Inventory management is the process of tracking and managing inventory in a business. This includes the purchase, storage, and sale of inventory. Inventory management is a critical part of running a business, as it helps to ensure that businesses have the right products on hand to meet customer demand.
There are many different approaches to inventory management, and the right approach for a business will depend on many factors, including the type of business, the products sold, and the inventory size. No matter what approach is taken, though, effective inventory management is essential to keeping a business running smoothly.
This extensive guide on inventory management will provide you with everything you need to get ahead, including control fundamentals, best practices, and automation processes.
Inventory management definition
Inventory management is a vital cog in your company’s supply chain. Its basic functions are to control and oversee purchases, store stock, regulate the level of products available for sale, and fulfill customer orders.
Depending on the type of business you have and the sales channels you use, other aspects may be included in your inventory management definition. As long as those four key areas are addressed, though, you’ll have a good foundation on which to build additional processes.
Many small-to-medium businesses (SMBs) use Excel, Google Sheets, or other manual tools to keep track of inventory databases and make decisions about ordering. However, managing inventory can quickly become a complicated process, with many variables to consider. As a result, many growing businesses graduate to an inventory management app or software system that offers more features than a manual database.
These inventory management systems go beyond the basics of reordering and monitoring stock. They encompass end-to-end production, business management, lead time and demand forecasting, metrics and reports, and even accounting.
Retail vs. Wholesale Inventory Management
The term “retail” is used to describe businesses that sell products or services directly to consumers. There are two main types of retail: online and offline.
Online retail refers to purchases made through a website or other digital platform.
Offline retail, on the other hand, entails transactions that take place in person, often at a physical store location (aka a “bricks and mortar” style operation).
Wholesale businesses, on the other hand, sell their products to other businesses. These businesses may be retailers who sell directly to consumers, or they may be other types of businesses that use the products they purchase in the production of their own goods or services.
Another key difference between retail and wholesale inventory management is that retail businesses typically have shorter lead times than wholesale businesses. This means that retail businesses need to be able to move products quickly, as customers are typically only willing to wait a short period of time for their purchase.
Wholesale businesses, on the other hand, often have longer lead times, as they may need to produce their products or wait for their suppliers to produce the products they need. As a result, wholesale businesses typically need to maintain higher levels of inventory, as they cannot rely on customer demand to drive production.
While there are some similarities between retail and wholesale inventory management, the two types of businesses have different needs and requirements. As a result, the approaches that work for one type of business may not work for the other.
See also: Wholesale Price Calculator
Why Inventory Management is Critical
In order to effectively manage inventory, you need to have a clear understanding of what types of inventory you have and where it is located.
You also need to know how much inventory you have on hand, as well as how much you will need to meet customer demand.
There are a few key metrics that can help you track and manage your inventory levels:
Lead time, which is the amount of time it takes to receive a product from a supplier;
Inventory turnover, which measures how often your inventory is sold or used in a given period of time;
Average inventory, which measures the average amount of inventory you have on hand over a given period of time; and
Days of supply, which measures how long it would take to sell all of your inventory if sales remained constant.
By tracking these metrics, you can get a better understanding of your inventory levels and how they fluctuate over time. This information can help you make more informed decisions about when to order new inventory and how much inventory to keep on hand.
Inventory management terms
There are a few key terms that you should be familiar with in order to effectively manage your inventory:
Barcode scanner, which is a device that can be used to scan barcodes and track inventory;
Bin location, which is a designated area where inventory is stored;
Bundles, which are groups of products that are often sold together;
Cost of goods sold (COGS), which is the total cost of all the inventory that has been sold;
Cycle count, which is a physical count of inventory that is conducted on a regular basis;
Deadstock, which is inventory that is no longer usable;
FIFO, which stands for “first in, first out” and refers to the order in which inventory is sold or used;
FILO, which stands for “first in, last out” and refers to the order in which inventory is sold or used;
Holding costs, which are the costs associated with storing inventory;
Inventory control, which is the process of managing inventory levels to ensure that they are appropriate for customer demand;
Inventory shrinkage, which refers to the loss of inventory due to theft, damage, or other factors;
Just-in-time (JIT) inventory, which is a system in which inventory is ordered and received only as needed;
Kits, which are groups of products that are often sold together;
Lead time, which is the amount of time it takes to receive a product from a supplier;
Lot tracking, which is the process of tracking inventory by batches or “lots”;
Minimum order quantity (MOQ), which is the least amount of inventory that can be ordered from a supplier;
Minimum order quantity (MOQ), which is the smallest amount of a product that can be ordered from a supplier;
MRP, which stands for “materials requirements planning” and refers to a system that is used to manage inventory levels;
PO, which stands for “purchase order” and refers to an order that is placed with a supplier;
Reorder point, which is the point at which a business needs to order more inventory to replenish its stock;
Safety stock, which is the extra inventory you keep on hand to avoid running out of stock.
