What is inventory management?

Inventory management refers to the processes a business uses to acquire, store, track, and ship items it sells. The process involves managing a physical space (typically a warehouse) in which inventory is stored. Inventory management also covers the people and processes moving items through said space.

Inventory management is related to — but different from — supply chain management. A supply chain is the network of suppliers a retailer uses to acquire products it sells. Inventory refers to the products and their storage once they have been acquired.

Approaches to inventory management vary depending on the type of business you operate and items you sell. For example, a retailer with low-bulk, high-value items, such as a jeweler, would typically have fewer items to manage than a grocer. However, the jeweler might face stricter requirements regarding the physical security of their inventory.

Likewise, business-to-consumer operations (B2C) have different inventory management requirements than wholesale business-to-business (B2B) retailers. B2C retailers usually stock a wider range of items and need to pick and ship fewer items for each sale. B2B sellers, on the other hand, maintain fewer item types and sell larger portions of them at once.

No matter what business type you operate, you need to manage your inventory efficiently and accurately.

Why is inventory management important?

Businesses that don’t manage inventory effectively face several risks.

The first risk is poor application of financial resources. An inventory is the lifeblood of a business, and it represents a huge investment. Businesses incur costs not only to acquire inventory but also for the taxes that may be due on items stored within inventories. There are additional costs such as utilities, insurance, and other security expenses associated with warehouses and associated storage spaces.

Inventories also represent a significant investment of time and effort. Employees must perform periodic inventory counts, which may occur only once per year for seasonal items. They may also happen as often as every few weeks for other types of inventory types.

Businesses must also continuously monitor the levels of stock of different items and determine when it’s time to replenish them. They can do this based on either economic order quantity (EOQ), which uses data from sales costs and order frequency to determine when to replenish. They may also use a reorder point (ROP) which is a simpler method by which products are replenished when the quantity in stock falls below a certain number.

Poor or nonexistent inventory management puts a business at risk of undercutting all of the time and money invested in its merchandise. Yet when conducted correctly, inventory management can provide a business with an incredible array of benefits.

The benefits of inventory management

The benefits of inventory management range from greater financial efficiency to improved customer satisfaction. On a whole, these benefits add up to higher overall business success. A well-managed inventory provides important advantages in the retail industry where the total number of stores — along with competition between retailers — is steadily increasing:

• The right amount of inventory
  If you have too few items in stock, you run the risk of not being able to fulfill orders. If you have more than you can sell in a reasonable time, however, you pay unnecessary costs to store those items. Effective inventory management helps businesses achieve a middle ground by determining exactly how many items they need to keep in stock without exceeding their inventory costs.
• Cost and time savings
  Inventory management helps to efficiently manage the monetary and time investments associated with this activity. If you have a precise accounting of the stock on hand at any time, you don’t need to perform frequent, time-consuming recounts. Nor do you need to spend money reordering items when your existing stock is sufficient to meet consumer demand.
• Better organization
  The way in which your inventory is physically organized impacts the time it takes for employees to find and ship items. In turn, this affects how quickly you can fulfill orders and grow customer satisfaction.
  Inventory management lets you know which items are most popular, those frequently combined in the same orders, and others that take the longest to transit in and out of storage. You can use this data to determine how to arrange inventory efficiently — for example, grouping certain types of products or items together or storing frequently purchased items in locations that are most accessible.
• Customer satisfaction
  Difficulty finding or picking items from inventory leads to slow delivery and unhappy customers. Inventory management enables faster shipping by helping a business manage the storage and movement of items efficiently. It also minimizes the risk of having to cancel an order or list items as out of stock due to insufficient inventory, an all-too-common source of customer frustration.
• Automation and analytics
  Automated tools provide opportunities to systematically track and analyze inventory data. By using inventory management software, a business can automatically collect data about existing stock, how frequently and quickly it moves through the inventory, and so on.
  This data can deliver insight into sales patterns while highlighting opportunities for improving inventory management practices. You can also use the data to automate processes such as pricing requests or estimated shipping times.
• Handling recalls
  Thousands of items are recalled in the United States each year. If an item sold is subject to a recall, the seller must accept returns from customers who purchased the product while identifying and removing any unsold products affected by the recall.
  This may be particularly difficult if the recall applies to a product manufactured during a certain period or shipped from a specific supplier. In situations like these, inventory management tools that quickly identify where and when the seller acquired the product are critical for responding to the recall quickly.

