Inventory Management

Inventory management is the practice by which all the physical goods a business sells or uses are purchased and stored. A business with good inventory management can meet sales or production demand at short notice, without overspending on stock it doesn’t need.

The considerable financial outlay involved in buying and storing stock means inventory management is critical to overall financial performance.

Inventory management directly affects a company’s cash flow, sales performance and customer satisfaction, profitability, and – for manufacturers – production efficiency.

Best-practice inventory management uses an orderly system for recording the costs, quantities, age, and locations of inventory items. It also manages the key documents involved, such as customer quotes, sales orders, purchase orders and supplier records.

Increasingly, inventory management also determines the workflows – usually via inventory management software – that connect business operations such as purchasing, warehouse management, production planning, and sales.

Key takeaways:

• Inventory management involves buying and storing goods for sale or use.
• Good inventory management is critical for financial success in businesses that sell physical items.
• Inventory management requires an orderly system for recording data on stock items such as costs, locations, and quantities.
• Inventory management encompasses many business workflows around buying, storing, making, and selling goods.

Inventory management is important because it directly impacts how profitably a business operates. A study by McKinsey & Company found that retailers are sitting on $740 billion in unsold goods in the United States alone. 

Inventory management helps companies avoid overselling or over-purchasing.

Efficient stock management and regular inventory audits mean you always have the right quantities of items in the right place at the right time, ready to meet consumer demand.

As a result, time and budget are spent efficiently to drive greater productivity, inventory carrying costs go down, and profit margins improve.

Inventory management also makes sure that customers receive the correct goods when they expect them – leading to more sales and a positive reputation for your brand.

There are dozens of inventory management benefits to be gained from optimising your stock control processes and implementing the right inventory system.

These can be boiled down to five main advantages:

1. Improves operational efficiency
2. Achieves total inventory visibility
3. Increases profitability
4. Leads to higher customer satisfaction rates
5. Supports sustainable business growth

1. Improves operational efficiency

The primary benefit of inventory management is that it facilitates an efficient and productive approach to controlling stock.

When inventory levels, storage locations, and stock control processes are fully optimised your operational efficiency increases – resulting in fewer costs and faster order fulfilment.

2. Boosts stock visibility

Real-time inventory management helps you understand where all your items and how many are available.

This knowledge is essential for two reasons: managing customer expectations and enabling smart purchasing decisions.

With an effective inventory system in place, you can let customers know exactly what’s in stock and when more is expected to arrive. You’ll also know when to replenish your inventory to avoid stockouts.

3. Increases profit margins

Inventory management eliminates the inefficiencies that lead to lost stock, overstocking, and stockouts – reducing inventory carrying costs and improving profit margins.

Stock management works alongside purchasing and supply chain management to lower the cost and effort required to prepare goods for sale. It minimises the time and labour ordinarily spent on inventory admin.

4. Lifts customer satisfaction

How you manage inventory on a day-to-day basis can grow or diminish your customer satisfaction levels. For a consumer, a late delivery can be an inconvenience.

Nobody wants to receive incorrect orders or late deliveries. Your customers will be much more likely to come back for more if they know your organisation can consistently deliver orders on time and let them know what’s available.

5. Supports sustainable business growth

As businesses scale in complexity, their inventory management requirements get more complex as well. 

New product lines, new staff, new production facilities, and new customers mean new challenges to managing inventory. Putting an effective stock system in place early is key.

The later you leave it, the more it will cost – and the less time you’ll have to do it.

A cloud-based inventory reporting system will also help you analyse business performance from a holistic perspective, unlocking data-driven decisions that help your company flourish.

The inventory management process is a series of workflows that help you track and control stock as it moves from your suppliers’ warehouse or factory to your storage facility, and then on to your customers.

In practice inventory management covers daily activities like purchasing new products or raw materials, managing the correct storage of goods, and fulfilling sales – and improves similar processes such as production management and demand planning.

The inventory management process can be divided into five steps:

• Purchasing
• Production
• Stock control
• Order management
• Reporting

If that sounds complicated, don’t worry – here’s a deep dive into the steps of the stock management process.

1. Purchasing 

Purchasing, also called purchase order management, is the process of sourcing and buying the goods, materials, equipment, and services required to produce and sell products.  

