, there are countless methods for storing and selling your products better. Whether you focus on optimising purchasing, control, production or sales is up to you. You might, for instance, want to plan improvements based on previous operating experience — say, by changing how you count stock. Or you might want to tweak processes to reflect product and order profile changes, customer gains and losses or shifts in demand. Many small businesses rely on manually counting stock to track what’s in store. But stock counts are disruptive and time-consuming, taking time away from making and selling products. So putting a system in place that doesn’t require stocktakes for accurate figures is imperative. Find out more:
Keep customers happyInventory management dictates:
Customers will be much more likely to come back for more if they know your organisation can consistently deliver orders on time and let them know what’s available. This is especially true when it comes to business-to-business transactions. For a consumer, a missed deadline might mean an inconvenience. For a business, it can mean lost sales and profits. Find out more:
Grow your companyAs businesses grow in complexity, their inventory management needs get more complex as well. When Sam adds new product lines, hires staff, opens new production facilities and grows her customer base, the organization of materials and stock will get harder. That makes it important to get control over your physical inventory from day one if you plan on scaling. Rapid growth tends to bring a lot of time consuming tasks: hiring staff, moving to bigger premises and negotiating with new suppliers. So putting an effective stock system in place early is key. The later you leave it, the longer it will take — and you’ll have less time to do it. Find out more:
But these aren’t the only advantages of inventory management. It can also bring several direct benefits to your business’ bottom line:
Find out more about inventory management strategy here. How to improve inventory management1. Focus on your needsA warehouse full of inventory can be a daunting task. One way of making managing it all easier is to identify the items that are the most important and focus on them first. It’s highly unlikely that every item in your warehouse will have the same demand from customers. Keep the top-selling items in stock, and you’ll have made a great start at keeping your customers happy. 2. Engage with suppliersIn any stock-based business, it is crucial to manage supplier relationships well. Developing constructive relationships with your business’ key suppliers is important to secure reliable supply, unlock competitive pricing and to understand emerging trends that may impact your business. 3. Develop an inventory management systemHow your business deals with order quantities, replenishment cycle times, safety stock, forecasts, seasonality and more is important. Tweak each operation according to your specific business — making sure to keep track of what works and what doesn’t. Making a dramatic improvement in one area can be better than a few small improvements across the board. 4. Utilise real-time dataInformation is a powerful tool, but only when it’s accurate and up to date. Real-time data and analytics — from layered inventory tracking right through to forecasting data, automatic ordering and individualised safety stock — can make a real difference to your business. For the most accurate data, consider using perpetual inventory management software, as it is the best way to ensure the information you need is always at your fingertips. 5. Go mobileMobile technology has revolutionised inventory management. Barcode scanning, for example, makes receipting and tracking goods far faster — and helps eliminate unnecessary errors. Sales apps, meanwhile, empower salespeople with inventory data on the road. You no longer need to be tethered to a computer in your warehouse. You can keep track of key business processes from home, on holiday, or wherever you are. 6. Develop an inventory management systemManaging your inventory on an ad-hoc basis will only ever get you so far. To really keep on top of your stock, you’ll need an inventory management system. Every company will have its own unique needs, so picking a system that matches your business is important. In the early days of her company, for example, Sam might be able to manage her inventory using spreadsheets. But a global stock-based business like Amazon requires a bespoke, multifaceted solution that caters to the huge number of orders processed every single day. 8 common inventory management techniquesNo matter the size of your business, employing some of these common inventory management techniques can be a great way to take control of your stock. Here are a few to consider:
