The inventory management process is a hugely important procedure for almost all businesses. Learn everything you need to know about the process here.
Inventory management is an essential process for almost every type of business. Inventory is often the largest current asset and poor or ineffective management of stock can lead to large losses or in some cases, business failure. Having the right quantity of materials on hand is essential for smooth operation and so good inventory management should be at the core of every business’ trading activity.
Yet the successful organization of inventory is not without its challenges. Inaccurate data, shifting customer demand, manual documentation, inefficient space management, expanding product portfolios, and inadequate software are just some of the issues that companies face when attempting to manage or improve their stock processes. Making use of potential solutions like inventory management software and overcoming such issues can result in huge boosts to operational efficiency.
What is inventory management?
Inventory management is how a business controls and tracks its stock – both raw materials and finished goods. It refers to the entire process of sourcing, manufacturing, storing, and finally selling products and components. In business terms, inventory management often more specifically refers to the idea of having the correct amount of stock, in the right place, at the right time, and at the right cost. It is a key component of supply chain management and can be a critical element of working capital optimization, as it governs the entire flow of goods from purchasing through to sale.
Many companies need inventory in order to make sales. A company cannot sell what it does not have. Yet retaining too much can also be damaging, as it can lead to outdated stock, spoilage, or unnecessary storage costs. Effective inventory management, therefore, can be seen as a way of maximizing potential sales through an understanding of the stock levels required.
In addition to its importance in relation to sales, having the correct quantity of goods is also crucial for the planning and budgeting of financial expenditures. A business that fully understands its stock levels can better manage other debts and obligations. For example, if a shoe company that is in debt has two months’ worth of inventory, it can choose to pay its debts sooner, knowing that it has time before it must purchase more shoes. A shoe business with poor inventory management processes may only have a few days worth of stock and must prioritise goods over other possible expenses, which could lead to cash flow issues.
For more about the basics of inventory management, please read our glossary page covering the question ‘what is inventory management?‘ in more detail.
Types of inventory
Inventory comes in a wide variety of shapes and forms. How it is defined may vary depending on the industry. However, generally speaking, inventory is categorized depending on where it stands in the production process. The five basic types of inventory are:
- Raw materials – The goods purchased to create and finish products. The manufacturing process is usually applied to raw materials to produce the desired goods
- Work-in-progress (WIP) – Also referred to as ‘unfinished goods’, WIP applies to items in production which may or may not be sellable. It can sometimes also refer to labor, overheads or packing materials
- Finished goods/for-sale goods – Items ready to be sold
- Packing material – Primary packing protects the item and makes it usable, secondary packing is the packaging that allows the item to be transported
- MRO supplies – Maintenance, repair and operating supplies. These are goods used to support the manufacturing process and can include nuts and bolts, office supplies, safety equipment, batteries, or any number of goods used to support business operations.
There are also several additional classifications, which include:
- Goods in transit – A business may transport any of the above from one place to another for a variety of reasons such as sales, purchasing or for further processing. It’s possible this inventory stays in transit for days, weeks or months
- Buffer inventory – Inventory kept for the purpose of meeting future uncertainty, particularly potential shortages or surges in demand. It’s also known as safety stock or anticipation stock
- Decoupling stock – Extra items or WIP that are kept to prevent work stoppages. For example, if a manufacturer has machines that work at different speeds, decoupling stock may be kept so there is a steady flow of production
- Cycle inventory – Inventory accumulated due to ordering in lots for the purpose of getting the right amount of stock for the lowest storage cost
Inventory management vs inventory control
It is important to note the difference between inventory management and inventory control, as the two are often mistaken.
Inventory control refers to regulating existing goods, which is to say, managing inventory already on-hand. This includes knowledge of what is in stock and how much is available.
This differs from inventory management, which is more predictive and refers to the forecasting, ordering, replenishment of product. It determines when to order (or reorder), just how much is needed, and the most effective source of supply.
The inventory management process
There unfortunately is no particular set structure for how this process should operate, and the methods used by each business will vary greatly depending on the industry and size of business. However, in general, the process is likely to look similar to the following:
- Goods are received – The goods will initially be delivered. If making use of a warehouse, there may perhaps be a dedicated receiving area. These goods can potentially include raw materials and components for the manufacturing process, finished goods for distribution, or indirect materials such as MRO supplies.