The purchasing manager or purchasing team raises a purchase order – a legally binding document outlining what the purchasing business needs – which is sent to a supplier.

The supplier fulfils the order and delivers the goods or service on the agreed due date. 

2. Production 

Production (also known as manufacturing) is the process in which your finished product is created from its constituent parts.

Not every company will get involved in manufacturing; wholesalers, for instance, might skip this step entirely.

All of the parts, materials, sub-assemblies, and components used to produce a product must be tracked – typically via a document called a bill of materials – so that a business has an accurate understanding of production capacity and costs. 

3. Stock control 

Stock control is the step in inventory management that deals with goods and raw materials once they’ve been purchased or made by a business before they’re sold to a customer. It involves organising where and how inventory is stored and keeping each product line within its minimum and maximum levels.

This step of the inventory management process requires effective auditing of stock levels and warehouse optimisation.

The goal of stock control is to ensure the right quantities of goods are stored in the right location to facilitate efficient order fulfilment.

Stage 4: Order management 

Inventory management also crosses wires with sales in a process called order management. Order management refers to the processing and fulfilment of customer orders. 

There are several steps in the order management process: 

• Order picking
• Packing
• Shipping
• Returns management
• Customer service
• Warehouse management

Because customer satisfaction is a major factor in the success of any business, order management plays a critical role in stock management and should be frequently optimised for efficiency. 

Stage 5: Inventory reporting 

Inventory reporting is the recording and analysis of sales and inventory data to make the best decisions at any given time. It involves tracking key inventory metrics to accurately understand the costs that go in and out of a business.

Reporting feeds directly into important inventory optimisation processes, such as demand forecasting and inventory planning, to enable a business to ensure the right budget allocation and systems are in place for maximum success.

No matter the size of your business, employing some of these common inventory management techniques can be a great way to take control of your stock.

Here are a few key inventory management techniques to consider.

Just-in-time inventory 

Just-in-time (JIT) inventory involves holding as little stock as possible, negating the costs and risks involved with keeping a large amount of stock on hand. The premise is that goods and materials are ordered and used only when they are needed. 

Just-in-case stock control 

Just-in-case (JIC) stock control is an inventory management technique deployed to protect against unexpected demand surges and supply chain disruptions. It enables businesses to reduce the risk of stockouts – and the lost sales that come with them – as well as negotiate fairer prices with suppliers. 

ABC inventory management 

ABC inventory analysis aims to identify the inventory that is earning you profit by classifying goods into different tiers. It’s loosely based on the Pareto principle – the concept that the majority of successes come from a minority of efforts. 

This inventory management technique enables you to make informed decisions around budget allocation, marketing, and purchasing at the product level.

This inventory management technique enables you to make informed decisions around budget allocation, marketing, and purchasing at the product level.

First in, First out (FIFO) 

First in, First out (FIFO) is an inventory costing technique used to measure the value of inventory stock. In FIFO, the items purchased or produced first in a specific product line are the first to be sold to customers. 

This technique facilitates easy inventory accounting and ensures you are assigning the correct value when calculating the cost of goods sold (COGS).

Last in, First out (LIFO) 

Last in, First out is an inventory costing technique that, unlike FIFO, involves selling the most recently purchased or produced items first and retaining older items until newer ones have been sold.

There are several downsides to this technique: namely, it gives an inaccurate picture of the value of inventory in a business and is not accepted under the International Financial Reporting Standards or the tax laws of many countries. 

Learn more: FIFO vs. LIFO – Advantages & Disadvantages 

Weighted average cost

Weighted average cost is an inventory valuation technique that divides the value of goods available for sale by the number of units available for sale to determine a weighted average cost per unit of your inventory stock. It’s used to assign a cost to ending inventory and the cost of goods sold.

Economic order quantity (EOQ) 

The economic order quantity is the optimal order quantity at any given point in time. An optimal EOQ minimises total holding and ordering costs.

As an inventory management technique, EOQ involves using a specific formula to calculate ideal reorder quantities for each SKU. In doing so, you can ensure the efficiency of your replenishment process.

Vendor-managed inventory 

Vendor-managed inventory, or the consignment inventory management technique, allows a consignor, usually a wholesaler, to give their goods to a consignee, usually a retailer, without the consignee paying for the goods upfront.

