I used to dread the word “inventory.” As a part-time cashier in high school, the word inventory only meant one thing: lots and lots of counting. It’s common for businesses to reconcile their inventory at the end of the year by counting up all their physical product and making sure it matches what's on the books. For big companies like the one I used to work for, this requires everyone's help.
These days, I understand just how important solid inventory management is. Inventory is a placeholder for money. You paid money for your inventory, and you’ll get that money back (and then some) when you sell it.
Holding inventory ties up a lot of cash. That's why good inventory management is crucial for growing a company. Just like cash flow, it can make or break your business.
What is inventory management?
Inventory management is the act of keeping track of a company’s stocked goods and monitoring their weight, dimensions, amounts, and location. The goal of inventory management is to minimize the cost of holding inventory by helping business owners know when it’s time to replenish products, or buy more materials to manufacture them.
Why inventory management is important
Effective inventory management is essential for ensuring a business has enough stock on hand to meet customer demand. If inventory management is not handled properly it can result in a business either losing money on potential sales that can’t be filled, or wasting money by stocking too much inventory. An inventory management system can also help you prevent a number of other mistakes:
Inventory management saves you money
1. Avoid spoilage
If you’re selling a product that has an expiry date, like food or makeup, there’s a very real chance it will go bad if you don’t sell it in time. Solid inventory management helps you avoid unnecessary spoilage.
2. Avoid dead stock
Dead stock is stock that can no longer be sold, but not necessarily because it expired—it could have gone out of season, out of style, or otherwise become irrelevant. By managing your inventory better, you can avoid dead stock.
3. Save on storage costs
Warehousing is often a variable cost, meaning it fluctuates based on how much product you’re storing. When you store too much product at once or end up with a product that’s difficult to sell, your storage costs will go up. Avoiding this will save you money.
Inventory management improves cash flow
Not only is good inventory management more cost-efficient, it improves cash flow in other ways, too. Remember, inventory is product that you’ve likely already paid for with cash (checks and electronic transfers included) and you’re going to sell it for cash, but while it’s sitting in your warehouse it’s definitely not cash. Try paying your landlord in dog collars or iPhone cases.
This is why it’s important to factor inventory into your cash flow management. Inventory directly affects sales (by dictating how much you can sell) and expenses (by dictating what you have to buy), and both of these elements factor heavily into how much cash you have on hand. In short, better inventory management leads to better cash flow management.
When you have a solid inventory system you’ll know exactly how much product you have, and based on sales you can project when you’ll run out and make sure you replace it on time. Not only does this help ensure you don’t lose sales (critical for cash flow), but it also lets you plan ahead for buying more so you can ensure you have enough cash set aside.
Money spent on inventory is money that is not spent on growth. Manage it wisely.
8 essential inventory management techniques
Inventory management is a highly customizable part of doing business. The optimal system is different for each company.
However, every business should strive to remove human error from inventory management as much as possible, which means taking of advantage inventory management software. If you run your business with Shopify, inventory management is already built in.
Regardless of the system you use, the following eight techniques to will help you improve your inventory management—and cash flow.
1. Set par levels
Make inventory management easier by setting “par levels” for each of your products. Par levels are the minimum amount of product that must be on hand at all times. When your inventory stock dips below the predetermined levels, you know it’s time to order more.
Ideally, you’ll typically order the minimum quantity that will get you back above par. Par levels vary by product and are based on how quickly the item sells and how long it takes to get back in stock. Although setting par levels requires some research and decision-making up front, having them set will systemize the process of ordering. Not only will it make it easier for you to make decisions quickly, it will allow your staff to make decisions on your behalf.
Remember that conditions change over time. Check on par levels a few times throughout the year to confirm they still make sense. If something changes in the meantime, don’t be afraid to adjust your par levels up or down.
2. First-In First-Out (FIFO)
“First-in, first-out” is an important principle of inventory management. It means your oldest stock (first-in) gets sold first (first-out), not your newest stock. This is especially important for perishable products so you don’t end up with unsellable spoilage.
It’s also a good idea to practice FIFO for non-perishable products. If the same boxes are always sitting at the back, they’re more likely to get worn out. Plus, packaging design and features often change over time. You don’t want to end up with something obsolete that you can’t sell.
In order to manage a FIFO system, you’ll need an organized warehouse. This typically means adding new products from the back, or otherwise making sure old product stays at the front. If you’re working with a warehousing and fulfillment company they probably do this already, but it's a good idea to call them to confirm.
