What Is Inventory Management? A Guide for Your Business
Stocking inventory for your small business can feel like a double-edged sword. Having an ample stockpile of finished products or raw materials guarantees you will dodge a major customer service pitfall: selling out. Yet the considerable upfront and carrying costs of having a chock-a-block storeroom can stunt your cash flow. While you may feel you have a finely honed sixth sense for reordering, you might be surprised at how much healthier your profit margins become when you apply a mathematical method to your madness.
This article will discuss how to manage inventory, explore best small business inventory management practices, and suggest technology solutions to get the job done painlessly.
Inventory Management: Definition
Inventory management is the practice of controlling how much stock gets ordered and when. It is a crucial aspect of managing your small business’s finances. Ensuring you have the right quantity of items available at the right time can be a bit of a balancing act. Striking that balance is critical to your bottom line because the contents of your storeroom or warehouse are a major asset that must be stored, insured, and tracked.
The goal of the inventory methods below is to control costs by determining your perfect order quantity and the ideal timing for each purchase.
The Importance of Inventory Management
Each item in your inventory is an earning machine. Though a stocked item costs money to manufacture or acquire, it has profit-making potential when sold. While inventory sits in your storeroom or warehouse, that potential is dormant. It is an investment that has yet to pay off. Having excess inventory is death to your cash flow, which every small to medium-sized business owner knows can make or break a business.
Inventory Management Techniques & Best Practices
Successful small business owners tend to employ a variety of tried-and-true methodologies for streamlining their stock ordering processes. Here are five key strategies:
Just-In-Time Method
The Just-in-Time Method (JIT) is a planning strategy that aims to minimize stock levels. Not only does JIT reduce the amount of stock that has to be tracked and insured, but it also reduces waste and the likelihood that excess products will need to be liquidated.
Adhering to the JIT methodology too aggressively does carry an element of risk. You wouldn’t want to streamline your stock so much that you are in danger of selling out, leaving you with dissatisfied customers. For that reason, it is important to set your safety stock levels using the formula given in the next section.
FIFO: First In, First Out
FIFO is a common-sense approach requiring that the first items received are the first items sold. The FIFO method is crucial for businesses that deal in perishable goods like food or flowers. But it can also be important for businesses that stock other products that are at risk of becoming obsolete over time.
Periodic Auditing
Every business needs to schedule inventory counting sessions from time to time. Some small businesses do this annually, but depending on your industry, you may want to count stock more frequently.
Some businesses choose to spread stock reconciliation out over the year by choosing a product class to audit each month or each quarter. This is called “cycle counting.” Having robust technology and inventory software in place that assists with inventory control can significantly reduce the time you spend on counting stock.
Big-Picture Forecasting
Software can take you far when it comes to forecasting. It can, for example, pinpoint the number of sales a product had during the same week of the previous year. But sometimes there are factors to consider beyond your historical sales. Some of them are:
Your current growth rate
Market trends
Seasonality and holiday sales
Your planned marketing campaigns
The overall economy
Identify Dead Stock
Since excess stock is a waste of space and capital, spend some time identifying stock that hasn’t sold in six to twelve months. This can be an important retail inventory management practice for businesses that need to keep on top of trends petering out or seasons changing, for example in apparel businesses.
When you spot a slow-selling item, it might be time to have a sale or promotion to liquidate it.
How to Use Inventory Formulas to Stay Ahead
There are a variety of calculations you can do to make stock management easier. If you are math-shy, don’t worry; some can be calculated for you by inventory management software. Here are four fundamental formulae you should know.
Safety Stock Formula
No business wants to lose sales due to running out of an item. It’s important to determine how much stock you should always have on hand to meet demand—without needlessly wasting money by overstocking. The perfect balance between understocking and overstocking is called your safety stock number or “par level.”
To determine an item’s safety stock number:
Multiply the maximum number of days it will take to stock the item (lead time) and the maximum historic sales rate per day (daily usage).
Then multiply the average lead time (in days) with the average historic daily usage rate.
The difference between the two is your safety stock number.
(Max. Lead Time x Max Daily Usage) – (Avg. Lead Time x Avg. Daily Usage) = Safety Stock Number
Reorder Point Formula
The reorder point formula will help you decide when it is the right time to stock an item. The safety stock number from the formula above will be used to determine it.
The calculation is a simple one:
Lead Time + Safety Stock = Reorder Point
Economic Order Quantity Formula
Your Economic Order Quantity, or EOQ, is the ideal number of units a company should order to minimize the total costs associated with holding inventory. When you reach your reorder point, this is the perfect order quantity for your purchase order.
The EOQ formula is a tricky one, though the right software can make it automatic for you.
EOQ = the square root of 2DK/H
Where:
D = Product Cost Per Year (including shipping and handling)
K = Demand Rate (quantity sold per year)
H = Holding costs (per year, per unit)
Using this formula can be helpful if you need to decide whether it makes sense to take advantage of large quantity discounts.
Days Inventory Outstanding Formula
Days Inventory Outstanding, or DIO, refers to the average number of days it takes for an item to sell after it is stocked. Theoretically, a lower number is more desirable because it is less cost effective to hold on to your supply for too long. You will have to use your judgment if your industry’s standard is to have greater or smaller quantities of stock on hand.
DIO = Cost of Average Inventory/Cost of Goods Sold x 365.
How to Manage Your Inventory with SumUp
The SumUp Air Lite Card Reader enables businesses to take credit, debit and contactless payments.
Figuring out how to manage inventory is made dead simple when you use SumUp for credit card processing at your point of sale. With a Product Catalog you can use to create your range of products on virtual shelves, SumUp’s free, cloud-based app includes all the tools you need to practice good inventory management. The app’s effective inventory management tools will:
Enable accurate forecasting on any device
Check and revise stock levels in real time, even if it is stored in multiple locations
Help you determine your safety stock levels, reorder points, and EOQs
Prevent excess or wasted finished goods and raw materials
Optimize your employees’ time
Improve cash flow and boost your bottom line
Take the Guesswork Out of Inventory Control
There are times when it is tempting to make educated guesses as you stock your products. However, you should know that the best practices outlined above have saved countless business owners time and money. Part art and part science, good inventory practices are a must-have for small to medium-sized business owners.
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