Cross-docking 

Cross-docking is an inventory management technique that virtually eliminates the need to hold inventory.  

Products are delivered to a warehouse where they are sorted and prepared for shipment immediately. They’re usually then reloaded into other trucks at the same warehouse and sent out for delivery immediately. 

Cycle counting 

The inventory cycle count technique involves counting a small amount of inventory on a specific day without doing an entire stocktake. This method helps your business regularly validate accurate inventory levels in your inventory management software. 

Dropshipping 

Using the dropshipping method, products are stored and managed by your supplier until they’re sold. When a customer places an order, you pass that order on to your supplier and they ship the goods directly to your customer. 

There are myriad strategies for storing and selling your products better.

When deciding which to implement, consider your overarching business goals and the resources available to you.

1. Periodic inventory management

There are two common methods or systems for managing inventory: Periodic and Perpetual.

Periodic inventory management is an inventory and accounting methodology where inventory and its value are measured at set intervals.

In periodic inventory management staff physically count every item in stock at the end of a set time – typically once per accounting period. This provides an ending inventory balance, which can be compared to the opening inventory balance to calculate an average inventory figure.

The average inventory can then be used in conjunction with inventory accounting metrics such as Cost of Goods Sold (COGS) to calculate figures such as the inventory turnover ratio.

2. Perpetual inventory management 

Perpetual inventory management is an inventory and accounting methodology where inventory and its value are measured continuously.

In perpetual inventory systems, the number (or volume) of goods is tracked in near-real time. Stock-on-hand values are also updated live.

COGS is often calculated according to the average landed cost methodology, which takes a weighted average of the different prices paid for goods to calculate their value.

3. Demand planning 

Demand planning is when a business attempts to predict what future customer demand will be for each product they sell. This strategy enables businesses to better allocate their spending and resources and understand upcoming storage requirements.

“In the post-pandemic world, when uncertainty arises almost daily from any number of sources – demand and price shocks, supply disruptions, shipping delays, and labour shortages – managers need a better system that doesn’t just whipsaw in reaction to uncertainty but tells them proactively what to do and what to expect over the medium and long-term time horizons.” – A New Approach to Production & Inventory Planning (Harvard Business Review)

4. Inventory optimisation 

Inventory optimisation is applying a calculated approach to inventory management to keep costs and excess inventory low while improving customer satisfaction and fulfilment times. It also focuses on ensuring there is enough capital available in a business to facilitate healthy growth.

5. Warehouse optimisation 

Warehouse management plays a critical role in managing inventory effectively.

By optimising your warehouse layout, processes, and staff training you can minimise the time and cost of labour efforts required to manage inventory.

Inventory management best practices enable businesses to optimise their stock control processes while avoiding risks and bottlenecks.

Recent research found that 99% of retailers are losing revenue due to unsold inventory stock. By adhering to these practices, you can avoid lost revenue and storage challenges by ensuring the right amount of stock is always available to meet demand and avoid overstock.

6 key inventory management best practices: 

1. Correctly categorise your inventory
2. Implement perpetual inventory management software
3. Set optimal safety stock levels
4. Perform regular stock takes
5. Set optimal min and max levels for inventory
6. Optimise your inventory control processes

1. Correctly categorise inventory

Organise your inventory goods based on specific criteria such as usage, demand, or value to ensure resources and attention are focussed on the most critical items.

2. Use a perpetual inventory system

For the most accurate data, consider using perpetual inventory management software, as it is the best way to ensure the information you need is always at your fingertips.

Perpetual inventory software provides real-time data and analytics, meaning your inventory tracking process becomes fully automated and can reveal highly actionable insights about your business.

3. Set ideal safety stock levels

Safety stock helps prevent stockouts that are caused by fluctuations in supply or demand.

It acts as insurance against supply chain disruptions and shifts in consumer desires.

Calculate optimal safety stock levels using the safety stock formula to protect your business from these potential challenges.

4. Perform regular stock takes

Stock takes, also known as stock counts, help you understand how much of each item you have available. You can use stocktaking software to streamline this process, but it’s important to perform semi-regular manual counts to spot any discrepancies caused by shrinkage or spoilage. 

5. Set optimal min and max stock levels

To avoid stockouts or having too much capital tied up in inventory, it’s important to set optimal min and max stock levels for every item.

