Back in the mid-1990s, I was a manager for Blockbuster Video. Most days, it was a fun job. You got free movie rentals, there weren’t many complicated issues to resolve, and you could watch movies while you were working.
The one downside of the job was that every two months you were responsible for doing an inventory. This was done after hours and was an all-night event (provided you didn’t have any issues. If you did, it could stretch well into the morning and even right up until opening).
Every rental and retail tape had to be scanned. Every soda and candy bar counted. It was a tedious and time-consuming task that made me hate the word “inventory.”
Fortunately, inventory management has come a long way since the 1990s. Technology has automated inventory management to the point where your actual physical involvement is minimal.
If you’re still manually counting items and entering them on spreadsheets, know that there’s a better and easier way.
Today we’ll break down what inventory management is and how to make the task of tracking your inventory as simple and painless as possible.
Inventory Management Best Practices
Inventory management is a key component of your business’s success. Properly tracking inventory can save you money in a variety of ways, from preventing shrink, to helping eliminate stock outs, to preventing you from wasting money on carrying costs for items you don’t need.
Unfortunately, many small and mid-sized businesses don’t spend enough time on their inventory management program. They justify this by explaining that they don’t have the time or the right tools to make inventory management a priority, or that the tools are too expensive for their budgets.
The good news is that managing inventory is easier than ever thanks to inventory management software.
There’s a solution for every business, regardless of size and budget, on the market. It’s simply a matter of creating a list of what you need for your inventory management program, then finding the solution that meets those needs.
However, before you get to that step of the process, it’s important to figure out how you will manage inventory.
Following these steps will give you a solid foundation to build on.
· Clearly Map Processes
Outlining the step-by-step process for each area of your business can help you maintain order, prevent problems, and quickly solve issues when they arise.
If you’re trying to improve your inventory management process, the first step is to sit down and clearly define each part of your inventory system. From receiving, shipping, returns, and warehouse layout and beyond, you’ll need to create a well-defined roadmap for how things should be done.
Understanding what all the different components are and how they work together will make managing your inventory easier.
· Track Product Information
The next step in implementing inventory management at your business involves tracking all of the information for the various products you sell, the items you use to manufacture them, and so on.
The key here is to be thorough. You’ll need to track all the information. Inventory management software can help with this process without the headache of dealing with a complicated Excel spreadsheet.
· Set Par Levels
For the next stage, you’ll want to figure out par levels for all of the products you sell and all the materials you use.
A par level is the minimum level you need to have on hand at all times to meet demand. Naturally, this level will vary by item.
You can determine par levels by examining your sales data and working backward from there.
Setting a par level makes inventory management easier because you will automatically know when it’s time to re-order any time an item falls below the par level. This will prevent issues and lost sales due to stock outs.
Inventory management software can simplify this process by monitoring par levels for you and re-ordering automatically when necessary.
· Timely Posting
Inventory problems can grow exponentially if you’re not posting in a regular and timely fashion.
Create a plan to ensure you’re updating inventory counts and transactions regularly to prevent problems from snowballing into massive headaches.
Keeping accurate, up-to-date inventory counts can help you avoid running out of key items and disappointing customers.
Whether you post these items by hand or with software, it’s important to keep your inventory numbers updated as often as possible.
· Plan for Problems
No matter how great your inventory management system is, there will invariably be times where there are issues. It’s important to prepare for these events by having contingency plans in place.
Some common problems to prepare for include:
· Cash flow shortfalls
· Seasonal fluctuations
· Oversells from unexpected sales spikes
· General miscalculations
· Manufacturer delays
· Discontinued items or components
These are just some of the common problems that can derail even the most dialed-in inventory management program. Be prepared for the unexpected so you’re not caught off guard.
· Conduct Regular Audits
The importance of conducting regular audits cannot be understated. Audits allow you to compare your physical numbers with the numbers on your spreadsheet or software and are crucial for spotting discrepancies.
Whether you do full audits, spot checks, or cycle counts by product type or item, you need to conduct physical counts regularly to keep everything in alignment.
· Forecast for future needs
We talked earlier about par numbers for stock levels.
