The primary objective of Inventory Management is to make sure that you have just the right amount of inventory on hand to meet customer demand.
Without proper Inventory Management, a business will not be able to keep up with orders from its customers for a very simple reason – it will not have enough raw material, components or parts to manufacture its own products, or it won’t have enough finished products acquired from suppliers to resell.
If you see empty shelves in stores or a long backlog of unfinished orders or customers canceling orders or loss of revenue and profit, you can often point the finger at one problem – Poor Inventory Management!
Here’s what we’ll cover in this article:
- What is inventory?
- Inventory management defined
- The 7 Key Objectives of Inventory Management
- The techniques used for managing inventory
- Key Takeaways
What is Inventory?
Inventory refers to the list of items including raw materials, components, partially finished products and finished products that a company acquires or manufactures for sale.
If you’re a manufacturer, “Doing Inventory” refers to the action of counting these items as they go through the production process from raw materials to a work-in-progress to a finished product.
Similarly, if you’re a retailer or reseller, “Doing inventory” would refer to the action of counting products as you acquire them from a vendor or supplier, store them in your warehouse, transfer them to a shop and/or ship them to customers.
What is Inventory Management?
Inventory Management is the systematic process of managing the procurement, storage, tracking, transfer and shipment of all types of inventories including raw materials, parts, work-in-progress and finished products as required by a business.
To perform Inventory Management, you would typically use Inventory Management software or system.
You could use Excel while your business is still small but as you grow you will need to consider a more professional system.
The Objectives of Inventory Management
It’s neither good to have too much inventory nor to have too little inventory.
If you have excess inventory, it means you’ve got money locked into raw materials or products for which there aren’t enough customers.
If you have insufficient inventory, you may not have on hand or be able to manufacture enough products to meet customer demand.
Sound Inventory Management techniques will help you find the right balance so that you always have the optimal amount of inventory to meet customer demand.
Here are the top 7 Objectives of Inventory Management:
- Ensure optimal Inventory Levels
- Improve Cash Flow
- Reduce Storage requirements
- Minimize Waste and Shrinkage
- Reduce Product Shelf-time
- Support Demand Planning
- Analyze Sales Patterns
1. Ensure Optimal inventory levels
The primary objective of Inventory Management is to ensure that you have enough stock or inventory of raw materials, components, parts and finished products to meet customer demand.
Of course, how much stock is “enough” will vary from business to business and often from season to season.
Let’s take an example.
Say you run a children’s toy store.
Sure, you’ll sell products throughout the year as parents buy toys for their kids, for friends for birthdays and for anniversaries.
But you’ll probably need to carry way more product inventory during the holiday season as you’re likely to see a big jump in customer demand compared to the rest of the year.
With proper Inventory Management, you can ensure that you have enough stock on hand to manage the peaks and troughs of customer demand.
2. Improve Cash Flow
Inventory is an investment. It costs money.
Yes, you may have delayed payment agreements with your vendors. Or you may take stock on consignment. Or you might get credit from your suppliers. Still, inventory has a value and at some point, you’re going to have to pay up whether or not you sell the product.
This means your money is going to be tied up in inventory and will not be available for other more useful purposes – like marketing, advertising, promotions, employee compensation, bonuses, etc.
Keeping your inventory at optimal levels will free up cash that you can deploy for more profitable purposes.
Make sure that you make improving your cash flows a clear objective of inventory management.
Side note: Because inventory is an investment, ie. it costs money, in accounting terms, it is considered an asset. Of course, it is an asset we would rather not have on our books because the money invested is “stuck”. Nevertheless, it is still an asset. And because we expect inventory to be cleared within a single fiscal year, we account for it as a current asset.
3. Reduce storage requirements
You need to store your products someplace. The same goes for raw materials, components, parts.
You’ll need shelves, boxes, cabinets, pallets, special stores (eg cold storage) and warehouses.
This is a cost.
And now if you’re carrying excess inventory, you would need to store it someplace too, wouldn’t you?
What an unnecessary cost that would be.
Good inventory management will remove unnecessary storage costs which will directly improve your profitability.
4. Minimize Waste and Shrinkage
Imagine you sell perishable goods. Or goods that deteriorate over time and lose value as time passes.
Think of food (meat, dairy, fruit), flowers/plants, certain medications, etc.
Wouldn’t it be a real waste to throw these goods away because they reached their expiration date before you could sell them?
With good inventory management, you could keep only as much stock on hand as you could sell before its expiration date.
Shrinkage (and Theft)
Another cause of stock wastage is theft. And Theft, in turn, causes what’s called Shrinkage.
Shrinkage is an accounting term that basically means that your inventory has fewer items compared to what it should have according to the records in your books.
Shrinkage because of employee theft, shoplifting or return fraud is a real problem and can directly hurt your bottom line.
If you don’t know exactly what stock you have on hand, how will you know when it goes missing?
With good Inventory Management, you’ll at least be able to identify a theft soon after it happens and so take action to prevent similar thefts in the future.
5. Reduce product shelf time
If you own a store, you know how valuable your shelf space is.
And wouldn’t you want your products to spend as little as possible sitting on a shelf?
One of the objectives of inventory management is to reduce the amount of time finished products sit on the shelf or in your warehouse waiting for customer to buy them.