These will inform your replenishment decisions and help you optimise the purchasing process.

6. Optimise your inventory control process

Dealing with different order quantities, replenishment cycle times, safety stock, forecasts, and seasonality can be complicated.

But it doesn’t have to be.

Tweak each operation according to your specific business – making sure to keep track of what works and what doesn’t.

There are two main types of inventory management systems: manual and automated.

Inventory management must be flexible to work inside so many different business models. As a result, it comes in all shapes and sizes.

1. Traditional inventory management system

Traditional inventory management refers to paper- or spreadsheet-based systems where inventory is managed manually. This type of inventory management is best suited to very small businesses with fewer materials and products to manage.

2. Automated inventory management system

Automated inventory management involves the use of modern inventory systems, such as software and barcode scanners, to streamline or eliminate the tedious manual processes involved with managing goods.

3. Consignment inventory management

Consignment stock is goods held by one business but owned by another – typically the wholesaler or manufacturer – and management of this inventory, therefore, requires special considerations.

4. ERP inventory management system

A more comprehensive alternative to inventory software, ERP inventory systems are a type of software platform that integrates stock management with finance, logistics, accounting, and other key business functions.

5. 3PL inventory management

Third-party logistics (3PL) inventory management is an approach to inventory control that enables a business to track and manage stock held by a fulfilment service provider – often across multiple 3PL warehouses.

Cloud-based inventory management software is a perpetual inventory system that captures and controls inventory data, allowing businesses to better manage their stock.

Inventory software helps you reduce your admin time and drastically cut back on unnecessary inventory costs – both of which positively impact your bottom line.

“Inventory management software can automatically prioritise orders based on available inventory, customer location, and other factors, reducing fulfilment time and improving customer satisfaction.” - Framework for Optimized Sales and Inventory Control by Seventh Sense Research Group

Features of inventory management software

Inventory management software does more than help you control and process inventory.

Many systems will include features that aid in other related aspects of operations, such as procurement, supply chain management, manufacturing, and sales.

Some common inventory management software features include:

• Inventory management
• Purchasing management
• Supplier management
• Inventory reporting and analytics
• Production planning
• Batch tracking
• Demand forecasting
• Barcode scanning
• Warehouse management
• Multichannel order management
• B2B eCommerce
• Bill of materials management

Some specialist tools may also offer features tied to a specific industry, business need, or operational style – such as customer management, food and beverage manufacturing, and product design.

Inventory management can look a little different depending on the size and industry of your business. To better highlight these contrasts, let’s explore some of the more common inventory management examples you’re likely to encounter.

Retail inventory management 

Retail inventory management is typically a fast-moving environment.

Products on shelves need to be replaced promptly to avoid missed sales.

Because the need to meet customer demand is especially high for retail shops, retailers must walk a fine line between running out of stock and carrying more inventory than they can manage. 

Warehouse inventory management 

Warehouse inventory management is perhaps the most known example of inventory management in a business. This refers to the controlling of goods and materials inside a warehouse – a facility specifically designed for holding inventory. 

Wholesalers and large retailers or distributors are most likely to manage warehouse inventory because they typically hold more stock than smaller operations. 

Ecommerce inventory management 

Ecommerce inventory management refers to the tracking and control of goods sold online through various ecommerce marketplaces and platforms.

Because of the high volume of sales associated with ecommerce, it presents unique challenges around ensuring there is enough stock available to meet demand. 

The good news is that the challenges and solutions are largely the same.

Multichannel inventory management allows sellers to connect all their sales channels in one place, making it a top-priority feature in ecommerce inventory software. 

Manufacturing inventory management 

Manufacturing inventory management is a core function of production management and involves several unique aspects – specifically, the control of the various raw materials, components, and assemblies required to build a product. 

This example of inventory management comes with a long history of optimisation efforts, as manufacturing businesses frequently seek to create a lean business environment. 

A large part of managing manufacturing inventory is the elimination of wasteful activities and the reduction of costs associated with holding and creating goods. 

Learn more: The 8 Types of Inventory in Manufacturing

Inventory accounting deals with valuing and accounting for changes in assets.

An accurate inventory accounting system keeps track of changes to inventory at all three stages and adjusts asset values and costs accordingly.