Taking that a step further, be sure you’re using your inventory management data to create accurate forecasts of what stock levels you’ll need for the quarter or year ahead too.
Forecasting is often overlooked in inventory management, but a good program can allow you to see seasonal fluctuations and other variables that affect your sales and stock levels throughout the year.
Armed with this knowledge, you’re better equipped to make smarter inventory decisions for the road ahead.
· Consider using a “safety stock” system
One great way to prepare for the unexpected contingencies we discussed earlier is by utilizing safety stock.
Safety stock is just an excess amount of stock set aside for emergencies. This way, if you have an unexpected event that depletes your sales stock, you may be able to weather the storm until you find an alternative solution with the small amount of excess stock you’ve set aside for emergencies.
The key here is not to carry an excessive amount of safety stock. You’ll want to find a safety stock level that will get you through an emergency, but not tie you up with a bunch of extra items.
Here’s a formula to help determine how much safety stock you should keep on hand:
Safety Stock = (Maximum Daily Usage x Maximum Lead Time) – (Average Daily Usage x Average Lead Time)
And with that in place, you have the basic structure to build an inventory management system for your business.
Naturally, you’ll want to tweak and add things that are relevant to your company or industry, but with these items covered, you’re ready to begin.
4 Popular Inventory Management Techniques
With the basics in place, your next big decision is choosing an inventory management technique that works for you. There are multiple options here, and some are better than others, but all are dependent on your size, goals, and other variables.
There are no right or wrong answers when it comes to choosing an inventory management style, only what’s right for your business.
So, let’s dive in!
1. ABC Inventory Management
ABC inventory management (which is sometimes referred to as selective inventory control) centers on the idea that not all products are created equally. Because of this, there should be a focus on your products that generate the most revenue.
This doesn’t mean only focusing on your best products from a sales perspective, but rather across the board – from sales, production, marketing, and beyond.
Have you ever heard of the Pareto Principle?
If you haven’t, it’s only because you probably know it better as the old “80/20 Rule.”
ABC inventory management operates on this same principle – 20% of your activity generally creates 80% of your profit. Therefore, it makes sense to focus on the 20% inventory that most dramatically moves the needle in your business.
Here are some of the pros you’ll get with this approach:
· Allows for inventory optimization
· Better resource management
· Better forecasting
· Better customer experience
2. First In, First Out (FIFO)
So, what is FIFO?
Basically, in the First In First Out approach, we track inventory like this: The first items into stock are also the first items we sell.
The upsides of this approach are numerous.
· Keeps inventory constantly rotating
· Helps ensure your taxes and accounting are accurate
· Prevents perishable goods from expiring
· Provides a great way of tracking Cost of Goods Sold (COGS) over time
3. Last In, First Out (LIFO)
As the name suggests, this is basically the opposite of the First In, First Out approach. Here, the newest inventory received is the first inventory sold. This means your older inventory is often left over at the end of the accounting period.
So, you may be wondering what the advantage of this approach is – after all, you’re sitting on old inventory.
The big benefit of LIFO is from a tax and accounting perspective. Last In, First Out produces a higher cost of goods sold, and a lower dollar amount when it comes to leftover inventory. This can be a boon on your taxes.
4. Average Cost Method
At first glance, Average Cost appears to be a best of both worlds approach from the name. And in some cases, it can be – but it ultimately comes down to your business, your inventory, and your specific needs.
As the name implies, Average Cost inventory methods use a weighted average method to determine the taxable value of all inventory on-hand. This means everything is essentially valued in the same way regardless of what you paid in costs or when you sold it.
The biggest selling point of the average cost method is that it’s easy to implement, particularly compared to LIFO and FIFO.
If you’re just getting started with your inventory management efforts, the average cost method is a good way to dip your toes into the water.
Ways to Manage Inventory
When it comes to managing your inventory, there are several different ways to handle tracking and counting. Here are the three most common:
1. Pencil and Paper
The simplest method is the oldest method: a pencil and some paper.
Manually counting and tracking your inventory with this method has been around since the good old days, and if you’re not a huge business with multiple locations and thousands of items, it can still work.