Challenges associated with inventory management

There are times when factors that occur beyond your control — supplier problems, transportation issues, or human error — negatively impact inventory management. Retailers should factor the following challenges into their inventory management strategy.

Overstock, understock, and dead stock

Striking the right balance between overstocking and understocking items in your inventory can be difficult. If you overstock, you end up incurring costs for storing more items than you can sell in a reasonable time. If you understock, you may not be able to fulfill orders in a timely manner, if at all.

Dead stock refers to items that expire before you can sell them or those that simply get lost inside your inventory system — and therefore never sell. Dead stock bloats your inventory with unnecessary items while depriving you of the revenue that could have been generated by selling said stock.

Businesses can prevent these issues with an inventory management strategy that delivers a deep understanding of sales trends and how demand for different items fluctuates seasonally. Integrating technology such as barcode scanning can help you make accurate stock projections. You should also plan for potential disruptions to your supply chain and maintain safety stock to fall back on if disruptions do occur.

Spreadsheets and manual records

Some businesses use spreadsheets in an attempt to manage inventory manually. While this approach may work if you have a very small inventory, it’s not practical at scale. You’ll struggle to manage more than a few dozen items if you try to do it manually.

Manual inventory management also increases the risk of human error. Employees who enter a SKU incorrectly or miscount the number of items in stock can trigger inaccurate counts in an inventory management system.

Automated inventory management systems help businesses avoid these pitfalls. By scanning items automatically as they move through your inventory, it minimizes data entry errors and miscounts. At the same time, automation makes inventory management scalable because the number of items tracked is not contingent upon the number of employees working in spreadsheets or other manual systems.

Supply chain issues

Businesses usually have limited control over their supply chains, but they still must do everything in their power to ensure supply chain disruptions don’t leave them unable to fulfill orders. Suppliers who are unreliable, deliver items late, or supply the wrong items place you at risk of inventory problems.

Businesses can correct these issues by monitoring supplier activity, systematically tracking the receipt of items, and analyzing supply metrics to determine if you should look for a new supplier.

How to get started with inventory management

Inventory management can be broken down into a number of different processes and strategies. The following key strategies and concepts are for your consideration as you get started with inventory management.

Forecasting

Forecasting helps determine how much inventory to have in stock for a given period. It is a proactive approach that allows you to stock the right items before you need them, rather than acting when your stock falls below a certain threshold.

When forecasting inventory needs, the most basic data to consider are past sales trends and their correlation with future expectations — this includes factoring in seasonal fluctuations on demand. To make the process simpler, consider using data from the previous year to establish a “base demand” for each season.

Keep in mind, sales trends are impacted by marketing efforts and conversion rates. If you are launching a new marketing campaign focusing on a certain item category, you may need to anticipate the increase in sales by stocking more of said items than in the past.

Minimum stock levels

A minimum stock level is the smallest quantity of each item you should have in stock at any time. You can think of it as a baseline for how much stock to maintain.

Minimum stock levels can help to systematize product orders from your suppliers based on a simple metric. When stock levels are declining and getting close to your predetermined minimum stock level, you know it’s time to reorder.

However, minimum stock levels are not necessarily the ideal quantity of stock you should maintain. During times of peak demand or rapid business growth, you may need more than your minimum in order to ensure steady order fulfillment. For this reason, it’s important to use more than just minimum stock levels to manage inventory.

First in, first out

First in, first out (FIFO) is an inventory management strategy in which the oldest stock in your inventory is the first stock you sell when a new order is placed. In order to use this method, your warehouse should be set up so your picking system ships the oldest items first.

