How to manage inventory — techniques and process
Inventory management is a delicate balance. You need the right amount of stock to serve your customers and drive revenue—but not too much, because that can lead to cash flow problems, wasted materials, higher risks, and tax implications. Inventory managers must use the right strategies to avoid shortages and over stocks
To help you improve your inventory management processes, this post will cover:
- The importance of inventory management
- The inventory management process
- Inventory management techniques
The importance of inventory management
Inventory management is the process of understanding and handling the demands of ordering, storing, tracking, and selling materials or goods. The purpose is to make sure you have enough products to serve your customers without the burden of overstock.
Poor inventory management quickly leads to chaos. For example, in 2022 Walmart’s new automatic reordering system kept ordering products that were still in stock until the only place to store the overstock was in store aisles. While trying to bounce back from supply-chain shortages, the retail giant increased their stock by 32%, overlooking the fact that people were buying less due to rising inflation. If Walmart had maintained accurate inventory levels, it could have avoided this disaster.
A robust inventory management system:
- Increases tracking efficiency. Monitoring the flow of goods from supplier to customer lets you know exactly how much stock you have.
- Decreases order time. Maintaining accurate inventory levels lets you respond to changes in demand without disrupting your supply chain, lowering product quality, ordamaging the customer experience.
- Improves business decisions. With better inventory data, you can make accurate decisions about quantities, pricing, and reordering, reducing expenses and increasing profits.
The inventory management process
The inventory management process starts when you order inventory and ends when you update stock levels and restock goods. There are critical decisions to make at each step.
Ordering the right products at the right time requires a lot of data and industry insight. You should understand:
- Product demand. Use marketing forecasts and sales forecasts to accurately determine demand for products. Take into account seasonal changes and larger economic factors.
- Cost of inventory. To gauge how much inventory you can afford, investigate how much each product costs to order, store, and deliver.
When ordering new inventory, start small. You’ll have a clearer idea of how to balance product demand and operating costs once you work through the sales cycle and it’s time to re-order.
Storing inventory is about more than building shelves. You need an efficient storage system to keep products organized.
First, establish a receiving workflow to review orders, check that deliveries are accurate, and sort them for proper storage. Inventory should be cataloged and systems updated as good sare shelved.
Build a thorough tracking system using stock-keeping units (SKUs)and universal product code(UPC) barcodes. The supplier makes the UPC and the vendor creates the SKU—a combination of letters and numbers—to identify each product and where you store it.
Finally, create an organized inventory area within your storage facility to place items once you’ve sorted them and labeled them for tracking. An efficient method is to organize product locations clockwise. Name each zone with a letter and then number each shelf within every zone.
When a customer places an order, verify that the products are in stock. A good inventory software will keep numbers updated and automatically verify availability. As you prepare the order, track your items’ SKUs with each step.
- Pull products from their lot using SKUs to find them easily. Make sure you’ve arranged your inventory so that you can go through it in a single pass and pull multiple items. A good best practice is to pull older inventory first so it doesn’t gather dust and risk damage or decay on the back of a shelf.
- Pack products and get them ready for delivery. You need a clear space to work, a logical and consistent workflow, and a foolproof packaging system to keep items protected.
- Ship the order to your customer. Track shipping progress so you can alert customers when their orders leave the warehouse and when they arrive at their doorsteps.
4. Reporting and auditing
Maintaining accurate inventory records is the key to success in your supply chain. It ensures you order the right quantities and helps identify losses, improving your overall cash flow. Keep a record of where your inventory is with each step in your business’s process—from the moment it arrives in your warehouse, to storage, shipping and handling, and delivery or purchase.
Auditing is the process of physically counting your inventory to make sure the count matches your records. How often you audit inventory depends on the size of your inventory, staff, store, and more. You can count with pen and paper but automated counting—for example, using a bar code scanner—will save you time and improve accuracy.
The more you work through the ordering cycle, the more information you will have to guide your decisions. There are three main metrics to help you gauge when to reorder.
- Stock levels show how high or low your inventory count is so you know how soon to reorder.
- Turn over is the rate of how many products you sell during a time period. This tells you how fast you’re going through inventory.
- Cycle time measures the time it takes from the arrival of a shipment of inventory until you fulfill an order.
You also can implement one or all of these reordering procedures.
- Reorder points. Set limits that act as triggers. Decide the minimum and maximum level of stock you need. When your inventory hits the minimum limit, this is the reorder point to replenish up to the maximum level. Setting both a minimum and maximum helps you avoid under-and over-stocking.
- Periodic replenishment. Reorder your stock at set times. For example, you might check inventory levels every month and reorder if they’re low. Stick to the interval schedule, even if you run out of stock in the meantime. This method works well for large-capacity warehouses.
- Top-off replenishment. When demand for a certain product is slower than usual, use the opportunity to reassess inventory levels and bring stock back up to its maximum levels. This method is helpful for high-turnover products.
Inventory management techniques
Inventory management is a complex process, but here are five proven methods that can help you make it as simple and accurate as possible.