The downside to this approach is that it’s very easy to make errors, it’s time-consuming to count things all the time, and it’s not scalable as your business grows.
Again, if you have a small business, this approach can work. As you grow and things get more complicated, you’ll need a better approach.
2. Excel Spreadsheets
If you’ve outgrown pen and paper, an Excel spreadsheet is another popular way to track your inventory.
The advantages of the spreadsheet are that it’s customizable, savable, and can do many complex calculations for you.
The issues are that, like pencil and paper, it’s easy to manually enter something incorrectly and throw off your counts. Beyond that, the spreadsheet can scale well enough for a small business but will become unwieldy as you grow. It’s easy to watch your spreadsheet become a spread novel.
Still, the Excel spreadsheet is a solid option for companies who’ve outgrown pencil and paper but aren’t quite ready to jump to our next choice.
3. Inventory Management Software
Our final option is inventory management software, which is a real game-changer in many regards.
IMS will automate huge chunks of your inventory management process. It can monitor stock levels, track items, re-order when items are below par points, and track items throughout the warehouse with barcode and RFID technology.
Given the abundance of options on the market, it’s hard to find a downside to inventory management software. There are programs available that fit a wide range of industries, budgets, and needs. Because of this, it’s mostly just a matter of doing your homework and finding the solution that fits your business.
Frequently Asked Questions
Before we wrap things up, here are answers to some of the most commonly asked questions we get about inventory management:
· Are spreadsheets a good way to manage inventory?
We touched on this in the last section, and the answer is dependent on many factors.
A spreadsheet is a middle-of-the-road solution. It’s better than pencil and paper, but it’s not as good as the software solutions on the market. As your company grows, you’ll discover that the spreadsheet doesn’t scale well and that it’s easy to make errors with this method.
It is, at best, a temporary solution.
· What is an IMS?
An IMS is an inventory management system. It is a software system for tracking inventory levels, orders, sales, and deliveries. It can also be used in the manufacturing industry to create a work order, bill of materials and other production-related documents. Companies use inventory management software to avoid product overstock and outages. It is a tool for organizing inventory data that was generally stored in hard-copy form or in spreadsheets. (via Wikipedia)
· Is an IMS Expensive?
There’s no definitive answer to this question, as expensive is often subjective.
However, there are inventory management solutions for every kind of budget. From low-cost and free software with limited functionality to modular systems that can be custom-fit to your business and cost thousands of dollars a month.
Odds are, there’s a solution out there that offers exactly what you need at a price in your budget range. You’ll be able to try out many different options through demos and free trials to find the one that’s right for you.
· What are the Goals of Inventory Management?
Inventory management covers a lot of territory in terms of how it impacts your business. Here are the three key goals:
1. Provide Exceptional Customer Service
By maintaining the right amount of inventory, you guarantee that customers get the items they want in a timely fashion.
2. Provide Cost-Efficient Operations
Good inventory management allows you to know where your entire inventory is at any given time, thereby ensuring you ship from the most logical and affordable locations and so on. It can also save you money by ensuring you’re using your warehouse space effectively, so you’re not paying for space you don’t need.
3. Minimize Inventory Investment
Utilizing inventory management ensures you’re not spending money on excess inventory you don’t need and prevents you from running out of key items.
· How Do I Know if my Inventory Management is Successful?
Understanding whether your inventory management efforts are successful comes down to measuring some specific key performance indicators. These are the ones we recommend prioritizing:
1. Inventory Turnover
2. Stock Outs
3. Inactive Stock
4. Lost Sales
5. Carrying Costs
6. Order Cycle Time
By tracking these KPIs, you’ll have a clear picture of what’s working in your inventory management efforts and what needs refinement.
· Who is Responsible for Inventory Management?
In the broadest sense, the purchasing department is generally the group in charge of inventory management—specifically, the inventory manager. Sometimes companies will have an inventory control specialist.
The task of implementing inventory management at your business can often feel daunting. Inventory management has many moving parts to keep track of, but the effort is worth it because success in this area can dramatically impact your bottom line.
We’ve gone over some of the basics today, which is plenty to get you started. However, if you have questions or need guidance, we’re here to help.
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