Learn more about JIT, ABC analysis and dropshipping here. How to grow your inventory management skillsUse the Unleashed Academy video training series to learn more about inventory management and put your knowledge into practice. Inventory management glossaryLet’s look at some of the basic terminology and formulas you need to know before diving deeper into inventory management systems. Cost of goods soldCost of goods sold (COGS), otherwise known as cost of sales, refers to the direct costs of producing goods. This includes the cost of the materials and labour directly used. Days inventory outstanding (DIO)Days Inventory Outstanding, also known as Days Sales of Inventory, is used to measure the average number of days a company holds inventory before selling it. Economic order quantity (EOQ)The economic order quantity is the optimal order quantity at any given point in time. An optimal EOQ minimises total holding and ordering costs. It is sometimes known as the optimum lot size. Finished productsFinished products, or finished goods inventory, refers to the number of manufactured products in stock that are ready to sell. Inventory accountingInventory accounting deals with valuing and accounting for changes in assets. Inventory involves goods in three stages of production: raw goods, in-progress goods, and finished goods. An accurate inventory accounting system keeps track of changes to inventory at all three stages and adjusts asset values and costs accordingly. Inventory costsInventory costs are the costs associated with procuring, storing and managing inventory. They can be categorised into one of three types: ordering costs, carrying costs and shortage costs. Inventory management softwareA software system for tracking inventory levels, orders, sales and deliveries. It can also be used in production to create a bill of materials and other production-related documents. Lead timeIn an inventory management context lead time is the period between an order being placed to replenish inventory and when the order is received. Point of saleThe point of sale, or point of purchase, is the time and place in which a retail transaction is completed. It usually involves an invoice and options to make payment. Purchase orderA purchase order is a document created by a buyer and sent to a vendor requesting goods or services. The buyer will, at a minimum, specify what products are being ordered, the quantity, the agreed price, and delivery and payment terms. Reorder pointThis is the level of inventory which triggers an action to replenish it. It is a minimum amount of stock a business needs to have, such that, when stock falls to this amount, the item must be reordered. Safety stockThis refers to a buffer or reserve of critical stock that is held to protect against unforeseen supply or demand pressures. Sales channelsA way of bringing products or services to market so that consumers can buy them. Sales channels can be direct if it’s selling directly to consumers, or indirect if an intermediary is involved. Stock levelsOtherwise known as inventory levels, stock levels are the quantity of goods or raw materials kept on the premises of a business. Supply chainA supply chain is a system of organisations, people, activities and resources involved in supplying a product or service to a consumer. 4 fundamental inventory management formulasFor new business owners, the following calculations might seem daunting, but don’t let that deter you. These formulas are essential for keeping stock levels optimised. Let’s explore:
Calculating Economic Order Quantity (EOQ)You use the reorder point calculation to determine when to reorder stock. Small business owners often rely on intuition and past experience to know when to place another order, but as the business grows, this quickly becomes unsustainable. What are inventory costs?Knowing your inventory costs helps you make smarter decisions. There are three broad categories of inventory costs: ordering costs, carrying costs, and shortage costs. Inventory ordering costsThis is the expense incurred in creating and processing an order to a supplier. You’d use this to determine the EOQ of your inventory. Examples of ordering costs are:
Inventory carrying costsCarrying costs are the expenses related to storing unsold goods. This includes the tangible costs such as storage, handling, and insuring, as well as intangible costs such as depreciation, the cost of deterioration and obsolescence and opportunity costs. Carrying costs will generally comprise 20% to 30% of a business’ total inventory costs. Inventory shortage costsAlso known as stock out costs, this is the expense that arises from an out-of-stock situation. This can include measurable costs such as the cost of expedited shipping, buying last minute from another supplier, or loss of the margin on incomplete sales. These also include costs that are hard to quantify such as loss of customer confidence or loss of customers, idle employees and loss in goodwill. Learn more about inventory costs. Next stepsDeciding when you might need dedicated inventory management software is a key step in the growth of your company. To find out more about how to manage your inventory better, take a look at our guide to inventory management systems. Or if you’d like more information on the fundamentals of stock, read our inventory management basics blog. Start your free 14-day Unleashed trial now. All features included. No credit card needed. Sign up now What are the types of inventory management system?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).
What are the 4 types of inventory control?The four types of inventory most commonly used are Raw Materials, Work-In-Process (WIP), Finished Goods, and Maintenance, Repair, and Overhaul (MRO). You can practice better inventory control and smarter inventory management when you know the type of inventory you have.
What are the 3 types of inventory management?Financial Management.. Order Management.. Warehouse Management.. Supply Chain Management.. What is demand inventory management?Inventory demand forecasting is the process of predicting customer demand for an inventory item over a defined period of time. Accurate inventory demand forecasting enables a company to hold the right amount of stock, without over or under-stocking, for optimum inventory control.
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