Supplier, which is a company that provides goods or services
Supplies and Materials, which are the raw items you use to create your products
Stock keeping unit (SKU), which is a code that is used to track inventory;
Turnover, which measures how often your inventory is sold or used in a given period of time;
Units of measure, which are the standard measurements that are used to track inventory levels.
Variant, which refers to a product that comes in different sizes, colors, or styles.
By understanding these terms, you can better manage your inventory and ensure that you always have the products your customers need.
Inventory management formulas
There are a few key formulas that you should be familiar with in order to manage your inventory effectively:
The turnover formula measures how often your inventory is sold or used in a given period of time. It is effective in helping understand your inventory levels and make decisions about when to order new inventory.
turnover = (sales)/(average inventory)
Cost of goods sold formula
This formula calculates the cost of all the inventory that has been sold. It is effective in helping businesses keep track of their expenses and make decisions about pricing.
cost of goods sold (COGS) = (inventory at beginning of period) + (inventory purchases) - (inventory at end of period)
Read more: How do I calculate my COGS?
Economic order quantity (EOQ) formula
This formula helps businesses determine the optimal amount of inventory to order. It is effective in helping businesses save money on inventory costs and avoid stockouts.
EOQ = √(2DS/H)
D = annual demand
S = ordering or setup cost (per order, generally includes shipping and handling)
H = holding or carrying cost (per year, per unit)
Days inventory outstanding (DIO) formula
This formula measures the number of days it takes to sell all of your inventory. It is effective in helping businesses understand their inventory levels and make decisions about pricing and promotions.
DIO = (average inventory)/(sales per day)
Reorder point formula
The reorder point formula is used to calculate the point at which a business needs to order more inventory to replenish its stock;
reorder point = (average daily sales) x (lead time in days)
Safety stock formula
The safety stock formula is used to calculate the amount of inventory you need to keep on hand to avoid running out of stock. This formula ensures that you have enough inventory on hand to meet customer demand, even if your supplier is delayed in delivering new stock.
safety stock = (maximum daily demand) x (maximum lead time in days)
Minimum order quantity formula
This formula calculates the smallest amount of a product that you can order from a supplier. It is effective in helping businesses save money on inventory costs and avoid stockouts.
minimum order quantity (MOQ) = (reorder point) - (safety stock)
Maximum inventory level formula
This formula calculates the highest amount of inventory you can have on hand without incurring storage costs.
maximum inventory level = (minimum order quantity) + (safety stock)
Most businesses maintain stock across multiple channels as well as in multiple locations for multiple customers, so it’s important to ensure that you break down this calculation by location.
Inventory management software
While many small businesses start using inventory spreadsheets, most businesses ultimately choose to use inventory management software to help track and manage inventory levels.
Inventory management software typically includes features such as:
- Real time tracking of inventory levels
- Bill of Materials (BoM)
- Traceability and Lot Tracking
- Order management
- Purchase Orders
- Manufacture Orders
- Barcoding or QR coding
- Location management
There are several different software options available, and the right choice for a business will depend on factors such as the size of the business and the type of products that they sell.
Craftybase MRP is inventory management and manufacturing software that helps small manufacturers track all aspects of their business operations, from raw materials to finished products.
The software includes features such as inventory management, production scheduling, quality control, cost tracking, customer relationship management, and stocktaking.
Craftybase also integrates with other software systems, such as Shopify, WooCommerce, Wix, Faire, and more, to make managing your manufacturing business easier than ever.
See how Craftybase will take your manufacturing business to the next level - sign up for our free 14 day trial today.