What is Inventory Management? And why does it matter to your business?
It seems not long ago that the term ‘Inventory Management’ meant just bringing in a massive amount of stock and then counting it every 6-12 months.
This mentality is now totally antiquated and downright inefficient. These days, inventory is a placeholder for money and needs to be managed accordingly.
Both buying and holding this 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.
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.
Why is inventory management 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.
How can inventory management help you:
1. Avoid spoilage
If you’re selling a product that has an expiry date, 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 usually 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
Your inventory is a product that you’ve likely already paid for with cash. But while it’s sitting in your warehouse, it’s definitely not cash.
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.
Essential inventory management techniques
Inventory management is a highly customizable part of doing business. The optimal inventory control method is different for each company. Regardless of the system you use, the following will improve your inventory management—and cash flow.
Set par and reorder levels
Setting a par level for your product allows you to ensure there is product on hand at all times. When your inventory dips below these predetermined levels, you know it’s time to order more.
Setting par levels requires some upfront research and decision making, as each product is consumed and replenished at different rates.
There are 3 main stock consumption methods available. First in First out (FIFO), Last in First out (LIFO) and Just in time (JIT).
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. This is the most common technique.
LIFO 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. 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, and hence it is not a common strategy.
JIT is more risky, although if done correctly can benefit the business financially. Effectively you keep the lowest inventory levels possible to still meet demand and replenish before a product goes out of stock.
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.
While a digital inventory trail is essential, it’s not always perfect. Regular reconciliation is vital to ensure physical stocks equal what your digital systems show. Techniques can be tradition periodic stocktaking, sporadic spot checking, and/or cycle counting procedures.
Prioritize your key stock
Some products drive more revenue than others. You can grade the value of your stock based on a percentage of your revenue and make sure you always have these products on hand so you don't miss out on future sales.
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, such as; market trends, previous sales, projected growth, contract sales guarantees, planned promotions, etc.
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.
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.
An effective inventory management system can help reduce costs, keep your business profitable, analyse 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.