Inventory management: issues, optimization, and methods
Inventory control is often cited as a key factor in the success of a business. But how much do you actually know about it? Erplain can help you with your inventory management from A to Z. In this article, we are taking a detailed look at the importance of stock management and the various techniques available.
What is inventory management?
A key part of the supply chain
Inventory management is how you keep track of your merchandise and is a key part of supply chain management (SCM). For a business, it isn't simply about knowing how much inventory you have, it also tells you about a product’s location, weight, size, and quality. Inventory control helps you to reduce the storage and holding costs for merchandise. If a business tracks their inventory in real time, it means they can restock when needed. There are different types of inventory:
- Raw materials, which are the materials needed to produce goods. Wood, plastic, metal, and fabric are examples of common raw materials. There is a distinction between direct raw materials (wood to make a chair for example) and indirect raw materials (such as oil for maintaining a machine).
- Products in production, which are unfinished products that still need to be turned into finished products.
- Finished products, which are processed products that can be sold as they are.
- Products for maintenance, repairs, and use, meaning products that are required for production but that are not the finished product. These include safety equipment, office and cleaning supplies, and even computers and printers.
Why is inventory management important?
Inventory management is an essential tool. Poor stock control results in lost earnings (understocking) or unnecessary costs (surplus). Certain industries involve a lot of perishable goods (food, beauty, etc.). Inventory control helps reduce merchandise waste. It also helps avoid dead stock. These are any obsolete or out of season goods that have a low or non-existent stock rotation.
How storage affects your cash flow
A business that keeps too many products in stock faces higher storage costs. As well as saving on storage costs, optimized stock management improves cash flow. Products have to be stored from the moment you buy them to the moment they’re sold. This has an impact on your available cash flow. To optimize your cash flow and working capital requirement (WCR), good stock control goes hand in hand with good order management.
There may be countless advantages to inventory control, but you need to manage them well. A lot of SMBs regularly make the same mistakes with their inventory management. Stock management performed manually, at a later date or separately from orders, and a lack of a strategic vision are all errors to avoid. Poor stock control leaves you exposed to a number of risks, most notably:
- a sudden hike in demand and insufficient inventory to meet it;
- a budget deficit that prevents you from placing new orders;
- stock-outs, meaning you cannot fulfill orders;
- unforeseen events such as production shutting down in-house or with a supplier, or delayed delivery of your replenishment orders;
- customer dissatisfaction caused by stock-outs and late deliveries;
- a lack of storage space at certain busy times of the year (Christmas, seasonal products, etc.).
What are the different techniques for managing inventory?
Every business is free to choose their own stock management method. The main inventory control techniques include:
- Stock forecasting, or sales projection, which is based on various criteria (seasonality and market trends, past sales, growth rate, guaranteed sales, etc.)
- A reorder point is the minimum level of inventory at which a business orders more products. This is so a company does not have more products than it needs to maintain its business. A minimum inventory level must be defined for each product, according to the replenishment lead time and speed of sales. The reorder point concept is closely linked to the notion of safety stock. Functioning as emergency inventory, safety stock is a reserve to be used while you’re waiting for replenishment. To determine your level, you need to factor in normal delivery conditions as well as allowing a margin for unforeseen events. This margin allows for any supply chain disruptions caused by late deliveries or receiving damaged merchandise.
- The ABC analysis involves differentiating between products depending on the share of your revenue they represent. Businesses that use this method divide their product families into three distinct categories: A, B and C. Category A is the inventory that brings in 80% of your revenue. Category B represents 15% of your revenue, compared to 5% for category C. In other words, A inventory includes all the most important products. This is the category that the business needs to concentrate most of its efforts on. The amount of inventory must always be enough to satisfy demand. Conversely, C inventory corresponds to dead stock, meaning stock with a slow rotation. If a business has limited storage capacity or demand is lower than expected, it can reduce the price of C stock to speed up sales.
