Inventory management is the process of managing the flow of goods from production channels all the way until distributions are made to customers. In order to meet organizational objectives, inventory management often involves the following:
- Product design and specifications
- Selection and classification
- Purchase and acquisition
- Storage and distribution
- Movement within a facility or plant
- Time-saving productivity
- Inventory-level decisions
- Tools to reduce stock turn-over rates
Let’s review the methods as well as the overall process behind inventory management!
How Does Inventory Management Work?
Inventory management works best when the plans are thoroughly thought out and implemented in a consistent manner. In order to better understand how inventory management works, it’s important to take a closer look at the definition of inventory and the functions that it serves.
What Is Inventory?
Inventory is a term used to describe goods that companies have on hand and in stock with the intent to sell these goods. Another way of looking at inventory is that they are goods that have already been purchased by a company and are waiting to be sold, or they are goods that have already been manufactured but not yet sold.
What Is the Basic Function of Inventory?
The basic function of inventory is to give suppliers or companies a surplus of goods to package and distribute whenever customers make a purchase. When a customer’s order is placed, the product they purchase is taken from the customer’s inventory, packaged, distributed, and delivered to the company.
If the inventory is being sold at faster rates than the inventory is being replaced and restocked, then there will ultimately be a shortage of products in stock. This is what happens when companies sell out of certain products. Another term for this situation is a stock-out.
Why Is Inventory Management Important?
Inventory management plays an important role in every company. It ensures that companies have solid and stable plans for their inventory. Inventory management is also important because it keeps the company from having too much money on hand or stock in stores. Inventory management affects business finances as well.
What Is Inventory Management System?
Inventory management system is a term that describes a series of procedures that are used in order to keep track of inventory. These systems also allow managers to forecast demand and order additional goods accordingly, which, in turn, helps with purchasing, scheduling production, and keeping track of costs.
What Are the Goals of Inventory Management?
Generally speaking, the main goal of inventory management is to keep inventories as low as possible while also ensuring that goods are available whenever they are needed. It should be noted that the lowest possible inventory levels do not necessarily mean zero.
Zero inventory is not desirable for companies because it means there’s no flexibility and they won’t be able to make sales or fulfill orders without inventory. So, the goal is to minimize inventory by optimizing safety stock, adjusting the frequency of orders, or rules regarding how much of one item people are allowed to purchase.
Key Benefits of Inventory Management
There are many benefits to effective inventory management. One key benefit is that inventory management lets businesses improve their efficacy by reducing inefficiencies caused by both overordering or under-ordering products.
Inventory management also creates a sense of predictability for the finances of a business. Proper inventory management processes enable companies to achieve a high level of customer service that is often lacking when it comes to out-of-stock items.
Inventory Management Challenges
There are also several challenges that can arise when managing inventory and these challenges can include:
- Risk of excess inventory
- Extended processing times associated with over-ordered goods
- Increased logistical costs due to longer delivery times for under-ordered parts
Example of Inventory Management
When a customer walks into a retail store, they pick out the items that they want. In order for them to do this, the retailer must maintain an inventory of all items that are currently for sale. If there are not enough items on hand to satisfy the current demand, then customers will not be able to make their purchases, ultimately causing the store to lose out on potential sales.
To avoid having no inventory and missing out on sales, retailers must be intentional about how much stock is kept on hand at any given time. They also have to be careful when ordering stock because if they order too much or too little, it can result in a loss of money spent on unnecessary inventory, which results in lost sales revenue.
Methods for Inventory Management
There are many reasons why companies have different inventory management methods. The demands of one industry are not going to be the same as other industries, and one company’s methods will be better suited for their industry than others. There are many methods for inventory management, but today, let’s take a look at some of the most popular methods!
A cycle count is the process of counting inventory within a specific time period. This is usually performed on either a monthly basis or at the end of an accounting period.
LIFO & FIFO
LIFO and FIFO are both inventory cost valuation methods that can be used to track and value inventory. LIFO stands for “Last In, First Out” while FIFO stands for “First In, First Out.” These terms are often used in conjunction with the accounting process.
Just-in-Time inventory management is a manufacturing practice that eliminates waste and minimizes the amount of inventory needed to meet customer demand. This process has some advantages, like production tracking, but there are also disadvantages, like being difficult to implement.
Par levels are the preferred target levels for inventory. These levels can be increased or decreased based on a myriad of factors, such as sales or demand. Par levels tend to be set at high, medium, and low, with most companies trying to maintain a minimum of one percent per level.
This leveling system allows companies to keep their inventories at optimal levels while also making sure there is always enough stock on hand for customers.
Safety Stock Inventory
Safety stock inventory is the minimum quantity of inventory that a company needs in order to prevent shortages or disruptions of service. This is the amount of inventory above and beyond what is needed for normal operations.
Reorder Point Formula
The reorder point is the minimum amount of inventory that a company needs to have at all times in order to avoid serious sales delays. The reorder point represents the maximum potential demand for a product, which is different from the typical demand in that the reorder point formula reflects the most likely of all demands possible based on sales history and patterns.
