If you’re about to start a small business handling stock, even if you’re planning to start an online store only, establishing a smart inventory management system should be one of your top priorities.
Not only will it make your operations easier to manage, but it can become a good foundation for growing your company.
Having a scalable inventory control plan ensures you have fewer teething issue and can prevent you from losing revenue as demand grows.
In this guide, we take a look at what inventory management is, why it’s important, and how to manage inventory effectively.
We’ll also go through different types of inventory management and optimization techniques which might be right for your business.
What is inventory management and why is it important?
Inventory management is a set of techniques used to keep track of all your goods – from the time they enter your storage facility and you take ownership, up until they are sold and shipped out.
The aim of using an effective inventory management system is to keep track of inventory and figure out the volume of goods you need to have on hand to keep operations running.
As a result, you can avoid storing too much inventory and reduce maintenance costs. It can also prevent stockouts, which can cause you to lose potential customers.
Other benefits of inventory management include:
- Smooth cash flow. Holding dead stock or unsold products in your inventory can diminish your return on investment.
- Prevent spoilage. Order the appropriate amount of raw goods if you manufacture your own products.
- Reduce errors. Avoid picking and delivering the wrong items, or displaying an incorrect number of stock levels on your website.
- Keep your high-demand products stocked. Predict when you will run out of these goods and restock them beforehand.
- Improve customer relationships. If your products are always available during peak periods, buyers won’t leave you for your competitors.
Types of inventory
To optimize your inventory management system, you need to know what kinds of goods your business is dealing with.
Let’s look at the different types of inventory there are:
- Raw materials. If you make your own products, the goods required to produce products are called raw materials. For instance, if you sell baked goods, your raw materials would include ingredients such as flour, eggs, or sugar. As you manage the raw materials in your inventory, you can calculate how many products you can manufacture in the future, and when new shipments should be made.
- Unfinished goods. These are the items that are still in production and are not ready for sale. These would be shoes or clothes requiring additional stitching or computer software missing key features.
- Finished products. As the name suggests, this inventory covers goods that have completed the production process and are ready for purchase orders. This type of inventory also applies to businesses that outsource their products from third-party suppliers, such as a boutique business that buy clothing from wholesalers and then resells them.
- MRO goods. Short for Maintenance, Repair, and Operations, objects in this type of inventory are used to turn raw goods into finished products. For food businesses, these include supplies that support the cooking or baking processes, such as ovens or other kitchen appliances.
The items in this inventory category are used for packaging and shipping. There are two types of packaging:
- Primary. Materials that protect and display the product. Some examples include the bag that encases foods like potato chips or a carton box for bath bombs.
- Secondary. Goods used for shipping or storing the products, such as boxes or cases for bottled drinks.
Cycle stock inventory
Cycle stock inventory is the first set of stock that you will use to fulfill the customers’ demands on a regular basis.
As each of your items sells, you will use the goods from your cycle stock inventory to replace the purchased products on your store shelves.
If the cycle stock inventory runs out, many businesses will use their safety stock.
This is an additional set of products that are specifically made to manage emergency situations, such as unexpected demands or supply chain disruptions.
For example, if your wholesaler takes a longer time to deliver your products, you can display your safety stock to avoid losing sales.
Ideally, the number of items you have in this group should be able to satisfy the current demand. Make sure not to overstock so that you can keep the maintenance costs low.
To manage the inventory levels in your safety stock, here are some helpful guidelines:
- Multiply your maximum daily sales with your maximum lead time, or the number of days it takes for your items to arrive at your premises.
- Multiply your average daily sales with your average lead time.
- Subtract the difference.
Here’s the formula for better illustration:
Safety stock = (Maximum daily sales x Maximum lead time) – (Average daily sales x Average lead time).
Decoupling inventory are additional items that are set aside in case the production process suffers from technical issues, such as broken machinery.
It’s meant to help operations function normally before the primary problem is taken care of.
Inventory management techniques to optimize and keep track of stock
Ready to implement an effective inventory management system? Here are some suggestions for managing inventory efficiently.
1. Use inventory management software
These days, businesses use dedicated inventory management software to track, record, and generally manage their inventory.
