I used to dread the word “inventory.” As a part-time cashier in high school, the word meant only one thing: lots and lots of counting. It’s common for businesses to reconcile their inventory at the end of the year by counting all their physical stock 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 effective inventory management is crucial for growing a company. Just like cash flow, it can make or break your business.
Table of contents
- What is inventory management?
- Why is inventory management important?
- Inventory management helps you:
- Inventory management improves cash flow
- 11 essential inventory management techniques
- An inventory management system can work for a small business
- Take control of your inventory
- Inventory management FAQs
What is inventory management?
Inventory management is the act of keeping track of your ecommerce 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.
What is inventory control?
Inventory control can be used interchangeably with inventory management. Essentially, it refers to when you have control over your stock, typically due to effective inventory management processes. It’s much easier to maintain control of your inventory with centralized inventory management.
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. Inventory management also helps your business in a number of other ways.
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. Managing inventory effectively 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 adopting a diligent strategy, you can address this costly inventory mistake.
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.
Learn more: Everything You Ever Wanted to Know About Fulfillment Services
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 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 phone 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). 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 in real time, and based on sales you can project when you’ll run out so you can replace it before then. Not only does this help ensure you don’t lose sales (critical for cash flow), it also lets you plan ahead for buying more by ensuring you have enough cash set aside.
Money spent on inventory is money that is not spent on growth. Manage it wisely.
11 essential inventory management techniques
Inventory management is a highly customizable part of doing business. The optimal inventory control method is different for each company.
However, every business should strive to remove human error from inventory management as much as possible, which means taking advantage of inventory management software. If you run your business with Shopify, inventory management is already built in.
Regardless of the system you use, the following will improve your inventory management—and cash flow.
- Set par levels
- First in, first out (FIFO)
- Manage relationships
- Contingency planning
- Regular auditing
- Prioritize with ABC
- Accurate forecasting
- Last in, first out (LIFO)
- Just-in-time (JIT)
- Safety stock
- Reorder point
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 dips below these 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 upfront research and decision making, they’ll systemize the ordering process. Not only will it be 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.
By using a smart third-party fulfillment provider, you can set these tripwires early and use them to build better demand forecasting and understand your seasonal inventory needs.
The Shopify Fulfillment Network offers smart inventory allocation across our warehouses, coupled with a Success Team to consult on your fulfillment strategy—ultimately helping you set par levels, manage the relationships with all warehousing partners, and spot check your product. Learn more about scaling with Shopify’s fulfillment solution.
2. First in, first out (FIFO)
First-in, first-out (FIFO) 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 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 or generating a lot of purchase orders so they can adjust production. Ask them to notify you 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 in stock. However, it’s important to make sure the facts match up. There are several methods for doing this.
A physical inventory, or stock take, is the practice of 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
Some products drive more revenue than others. You can use an ABC analysis report to grade the value of your stock based on a percentage of your revenue:
- A = % of stock that represents 80% of your revenue
- B = % of stock that represents 15% of your revenue
- C = % of stock that represents 5% of your revenue
Therefore, your A stock represents your most profitable and valuable products. You’ll want to make sure you always have these products on hand so you don't miss out on future sales. Your C stock is your slow-moving or dead stock. This is stock you might want to sell at a discount, so you can get it off your shelves and free up cash from your inventory.
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. Last in, first out (LIFO)
The last in, first out, or LIFO, inventory management method assumes that the merchandise you acquired most recently was also sold first. The last to be bought is assumed to be the first to be sold. It’s essentially the opposite of FIFO.
This works under the assumption that prices are steadily rising, so the most recently purchased inventory will also be the highest cost. That means that higher costs will yield lower profits, and, therefore, lower taxable income—this is pretty much the only reason it makes sense to use LIFO.
In general, LIFO is a really difficult method to actually use to manage inventory. If you keep your oldest merchandise on the back of the shelf, it’s more likely to become obsolete and unsellable at a certain point. This rings true for both perishables and non-perishables. Items can get damaged, worn, and outdated.
9. Just-in-time (JIT)
Just-in-time, or JIT, inventory management is for the risk takers out there, though effective inventory management mitigates a lot of that risk. With JIT, you keep the lowest inventory levels possible to still meet demand and replenish before a product goes out of stock.
This requires careful and accurate planning and forecasting, but works well for rapidly growing brands with calculated launches and product line extensions.
💡 Tip: If you need to receive direct notifications of low stock levels, then install an inventory alert app from the Shopify App Store.
10. Safety stock
Safety stock is like an emergency fund—it’s basically inventory you “set aside” for use in case of emergency. It acts as more of a threshold for when you need to reorder merchandise before dipping into your emergency stock allocation.
Safety stock has a formula:
Safety Stock = (Maximum Daily Usage x Maximum Lead Time) - (Average Daily Usage x Average Lead Time)
It’s a good idea to work safety stock into your inventory management strategy in case your supply chain is disrupted, your merchandise is damaged, or some other unforeseen circumstance prevents your ability to receive or manage merchandise.
11. Reorder point
The reorder point tells you the level at which it’s time to replenish your stock. Once you know your safety stock level, you can consider lead time with your supply chain to determine the ideal point at which it’s time to place your order.
You can use the following formula to calculate the reorder point in your business:
Reorder Point = Lead Time Demand + Safety Stock
Calculating reorder points is vital for effective stock management, but it can be incredibly time consuming when dealing with a large number of products. A powerful inventory management system makes it a lot easier.
An inventory management system can work for a small business
While many small businesses start out with the old-school pen-and-paper method, this gets unwieldy quick—especially if you have growth goals. Not to mention it makes you more vulnerable to human error, which can lead to costly business mistakes.
When you use a powerful inventory software to help you track stock, you get access to benefits like stock alerts, automated purchase orders, year-end inventory reporting, and user permissions and accounts. Combined, inventory tracking software features give you complete control and insight into your business and how inventory moves from suppliers to customers and everywhere in between.
An inventory management system like Stocky, Shopify's inventory management solution for Shopify POS Pro, provides you these advanced inventory management features, and syncs with your Shopify store in real time. The best part is it grows with you—so you can scale your business with a tech stack capable of handling your inventory now and in the future.
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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 for the unexpected. With proper inventory management, 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.
Original Article: https://www.shopify.com/blog/inventory-management