Just-in-time (JIT) inventory management
JIT inventory management is a pull-based inventory method that aims to hold as little inventory as possible. Using only what is needed at the time keeps inventory low while still satisfying customers’ needs.
The advantage of implementing JIT is you can avoid holding on to unwanted stock, more nimbly respond to customer demand, and move your products more efficiently. However, this method requires accurate data and a good relationship with suppliers.
To make JIT inventory management work well, you need to:
1. Know your audience and demand patterns. JIT is based on a deep understanding of your stock needs. Constantly review inventory and sales data.
2. Work with flexible suppliers because JIT requires small batches of stock delivered on tight timeframes.
3. Link your inventory levels with demand fore casting. Use data from your inventory levels and demand forecasting to inform your replenishment quantities.
4.Use software with AI. If demand suddenly spikes, you could be left with insufficient stock to meet demand. AI software can make inventory demand more predictable.
Economic order quantity
Economic order quantity (EOQ) is another technique you can use when ordering inventory. It reduces the risk of overstocking by calculating how much stock you need to meet demand in a given time period, without dealing with overstock. You can identify your ideal order size with the EOQ formula.
For example, a fashion store calculating the EOQ of a pair of gloves might have the following data.
- Annual demand (D) = 2,000 pairs of gloves
- Set up costs (S) = $2 per pair
- Holding costs (H) = $2 per pair
The EOQ formula becomes:
This calculation shows that by ordering 64 pairs of gloves at a time, the store can meet demand without inventory problems. As 64 is far below the projected annual demand of 2,000units, they will need to place this order 31 times throughout the year before exceeding demand.
EOQ minimizes ordering and storage costs. However, the formula assumes that demand and costs are constant and doesn’t account for seasonal products, sales, or inflation.
Counting all your inventory once every year ensures accuracy, but it takes a lot of effort and doesn’t account for the rest of the year. With cycle counting, you count smaller segments of products on different days, in a way that doesn’t interrupt your normal workflow. You get up-to-date inventory figures and keep track of high-risk or high-value products.
There are three basic steps to cycle counting.
1. Decide what products to count. The strategy you choose depends on what’s most important to you:
- Cycle counting by usage counts products that move faster than most.
- Location-based counting focuses on one warehouse, store, or department at a time.
- Opportunity-based counting audits inventory every time you register a certain number of sales or when you change seasonal inventory.
- Control group counting chooses one product group and counts it several times in a short timeframe. This method exposes any bad habits so you can correct them in other product groups.
- Random sample counting goes through your inventory in random batches. This catches employee theft or other mysterious discrepancies.
2. Determine count frequency. When and how often you count depends on your available staff and work schedule. They could count every morning before the store opens, every night after closing, or maybe once a week. Count frequently enough to get through all your inventory at least once per year.
3. Document your process. This makes it easy for staff members to know what they need to do and how they need to do it.
ABC inventory analysis
ABC (always better control) analysis is a useful technique at the storage stage of the process. This technique separates inventory into three groups.
- High value, low volume products that are extremely important
- Medium value, medium volume products that are moderately important
- Low-value, high-volume products that are least important
ABC inventory analysis takes advantage of the Pareto principle or the 80/20 rule. You work under the assumption that 80% of value comes from just 20% of the inventory—the A group. Since the C group brings in far less value, you focus on it less.
To implement ABC inventory analysis:
1. Gather your product data. Sales history and sales forecasts are key data points for ABC analysis.
2. Classify your inventory. Use metrics like total sales, gross margins, and holding costs to determine product value. Then place them into groups A, B, or C.
3. Define inventory rules. Products in group A should never drop below a certain inventory level, but it might be fine for C products to do so. Determine what the minimums are for each group.
4. Monitor and reassess. To make sure your categories are accurate, keep track of your data and make adjustments when needed.
First in, first out (FIFO)
As the name suggests, FIFO is the practice of selling your oldest inventory first. This keeps your products from becoming obsolete, spoiling or passing sell-by dates, and being damaged in the warehouse.
The difficulty with FIFO is that it doesn’t account for the rising cost of product or raw materials that you purchase, when older products are sold. For example, if you buy 10 widgets at $100each and sell them for $200, your profit margin is $100 per widget. If you restock when your inventory drops to three widgets, but they now cost $125 each, the next three widgets you sell—that you purchased for $100—will seem to reflect a smaller profit margin.
Doing more with an inventory management system
A solid inventory management system has a lot of benefits. It ensures you have enough stock to meet customer demand, helps you control costs, and gives you the data you need to make accurate business decisions.
When you’re ready to start improving your inventory management, review your current process for weaknesses. Start with the ordering stage and review how you or your team are making the decision to order inventory.
Then, make sure you have software that can manage the data required for complex inventory management processes. Adobe Commerce uses AI and advanced data capabilities to help B2B and B2C businesses manage inventory more efficiently—including real-time inventory data and sourcing algorithms that expedite fulfillment.