Even if your company is small, inventory management software can make your process more efficient and sustainable, not to mention making the whole process a bit easier.
Most inventory management programs have features that are integrated with your point of sale, which help with inventory tracking, control, and optimization in real-time.
For example, every time there is a new order, the software adjusts the available stock for purchase to avoid overselling.
In addition to point of sale care, inventory management software can:
- Show an analytics report that outlines your most popular products.
- Notify you when an item has low stock levels.
- Hide out-of-stock items.
- Track products by information, such as SKU.
Some eCommerce platforms have these inventory management features built-in, so you don’t need a third-party integration to manage them.
For example, using a Zyro eCommerce plan, you can insert the stock quantity for all your products.
Every time a new purchase comes in, the system will notify you to process the order. Your store can manage inventory for you, to save you time and your business money.
What’s more, you can set alerts for when the stock quantity reaches a certain number. This way, you can restock your items on time.
2. Optimize order sizes
To avoid having too many or few items, you need to know the right number of goods to order and purchase from your suppliers.
There are three ways you can optimize order sizes.
Demand forecasting is a technique used to project future customer demand based on previous sales data.
It can help you determine the number of products you should have in your inventory to fulfill your buyer’s needs.
Though you will mainly look at your sales history to make such a forecast, you also need to consider other factors such as seasonality, product lifecycle, or trend changes.
If you have no existing data, you can use the variables above to make your forecasts.
Economic order quantity (EOQ)
EOQ is a formula for finding out the right order size you need to make.
You can use an EOQ calculator for this, but you need to prepare the following variables beforehand:
- Yearly demand estimates.
- Ordering costs, or how much to process and order the product.
- Holding costs, or the expenses for keeping the item in your inventory.
When calculating your EOQ, keep in mind your supplier’s minimum order quantity, or the lowest number of products they can offer.
If your EOQ doesn’t meet their requirements, they won’t process your purchase orders.
As the name implies, the reorder point is the level of inventory that informs you to restock immediately before your available items run out.
In order to determine your reorder point, you need to multiply your average daily sales with the average lead time in days, and then add the number of your safety stock.
Say you sell 100 goods in a day, and your supplier’s average delivery time is 7 business days. Your safety stock has 500 items.
In this example, you have to send a new purchase order to your supplier when the stock level is at 1,200 items.
3. Group your stock with ABC categories
This is an inventory system that classifies finished products based on how many sales and much profit they make.
There are three groups, which are:
- A category. Your best-selling items, which usually take only 20% of your total stock, yet contribute about 70% to your revenue.
- B category. These are mid-tier products which account for 30% of your inventory and share about 25% of your sales.
- C category. Lowest-value goods and they represent the majority of your stock but are only responsible for 5% of your income.
Many businesses use this technique to see which items should be prioritized, so they can make decisions according to what’s currently the most popular product.
It’s also an excellent inventory optimization system – you can determine the ideal stock levels for each category according to their demand rate.
That said, remember that the market can and will change at some point. A low-selling item can get popular quickly, which means your system has to adjust accordingly.
4. Use the First In, First Out (FIFO) method
FIFO is an inventory control system that organizes finished products according to their age. Here, you will place your oldest items at the front so that they get sold first.
This is to prevent them from being left in your storage for too long, losing relevance, and becoming a dead stock.
This technique is especially excellent for products that have an expiry date, such as food, toiletries, and cosmetics.
5.Audit your inventory regularly
To make sure that what is recorded in your system reflects what you own, you need to manually check on your inventory from time to time.
There are two ways you can audit your inventory.
Full physical inventory audit
Here, you will physically count each of your items in your entire inventory by hand and match the results with your data.
This is usually done at the end of the year and might even take up a whole day. Therefore, it may take a long time and disrupt your operations.
However, if you have no other way to manage inventory levels, this is likely necessary.
If you have a growing business, cycle counting can be a more effective solution.
You can find problems within your inventory quickly without stopping your operations.
All you need to do is pick a product category, check its quantity, and see whether the number matches the one in your system.
When using the cycle counting method, begin with categories that are about to enter peak season. This way, you can solve any issues before customer demands start to roll in.