3. Manage relationships
Part of successful inventory management is being able to adapt quickly. Whether you need to return a slow selling item to make room for a new product, restock a fast seller very quickly, troubleshoot manufacturing issues, or temporarily expand your storage space, it’s important to have a strong relationship with your suppliers. That way they’ll be more willing to work with you to solve problems.
In particular, having a good relationship with your product suppliers goes a long way. Minimum order quantities are often negotiable. Don’t be afraid to ask for a lower minimum so you don’t have to carry as much inventory.
A good relationship isn’t just about being friendly. It’s about clear, proactive communication. Let your supplier know when you’re expecting an increase in sales so they can adjust production. Have them let you know when a product is running behind schedule so you can pause promotions or look for a temporary substitute.
4. Contingency planning
A lot of issues can pop up related to inventory management. These types of problems can cripple unprepared businesses. For example:
- Your sales spike unexpectedly and you oversell your stock
- You run into a cash flow shortfall and can't pay for product you desperately need
- Your warehouse doesn’t have enough room to accommodate your seasonal spike in sales
- A miscalculation in inventory means you have less product than you thought
- A slow moving product takes up all your storage space
- Your manufacturer runs out of your product and you have orders to fill
- Your manufacturer discontinues your product without warning
It’s not a matter of if problems arise, but when. Figure out where your risks are and prepare a contingency plan. How will you react? What steps will you take to solve the problem? How will this impact other parts of your business? Remember that solid relationships go a long way here.
5. Regular auditing
Regular reconciliation is vital. In most cases, you’ll be relying on software and reports from your warehouse to know how much product you have stock. However, it’s important to make sure the facts match up. There are several methods for doing this.
A physical inventory is the practice is counting all your inventory at once. Many businesses do this at their year-end because it ties in with accounting and filing income tax. Although physical inventories are typically only done once a year, it can be incredibly disruptive to the business, and believe me, it’s tedious. If you do find a discrepancy, it can be difficult to pinpoint the issue when you’re looking back at an entire year.
If you do a full physical inventory at the end of the year and you often run into problems, or you have a lot of products, you may want to start spot checking throughout the year. This simply means choosing a product, counting it, and comparing the number to what it's supposed to be. This isn’t done on a schedule and is supplemental to physical inventory. In particular, you may want to spot check problematic or fast-moving products.
Instead of doing a full physical inventory, some businesses use cycle counting to audit their inventory. Rather than a full count at year-end, cycle counting spreads reconciliation throughout the year. Each day, week, or month a different product is checked on a rotating schedule. There are different methods of determining which items to count when, but, generally speaking, higher-value items will be counted more frequently.
6. Prioritize with ABC
Certain products need more attention than others. Using an ABC analysis lets you prioritize your inventory management by separating out products that require a lot of attention from those that don’t. Do this by going through your product list and adding each product to one of three categories:
- High-value products with a low frequency of sales
- Moderate value products with a moderate frequency of sales
- Low-value products with a high frequency of sales
Items in category A require regular attention because their financial impact is significant but sales are unpredictable. Items in category C require less oversight because they have a smaller financial impact and they're constantly turning over. Items in category B fall somewhere in-between.
7. Accurate forecasting
A huge part of good inventory management comes down to accurately predicting demand. Make no mistake, this is incredibly hard to do. There are countless variables involved and you’ll never know for sure exactly what’s coming—but you can try to get close. Here are a few things to look at when projecting your future sales:
- Trends in the market
- Last year’s sales during the same week
- This year's growth rate
- Guaranteed sales from contracts and subscriptions
- Seasonality and the overall economy
- Upcoming promotions
- Planned ad spend
If there's something else that will help you create a more accurate forecast, be sure to include it.
8. Consider dropshipping
Dropshipping is almost an ideal scenario from an inventory management perspective. Instead of having to carry inventory and ship products yourself—whether internally or through third-party logistics—the manufacturer or wholesaler takes care of it for you. Basically, you completely remove inventory management from your business. Even if you just want to use dropshipping to test new inventory before investing in a big order, it can be a great addition to your business.
Many wholesalers and manufacturers advertise dropshipping as a service, but even if your supplier doesn’t, it may still be an option. Don’t be afraid to ask. Although products often cost more this way than they do in bulk orders, you don't have to worry about expenses related to holding inventory, storage, and fulfillment. You can test out dropshipping today, with Oberlo, for free.
Take control of your inventory
Remember that with an effective inventory management system in place, you can help reduce costs, keep your business profitable, analyze sales patterns and predict future sales, and prepare the business for the unexpected. With proper inventory management system in place, a business has a better chance for profitability and survival.
It’s time to take control of your inventory management and stop losing money. Choose the right inventory management techniques for your business, and start implementing them today.