By integrating inventory management with accounting, you can achieve maximum financial visibility and stay on top of four critical aspects of running a business: Accounts Payable, Accounts Receivable, Cost of Goods, and Inventory Reporting.

Inventory costs

Here we break down the different types of costs commonly associated with inventory management:

Carrying costs - The costs associated with storing and maintaining physical inventory.

• Storage costs
• Overheads
• Insurance costs
• Property taxes
• Shrinkage costs
• Capital costs

Equipment and technology costs - The costs of using hardware and software to improve inventory management.

• Subscription costs
• Maintenance and repair costs
• Depreciation costs
• Licensing fees
• Staff training costs

Opportunity costs - The costs of losing potential benefits when inventory is mismanaged.

• Lost sales costs
• Brand reputation damage
• Expedited shipping costs
• Cancelled order costs

Ordering costs - The costs associated with placing and receiving orders.

• Administrative costs
• Receiving costs
• Returns costs
• Shipping costs

Production costs - The costs associated with manufacturing a product.

• Direct materials costs
• Direct labour costs
• Manufacturing overhead
• Cost of goods manufactured

Save time calculating inventory costs: Visit our inventory calculators page. 

Here’s a quick comparison of a few similar terms commonly associated with inventory management.

Inventory management vs inventory control

Inventory control is a subset of inventory management that specifically focuses on maintaining optimal inventory levels. Inventory management refers to the holistic approach that connects inventory control with purchasing, sales, and production.

Inventory management vs warehouse management

Inventory management is primarily concerned with the storage, organisation, and movement of inventory stock.

Warehouse management, on the other hand, focuses on improving the efficiency of a storage facility by optimising its layout, streamlining order fulfilment processes, and managing staff and equipment.

Inventory management vs asset management

Asset management deals with the optimal use and maintenance of all physical assets such as buildings, machinery, and tools. Unlike inventory management, it concerns all items used in the operation of a business, and aims to squeeze the maximum performance from a company’s assets.

Inventory management vs supply chain management

Inventory management is one of the key pillars of effective supply chain management. When an optimised and holistic inventory management plan is successfully executed, supply chain efficiency increases – and your inventory carrying costs plummet.

Inventory management vs ERP

Enterprise resource planning (ERP) is a holistic business strategy that provides an integrated approach to a company’s core operations. It connects inventory management with other processes not typically managed in an inventory system, such as HR, finance, and CRM.

• Average Inventory - A metric that determines the mean amount or value of inventory held by a business over a specific period.
• Backorder - A customer order that’s unable to be fulfilled immediately and is shipped later, when all ordered items become available.
• Bill of Materials (BOM) - A list containing all items, quantities, and assemblies required to build a product or component.
• Carrying Cost - The total sum of any costs associated with holding physical inventory until it is sold.
• Cost of Goods Sold (COGS) - The total cost of producing or preparing a product for sale, including any direct materials, direct labour, and manufacturing costs.
• Days Inventory Outstanding (DIO) - A formula that measures the average number of days inventory is held in a business.
• Dead Stock - Inventory that is unlikely to sell but is still kept in a company’s storage facility. Also known as obsolete inventory.
• Demand Forecasting - The process of analysing historical sales data, industry trends, and buying patterns to estimate future sales demand for a product.
• Finished Goods - Inventory that has completed all stages of the production process and is ready to be sold.
• Inventory Turnover - The frequency at which inventory is sold and replaced by a business during a specific period.
• Lead Time - The total amount of time it takes for an order to be received by a customer, or for a product to complete the production process.
• Order Fulfilment - The process of receiving, picking, packing, and shipping the items ordered by a customer.
• Reorder Point - The process of receiving, picking, packing, and shipping the items ordered by a customer.
• Replenishment - The process of reordering stock to restore inventory levels to their ideal on-hand quantities.
• Safety Stock - A buffer of inventory held by a business to mitigate the risk of supply chain disruptions.
• Shrinkage - The reduction of inventory levels caused by unexpected losses such as theft or spoilage.
• Stock-keeping Unit (SKU) - An alphanumeric code assigned to each item in a company’s inventory to distinguish them from one another.
• Stock Take - A process undertaken to determine accurate on-hand inventory levels in a business. Also known as a stock count.