Proper Inventory Management will ensure a continuous flow of materials and finished products from source to customer spending minimal time along the way either in a warehouse or in transport or on a store shelf.
6. Support Demand Planning
An important objective of Inventory Management is to help you plan for future demand.
As you now know, Inventory Management involves tracking the flow of items (raw materials, components, parts, finished goods) throughout the value chain as they move from your suppliers to your warehouses, to your stores and into your customer’s hands.
Based on your sales forecasts, your inventory management processes should tell you how much raw material you will need to order from your suppliers, how many parts or components you will need to keep in storage and for how long will these remain “blocked” as work-in-progress before they can be finished and delivered to a customer.
With good Inventory Management, you will be able to analyze sales patterns, estimate future demands and optimally stock up on raw material and finished products needed to satisfy that demand.
7. Analyze Sales Patterns
While your CRM can also analyze sales patterns, your Inventory Management System can go a step further. Your CRM can link a product sale to a type of customer or geography or demographic.
But your Inventory Management System can tell you for each product you sell, how long the product stayed on the shelf before it was sold, how long it stayed in production as a work-in-progress, how much did it cost to store that product, how much did it cost to transport it, was it available on consignment (so better for your cash flow) or were you required to purchase it, etc.
You can glean invaluable information from your inventory system and it can help you plan your sales strategies for the future.
An ideal solution is to link your Inventory Management System to your CRM and most of the top Inventory Management Systems will let you do just that.
Inventory Management Techniques
There are plenty of Inventory Management techniques practiced in industry. In this article, we’ll review a few of them.
If you’d like to see a detailed list of these Inventory Management techniques, we refer you to an excellent article by Avery Walts of Skuvault.
The Inventory Management techniques we will cover in this article are:
- ABC Analysis
- FIFO & LIFO
- Safety Stock
As the name implies the Just-in-Time inventory technique tightly correlates procurement of raw material or the finished product (if you’re a reseller or retailer) from the supplier with manufacturing schedules and customer demand management.
JIT is very difficult to execute and requires precise supply chain coordination between your suppliers, your manufacturing unit and your sales & fulfillment processes.
If you manufacture products, you will want the raw material from your suppliers to reach your factory just before it gets used in the manufacturing process. This will minimize the time the raw material “sits in inventory” before getting used.
Similarly, the finished product needs to be available just in time for it to get shipped to a customer. This minimizes the time the finished product “sits in inventory” before the customer receives it.
If you’d like to learn more about JIT Inventory Management, here’s a deep dive into the subject.
With ABC Analysis, you divide your stock into three categories: A, B & C.
Category A represents the most valuable stock, contributing the most to your sales but which may have low sales volume.
Category B represents less valuable stock with a moderate contribution to sales and moderate volume.
Category C represents the least valuable stock, contributing the least to your sales but with high volume.
Category A includes is the smallest group of products but one whose inventory levels need to be very closely controlled. If you understock a Category A product you could lose out on a large sale. On the other hand, if you overstock a Category A product you could have too much money stuck in inventory.
Inventory of Category B products can be more loosely managed than that of Category A products, though understocking Category B products could also cause you to lose out on a large sale.
Category C products are the ones whose inventory can be most loosely managed. Since these are the least valuable of products a small over stocking won’t hurt you financially. And if you have an understock situation with these products it won’t hurt you either even if you lose out on a sale.
FIFO & LIFO
FIFO, which stands for First-in-first-out, is an inventory management technique where the first product to enter the inventory is the first product to exit the inventory when a product is sold.
FIFO is a technique which can work well for perishable goods.
LIFO stands for Last-in-First-Out. LIFO works well with products that are identical and there is no practical difference between the product that entered the inventory first and the product that entered the inventory last.
LIFO can be useful in simplifying storage management as the product that went last into storage is the product that is taken out first.
Taking inventory on consignment means carrying a product from a supplier but paying the supplier only when the product is sold.
And if the product doesn’t get sold, it is typically sent back to the supplier with no cost to the reseller.
Consignment inventory can be great for a reseller as it does not require investment. But it’s not free of cost since the inventory still needs to be stored somewhere.
It’s can also be a great win for the manufacturer of the product. By reducing the risk for the reseller, they can get more resellers to carry their product and put it in front of customers.
Consignment inventory can work well for non-perishable products which can be taken back by the manufacturer in case the reseller fails to sell them.
Safety stock inventory management is a technique where you order some extra inventory beyond what your sales projections call for.
This technique gives you a small safety net in case you have greater sales demand than expected.
Naturally, the safety stock method will add to your cost but it will minimize the risk of not being able to service customer demand in case it turns out to be more than you expected.
- Inventory comprises raw materials, parts, components, work-in-progress products as well as finished products available for sale.
- The primary Objective of Inventory Management is to ensure that you always have the optimal amount of Inventory on hand so that you can satisfy customer demand.
- Inventory Management includes the range of activities from procurement, storage, tracking and transfer of raw materials and unfinished/finished products until and including the final shipment of a product to the customer.
- Inventory Management can help improve cash flow, reduce storage requirements, minimize wastage and shrinkage, reduce shelf-time and provide support in demand planning.
- To perform Inventory Management you can use various techniques like JIT, ABC, FIFO/ LIFO, Consignment and Safety Stock.