Inventory Management: What It Is and Why It’s Important

Struggling with stock outs and excess inventory issues? You need proper inventory management. But what is it, and how can it help?

Managing inventory is critical for businesses of all sizes. It ensures that the right products are available when and where they’re needed. But what is inventory management, why is inventory management important, and how does inventory management work? These are the questions we will answer in this article.

What is inventory management?

Inventory management is the process of organizing and tracking the stock of goods that a company owns. This includes raw materials, finished products, spare parts, and more.

Why is inventory management important?

Inventory management is important because it allows businesses to keep track of what they have in stock, make sure they are not overstocking or understocking, and order new stock as needed.

Without good inventory management practices, a business could quickly lose money due to wasted stock or missed sales opportunities. Additionally, inventory management is important for businesses because it can help them make sure that they are meeting customer demand. Without this process, the supply chain may suffer from increased congestion and cost of goods.

A warehouse worker checking stock levels with a barcode scanner

The Basics of Inventory Management

To effectively manage a company’s inventory, there are a few basic concepts that must be understood. These basic principles help businesses improve their inventory management practices and minimize dead stock, lead time, excess inventory, and other supply chain issues.

  1. Tracking: First, it is important to track what items are in stock and how much of each item is on hand. A physical or digital inventory list is necessary to accomplish this.
  2. Checking: Second, businesses need to keep an eye on the amount of inventory with periodic inventory checks and order new items as needed.
  3. Systemization: Finally, it is important to have a system in place (such as software systems) for receiving and stocking new items.

Benefits of Inventory Management

Now that we have answered the question, “What is inventory management?” we can move on to explore the benefits of inventory management. Many benefits come with having good inventory management practices in place. Here are just a few of the most notable benefits:

Improved Cash Flow

Good inventory management can help businesses to improve their cash flow by reducing the amount of money that is tied up in excess stock or too much inventory.

Reduced Costs & Increased Profits

By keeping track of stock levels and only ordering new products when needed, businesses can reduce their overall costs and improve profit margins.

Improved Customer Service

With good inventory management, businesses can be sure to have the products that their customers need and want when they need them. This leads to improved customer satisfaction and loyalty.

Improved Decision-Making

Good inventory management provides businesses with the data they need to make informed decisions about their stock levels, ordering, and pricing.

Poor management of inventory leads to stock outs

How does inventory management work?

All the inventory management techniques break down into 4 basic components. Following these components helps make for a more effective inventory management process in your business, and ultimately, vastly superior supply chain management.

  • Forecasting: Forecasting (sometimes called demand forecasting) is the process of predicting future customer demand to ensure that the right amount of products are available when they are needed.
  • Stock control: Stock control is the process of keeping an account of what products are in stock and ensuring that stock levels are maintained at the desired level.
  • Ordering: Ordering, sometimes called purchasing, is the process of ordering new stock as needed to maintain desired stock levels.
  • Receiving: Receiving is the process of accepting new stock and adding it to the inventory.

What are the two main types of inventory management?

The two main types of inventory management are perpetual and periodic. The type of business you operate, the industry you are in, or your position in the supply chain will determine which management strategy is best suited for your needs.

Perpetual Inventory Management

Perpetual inventory management is a system where the stock of goods is constantly updated. This means that the business always knows how much of each item is in stock. This type of inventory management is usually done with a computerized system that tracks the stock on hand and updates it in real time.

Cycle counting is an ongoing process that accounts for inventory over time. This is a type of perpetual inventory management, usually automated when items leave inventory or performed as a reconciliation at the end of each day.

Periodic Inventory Management

Periodic inventory management is a system where the stock of goods is not constantly updated. Rather, businesses take a snapshot (or count) of their stock every few weeks or months and use that information to make orders. This type of inventory management is often done with paper lists or spreadsheets.

Physical counting (aka “physical inventory”) means physically counting all of the inventory in your business. This is a type of periodic inventory management. The physical count is an arduous process for most businesses and usually requires halting certain processes to set aside time to complete.

A warehouse worker on a forklift checking inventory with a note pad

Determining the Right Inventory Level: Cycle Stock vs Safety Stock

Cycle stock is inventory that is kept on hand to meet customer demand. This type of inventory is ordered and replenished regularly so that it is always available.

Safety stock is inventory that is kept on hand to protect against shortages. This type of inventory is ordered and replenished less frequently than cycle stock so that there is always some available in case of a shortage.

How to Organize Your Inventory

Proper organization is key when it comes to inventory. Without a system in place, businesses can quickly lose track of what they have in stock and end up wasting money on unused items or missing out on sales opportunities.

By organizing inventory according to these methods, businesses can make sure they are always aware of what they have and when it needs to be replaced. This helps to improve efficiency and keep costs down.

By Product Type

One common way to organize inventory is by product type. This might mean organizing items by category (e.g. clothes, electronics, food), by brand, or by type (e.g. tools, furniture, home decor).

By Storage Location

Another way to organize inventory is by where it is stored. This might mean organizing items by location in your store or warehouse, or by how often they are used.

By Restocking Priority

Finally, another option is to organize inventory by when it needs to be restocked. This might mean organizing items by date of purchase or date of expiration. Whichever method you choose, make sure to keep your inventory list up-to-date and easy to use.

Methods for Determining Restocking Priority

There are two main methods for determining restocking priority: ABC analysis and lot sizing.