- Goods are reviewed – At this stage, the goods may be compared to purchase orders to ensure they match the order quantity and quality. They will also be sorted and stored once they have been reviewed.
- Stock is monitored – Inventory levels are consistently monitored, typically by an automated inventory management system. Physical checks may also occur periodically. By ensuring accurate measures of stock, a business can help prevent dead stock, stockouts, or missing/duplicated orders.
- Orders are received – Customers will place orders, either internally or externally. They will then move to approval.
- Goods are taken from stock – The required goods will then be sent to either: manufacturing (to be produced); the customer/retailer; or the appropriate business department.
- Inventory levels are updated and replenished – Records will be updated, perhaps via the use of inventory management software, and stakeholders will be notified. Goods will be restocked and reordered as necessary.
Inventory management methods
There are two main established methods of managing inventory: periodic and perpetual. Overall, the perpetual inventory system offers more benefits and is used by most major retailers. However, the periodic inventory system is occasionally favored by small businesses that are not able to justify the slightly higher cost associated with the perpetual system.
Periodic inventory management
In order to understand stock levels, occasional physical stock counts will be performed. Imagine, for example, a stationer that has to count every pen they have for sale. Now multiply that process across the supply chain. As businesses will often have levels of stock that rise into the thousands, this process can be difficult and time-consuming. Consequently, a periodic stock count may only happen a few times per year, which leads to inaccuracies.
Perpetual inventory management
In contrast, the perpetual system will continuously keep track of stock and update when a product is sold or received. An inventory management system will automatically update to ensure more accurate and up-to-date information. Businesses with high levels of sales or multiple retail outlets require perpetual inventory management systems to better time purchases, reduce human error, to better monitor issues such as theft, and more.
Inventory replenishment methods
- JIT is an effective inventory management method that aims to have as little stock on hand as possible. This strategy attempts to align material orders from suppliers with production schedules in order to decrease waste and increase efficiency. With this method, products should arrive just as they’re needed, which should reduce inventory costs.
Economic order quantity (EOQ)
- The economic order quantity replenishment method is used to determine the optimal order quantity for the purpose of minimizing costs, such as holding costs, shortage costs, and order costs. Ideally, a company will not have to make orders too frequently, nor would it have an excess of goods on hand. There are multiple ways of calculating EOQ, but one common way is the following, wherein S = setup costs per order, D = demand (annual sales), and H = holding costs, per year, per unit:
√ 2 x S x D / H
Material requirements planning (MRP)
- MRP is a computer-based inventory management system that works backwards from a production plan for finished goods to the requirements for raw materials. This process leads to minimized inventory levels, reduced customer lead times, and assurance that materials will be available when needed. MRP is widely used by manufacturers and has been key in the proliferation of consumer goods.
Benefits of proper inventory management
Improved supply chain efficiency
Inventory is a core component of the supply chain and so more reliable inventory leads to a healthier supply chain, both for the supplier and the customer. Order fulfilment is vitally important for all businesses. Whether a company is large or small, maintaining the appropriate levels of stock leads to happier and more loyal customers, a crucial part of supply chain management. Likewise, making reliable, on-time purchases can lead to stronger relationships with suppliers.
Storing goods can be expensive. For industries such as agriculture where the goods have a brief shelf life, this is even more pronounced. Inventory management techniques are essential for making sure just enough product is stored to reduce any unnecessary waste.
Inventory management techniques such as automation can also reduce the likelihood of potential human error, shorten supplier lead time, and avoid warehouse charges; all costs that can be avoided.
Better preparedness for demand fluctuation
Inventory management is about balance. With the use of good inventory management software, a company can keep better track of stock levels and can order just what is needed, as well as reduce the risk of overselling. Better planning and management also makes it far less likely to be burdened by either excess stock or stockouts.
Improving your inventory management process
A comprehensive inventory management system such as one that Taulia offers, can lead to:
- More accurate data & improved visibility
- The ability to adapt to shifting customer demand
- Reduction of human error related to manual inputs
- Simplified processes
- Reduced risk of overselling
- Avoidance of stockouts
- Greater cost savings
- Huge boost to operational efficiency