Surplus Inventory & Dead Stock
Surplus inventory is essentially extra inventory that a company has on hand. This can be something that was either ordered too often or too infrequently. Deadstock is considered to be unused inventory and it accounts for over 50 percent of the total cost of an organization’s total inventory.
Batch tracking is an inventory tracking system that allows different companies to track the contents of each batch and the amount of inventory within that particular batch. This allows for better traceability and the overall safety of products.
Perpetual Inventory Management
Perpetual inventory management is a form of inventory control that is used to track the number of goods that are being sold as well as how much has been sold. This process can also be used to help figure out the exact quantity of products that companies need to either order or produce in the future.
Demand forecasting is used to predict the market demand for a product or service. An organization can use different methods in order to forecast sales, including quantitative analysis or qualitative analysis.
A contingency plan can help an organization prepare for events that may arise within their business. This typically involves planning for anything that could either positively or negatively impact the organization’s production, services, or financial results. It’s all about having a plan in the event things go wrong as well as a plan in case sales skyrocket or business expands overnight.
Consignment inventory refers to situations in which a retailer has merchandise from a vendor that will be sold to consumers, but the retailer is only responsible for getting the product to those consumers, not producing the goods.
Dropshipping is a means of selling goods without having to stock or store any inventory. When sales are made, the order information is sent directly to the manufacturer or supplier. They will then ship the goods directly to the customers on behalf of the seller.
KPI Analysis is a way to analyze and measure everything that an organization does. Some of the common KPI types are Profit, Sales, and Operating Expense.
Economic Order Quantity (EOQ)
An Economic Order Quantity (EOQ) refers to the amount of product that is necessary to meet a customer’s needs. This number must be set in advance and it cannot be changed. However, the value can still fluctuate as a result of either an increase or a decrease in the demand for products.
Minimum Order Quantity (MOQ)
Full stock is the most desirable goal for most organizations. It refers to a level of inventory that ensures the company will maintain an adequate supply at all times.
Returned inventory refers to goods that have been returned by a customer back to the business the customer purchased from. These returns are typically the result of items being damaged, spoiled, or unwanted. Returns will either be accepted or rejected based on the company’s return policy. The returns might result in fees for the retailer.
ABC Analysis is used in order to determine the most profitable products for a company. This involves breaking down products into three different categories: A, B, and C. Category A refers to high-end products with low sales volume, category B refers to products with medium sales volume yet high-profit margins, and category C refers to low-profit margins yet high sales volumes.
Materials Requirement Planning (MRP)
Materials Requirement Planning (MRP) is a process of planning and forecasting in a way that helps an organization know how much material they need to produce in order to meet the demand of their customers. This can be used for both raw materials or finished products.
Day Sales of Inventory (DSI)
Day Sales of Inventory (DSI) is a model that is used to forecast sales based on the time spent at certain locations. This requires the retailer to know how many hours their employees are working in order to create accurate predictions for their time at those locations.
A location inventory is a listing of all the different locations where inventory can be found in an organization’s facilities including warehouses, production plants, and stores. This is helpful for finding out what items may need to be recalled if there is a problem with those items.
Inventory Management Process
The Inventory Management Process is a general process that can be applied for different types of inventory planning, tracking, and staying on top of management. The steps in the process include forecasting demand, ordering materials or products, initiating production, storing goods, and shipping products to customers.
Purchasing is an activity that involves obtaining goods and services that an organization needs in order to fulfill orders. This can also be referred to as sourcing.
Production refers to the point where a business starts creating goods or putting together services in its own facilities.
Distribution of Goods
Distribution of goods is a process in which retailers rely on third-party suppliers, commonly called drop shippers, to fulfill customer orders without storing inventory themselves.
Sales forecasting is a process by which an organization predicts the demand for its products or services. This allows the organization to have a current view of their sales potential as well as an idea of how much they should order for production purposes.
Analysis & Reporting
Analysis and Reporting is a term used to describe the process of analyzing data in order to determine trends and patterns. In some cases, this may also include the development of reports, such as a report for distribution or sales forecasting.
How Can You Measure Successful Inventory Management?
There are several different metrics that can be used to determine how successful an organization is at managing its inventory. The most common metrics used today include the following:
- Inventory turnover
- Inventory on hand or total assets
- Inventory turnover ratio
- Operating expense and sales
- Net profit margin
Inventory Management vs Inventory Control
Inventory control and inventory management are terms that both refer to the same activity, but the terms can be used interchangeably and in a variety of ways. Inventory control tends to refer only to inventory management within a specific department or area, whereas inventory management refers more to the overall goal of managing inventory for the entire business.
Effective Inventory Management is a Must-Have
There are several different ways to measure the effectiveness of inventory management, but these metrics tend to be similar in that they provide a general view of how effective an organization’s inventory management is. Having a consistent approach to the activities involved in inventory management can help an organization achieve consistency and maintain control of its operations.
Want to stay up-to-date on inventory management and supply chain technology? Subscribe to the FreightWaves e-newsletter to get valuable content delivered right to your inbox!