- The Economic Order Quantity (EOQ) refers to the amount you need to order to reduce your total inventory management cost. This is also known as the Wilson formula. The total cost of inventory control is made up of inventory acquisition costs and holding costs, with:
Depending on your sector, choose the flow management method best suited to managing replenishment:
- The Just-in-Time (JIT) technique requires a certain confidence and knowledge of the market. Popularized by Toyota, this modern, efficient inventory control method aims to reduce the risks of overstocking. It involves maintaining as low a stock level as possible. The amount of merchandise stored should be just enough to meet demand in real time. The business then replenishes when it receives an order, “just in time” to satisfy its customers when they need the product. You need very precise sales forecasting to implement this innovative technique. This method is great for brands that have seen rapid growth and plan every product launch or range extension meticulously.
- The First In, First Out (FIFO) method is specially designed for perishables. It involves selling based on a product’s date of acquisition. The first product to enter the inventory is the first to leave. In practice, FIFO is suitable for a number of product categories, including items with no expiration date (ED). The first products put into storage risk deteriorating the fastest, which is why they need to be sold first. Especially as the packaging and certain characteristics can degrade and become obsolete over time. The aim is to avoid the risk of storing products that might fall out of fashion and become hard to sell. Products in storage must be well organized so that the oldest stock is easily accessible.
- FIFO contrasts with the Last In, First Out (LIFO) method. This takes the opposite approach, giving priority to selling the most recently acquired products. The last product bought and stored will be the first sold to customers. This principle is pertinent for managing inventory where the price has a tendency to rise. This means the most recent stock will be more expensive. For the company, these higher acquisition costs equate to lower profits. This is the only reason that would make LIFO advantageous. This technique is less popular than FIFO and is considered to be harder to implement. The oldest products stored at the back of the warehouse tend to become harder to sell over time, which makes FIFO a better option. But while LIFO is out of the picture for perishables, there’s nothing to stop a company that sells non-perishable items from favoring LIFO.
But stock control isn't just a question of formulas, calculations, and technical logistics. When it comes to logistics management, success goes hand in hand with expertise and a few best practices.
What are the best practices for inventory management?
Here are a few tips to implement when it comes to best practices for stock control:
- Setting alerts for stock-outs to optimize response times;
- Introducing SKU product references and barcodes;
- Tracking batch numbers and serial numbers for improved traceability;
- Knowing the value of your stock at any given moment;
- Checking the stock rotation rate (you can find out the turnover rate for your stock by doing regular physical inventories);
- Don’t forget your outsourced inventory. With consignment, the consignor sends products to a vendor (the consignee) and is only paid when the merchandise is sold. The consignee can return any unsold products to the sender, who is obliged to take them back. From a legal standpoint, the consignor retains full ownership of the consigned inventory until it is sold by the vendor;
- Make sure you maintain a good relationship with your suppliers. Particularly when you are placing an order and negotiating prices and minimum amounts. It’s also important to communicate well with your partners so you remain clear and transparent. Inform your suppliers of busy periods so they can adapt their means of production and delivery capacity. Equally, you should also inform the supplier in the event of business slowing down or if a product sells badly;
- In-house, entrust inventory management to a single expert, especially if your business is experiencing a period of growth. The role of the inventory manager is to track stock levels, manage orders and payments, and negotiate with suppliers.
Key tool for stock control
But if there is one winning strategy for effective inventory management, it has to be automation. Any business with ambitious plans for growth soon abandons manual inventory control. Excel spreadsheets take the place of pen and paper. But the limits of using Excel soon become clear. Not to mention the risk of human error. That’s why more and more businesses are opting for inventory management software. As well as saving you time (and therefore money), this type of inventory software gives you direct access to features such as:
- inventory level alerts;
- automated ordering;
- annual inventory reports.
An inventory management tool gives you a comprehensive overview of your business, for better tracking and checks for your entire logistics process. Produce reliable projections and maximize customer satisfaction.