  • ABC analysis is a method of organizing inventory based on the amount of money that each item in stock costs. This analysis assigns each item a letter A, B, or C, where A is the most expensive item, B is the second most expensive item, and so on.
  • Lot sizing is a method of ordering inventory based on how often it is used. This approach divides items into groups called “lots” and orders a set number of lots at a time.
An inventory manager checking stock quantities with a tablet

Tips for efficient and effective inventory management

Good inventory management is essential for any business. There are a few tips for businesses looking to improve their inventory management practices. By following the tips below, businesses can improve their efficiency and keep costs down.

Consider Your Warehouse Layout

When organizing your physical inventory, it is important to consider the layout of your store or warehouse. This will help you to maximize space and make sure that items are easy to find. It is also important to have a system for receiving and stocking new items.

Adopt Technology

One tip is to use a barcode scanner to keep track of stock levels. Even better, a radio frequency identification (RFID) system. This makes it easy to track what items are in stock and helps to prevent ordering too much or too little of an item.

Another technology component is a warehouse management system to track where items are stored and how often they are used. This helps businesses make sure that they are using their warehouse space efficiently and prevents them from running out of popular items.

Implement Standard Policies & Procedures

Finally, businesses can improve their inventory management by setting up standard procedures for receiving and stocking new items. This helps to ensure that new items are properly sorted and cataloged and that stock is not wasted due to inconsistency.

Maintain Effective Communication

Good inventory management also requires effective communication. Businesses need to make sure that all employees are aware of the inventory system and how it works. This helps ensure everyone is on the same page and mistakes are avoided. In addition, businesses should regularly communicate with suppliers and customers about stock levels and availability. This helps prevent any misunderstandings and keeps everyone informed.

Review Procedures Regularly

A regular review of your procedures is critical to maintaining effective management of inventory. This is a proactive type of supply chain management rather than waiting for an issue to arise. If you find that you are consistently going out of stock of particular items, you may need to consider how often you are reviewing all the procedures in your inventory management process.

Train Employees on Proper Inventory Management Techniques

Although it seems simple, proper training can be the difference between consistent levels of inventory or total stock-outs, or even dead stock. If you know how proper inventory management is done, make sure your employees know it too! This applies especially to inventory management software, which often needs a skilled trainer to educate users in all its functions and proper usage.

Mistakes to Avoid When Managing Your Inventory

There are a few common mistakes that businesses make when managing their inventory. By avoiding these mistakes, businesses can improve their inventory management practices and keep costs down.

  • Not having a system for receiving and stocking new items can lead to inconsistency and wasted time and resources.
  • Ordering too much or too little of an item can be costly and can lead to stock shortages or overages.
  • Making assumptions about inventory levels can result in missing out on sales opportunities or running out of popular items.
  • Not tracking stock levels regularly can lead to wasted money on unused stock.
A group of warehouse workers checking inventory on a tablet device

Best Practices for Efficient and Effective Inventory Management

The following steps are the best practices for good inventory management in your business. You should consider this list the base essentials just about any company should implement to help properly manage their inventory. Following these steps will help ensure that you minimize the occurrences of too much stock, materials, or finished products at any point in time.

Keep Track of Your Inventory Levels

By tracking inventory levels regularly, businesses can make sure that they have the items they need on hand and avoid running out of popular items. This can be done by using a barcode scanner to track stock levels or by using a warehouse management system to track item usage.

In addition, businesses should make sure to communicate with suppliers and customers about stock levels and availability. Doing so will help prevent any misunderstandings and keep everyone informed.

Order Stock Based on Demand

The best way to order stock is to base it on demand. Doing so will help ensure that you have the items you need when you need them and that you don’t order too much or too little of an item. There are a few ways to track demand for inventory items.

One way is to use a barcode scanner to track stock levels. Preferably, a barcode scanner pushes data into a warehouse management system. This will help you track how often an item is used and how much space it takes up in the warehouse. By using this information, businesses can make sure that they are ordering the right amount of stock and avoid running out of popular items.

Use a Reorder Point System

A reorder point system is an inventory management tool that businesses use to order stock. The reorder point system is set to alert the business when the stock of an item falls below a certain amount. This allows businesses to plan and order more stock before they run out. Reordering stock before it runs out helps to avoid shortages and keeps customers happy. In addition, using a reorder point system can help businesses save money on inventory costs.

Maintain Accurate Records

Accurate records are essential for good inventory management. By maintaining accurate records, businesses can track stock levels, usage, and ordering history. This information helps make informed decisions about future stock orders. In addition, accurate records help to ensure that businesses are compliant with any government regulations governing inventory control.

Conduct Regular Inventory Audits

To ensure that their inventory is managed effectively, businesses should conduct regular inventory audits. By doing so, businesses can track stock levels, usage, and ordering history. This information helps make informed decisions about future stock orders. In addition, conducting regular inventory audits helps businesses stay compliant with any government regulations governing inventory control.

Implement an Inventory Management System

An inventory management system is a tool that businesses can use to manage their inventory. By using an inventory management system, businesses can track stock levels, usage, and ordering history. This information helps make informed decisions about future stock orders. In addition, an inventory management system helps businesses stay compliant with any government regulations governing inventory control.

There are a few different types of inventory management systems available. Some systems are software-based (inventory management software) and allow businesses to track their inventory with online cloud-based systems. Other systems are hardware-based and require businesses to scan barcodes or use RFID tags to track inventory. Whichever type of system a business chooses, it must find one that meets its specific needs.

Conclusion - Inventory Management

While there are many ways to manage inventory, there are just a few key principles to understand to be most effective with inventory management. Businesses need to find a method that works best for them and stick to it. When ignored, mismanaged inventory can be costly and may lead to shortages which will upset customers.

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