FIFO is used often to reduce the impact of inflation by assuming the purchase price of inventory sold at retail is lower than the purchase price of recent inventory. When the expense of the materials is recorded at the purchase price of sold items, the cost is lower than if the current item's market price were used to record the expense.

The FIFO method also helps minimize the risk of dead stock. This approach can be especially advantageous for inventories comprised of items with short expiration dates, such as food and cosmetics.

Last in, first out

Last in-first out (LIFO) is the opposite of FIFO. Under the LIFO method, the newest items are sold first.

LIFO’s main benefit is a tax advantage. The approach generates a higher cost of goods sold and a lower balance of remaining inventory. This results in a lower net income, creating a smaller tax liability.

The chief disadvantage of LIFO is it leaves you at risk of letting products expire. LIFO is thus typically used only with items that don’t expire, such as electronics or building materials. Another disadvantage of LIFO is many international accounting standards don't allow this type of valuation.

Audit your systems

It’s wise to audit your inventory on an ongoing basis by verifying that your records correspond with what is actually on hand in your inventory. The two major types of audits are spot checks and cycle counts.

A spot check is an audit of a certain portion of your inventory. Performing spot checks on a frequent basis — such as several times a month — can help identify inaccuracies that would not come to light otherwise until a more thorough audit was performed.

A cycle count is a deeper check which is a systematic analysis of your entire inventory. Cycle counts usually are performed at regular intervals spaced further apart, such as once per quarter.

Do an ABC analysis

An ABC analysis involves placing all items in your inventory into one of three categories. Category A refers to essential items because they are purchased frequently. Category B is for items of moderate importance. Category C is for rarely purchased items or otherwise offer minimal business value.

ABC analyses help you determine which items to prioritize when restocking inventory, as well as how to organize items within your warehouse. Category A items should be the most readily available. They should also be the first you restock in the event you cannot restock all items at once.

To perform an ABC analysis, look at sales data that shows which items are the most popular, as well as items driving the highest profit margins for your business. Also, consider keeping a close eye on market trends and purchasing behaviors that may cause a specific item to grow in popularity.

Have a contingency plan

The old adage “Failing to plan is planning to fail” is true in the case of inventory management.

In order to stay on top of potential disruptions to your inventory, you should constantly ask yourself what threats your inventory faces and then plan a working response.

One common challenge is running out of space in your physical inventory. If this happens, will you respond by removing some stock, acquiring more space, or a combination of the two?

Problems with suppliers are another common challenge. How will you respond if a supplier runs out of a product or is unable to ship it to you? Are some of your suppliers at a higher risk of running into problems like these than others?

Have an action plan for responding to these and similar business scenarios. The plan should detail how you’ll respond, what resources you’ll require to carry out the response, and the means required to acquire said resources. Be sure to specify who on your team is responsible for carrying out the plan.

Manage relationships with customers and suppliers

Every successful business must manage good working relationships with its suppliers and customers.

With suppliers, nurture strong relationships to ensure transparent communications in the event disruptions occur. You can do this by building individual connections with employees who work for your suppliers. Be sure suppliers know how to reach you if they encounter a problem.

Open communication with your customers is critical too, whether you are a B2C or B2B business. Avoid overpromising or underdelivering on orders. If you aren’t certain you will have an item in stock as promised, be transparent.

Make inventory management easy with the right platform

Inventory management can be relatively easy or quite difficult, depending on the tools you use. If you take a manual approach to track your inventory needs, you are bound to struggle with errors and inefficient use of time and resources. Likewise, overreliance on automation tools that only do part of the job may create gaps that leave you uncertain of your inventory needs.

An accurate inventory management system is a powerful way to help reduce costs, boost profitability, predict future sales, and mitigate risks. Adobe Commerce offers an integrated inventory management solution that allows you to track the availability of supplies from as many vendors as you use. It also automatically calculates the number of items you have available to sell, factoring in data such as how many items are currently stored in your customers' virtual carts. Additionally, Adobe Commerce provides reporting and analytics tools for insights on sales trends, helping you determine how many items to keep in stock.

To learn more about how Adobe Commerce can streamline inventory management, request a free demo.