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What is inventory management: Benefits, techniques, systems

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Inventory management plays an important role in the profitability of any business. Related to supply chain management and logistics, inventory management oversees the procurement, movement, storage, and usage of essential raw materials for producing goods and services.

Inventory management also takes care of the output side of the business—managing how much product is available to sell, ensuring that there’s enough to meet demand, but not so much that the company loses money on unsold inventory.

Ultimately, inventory management is a perpetual balancing act, juggling input and output to keep costs down and maximize sales and profits.

Here, you’ll find everything you need to know about this core business function:

  1. Inventory management, defined
  2. Benefits
  3. Process
  4. Inventory management vs. inventory control
  5. The role of order management
  6. Inventory management techniques
  7. Challenges
  8. Inventory management systems
  9. IMS functions and features

What is inventory management?

Inventory management is the discipline of monitoring and handling raw materials and the products made from them.

On the input side, this includes specific tasks such as sourcing, buying, receiving, storing, moving, selling, and shipping of materials used to make a company’s products. Managing inventory output involves storage of finished products as well as sales and shipping to customers.

When it comes to the profitability of a business, inventory management is a complex, high-speed juggling act that can make or break the bottom line of your business. Too much or too little of any input or output can jeopardize productivity, customer satisfaction, and profitability.

What are the benefits of inventory management?

Inventory management is foundational for business success. Without it, a company can’t be efficient, profitable or resilient. Considering the many economic variables beyond the control of anyone, inventory management is one of the areas firmly within each business’s control.

  1. Increased efficiency. In a manufacturing setting, maintaining the optimal levels of raw materials to keep production going without interruption helps increase efficiency. Two key factors are having the right materials on hand and making sure they’re in the right place at the right time. Additionally, moving finished product to storage in warehouses prevents production delays due to lack of space. Shutdowns or delays anywhere in process equals lost time, productivity, and profits.
  2. Reduced costs. Keeping optimal amounts (not too much, not too little – the perfect Goldilocks balance) of raw materials minimizes the risk of spoilage or waste as well as avoids paying for materials before they’re needed. By maintaining the right amount of product to meet demand, a company isn’t spending money on labor and materials to produce products that can’t be sold quickly enough.
  3. Improved customer satisfaction. Successful inventory management keeps the right amount of product available to meet customer needs as quickly as possible, reducing out-of-stocks and leading to happier customers.
  4. Better cash flow management. Accurate forecasting along with precise inventory levels and efficient logistics ties up less cash with unnecessary spending, production, and storage. This frees up cash flow and enables more efficient use of cash resources.
  5. Better decision making. Inventory management involves forecasting demand, costs, and other needs. More companies are using software to measure these variables to make smarter data-driven decisions. This helps reduce the cost of unnecessary spending and misguided demand forecasting.
  6. Increased profits. The ultimate goal of being in business is to profit from creating, producing, selling, and delivering a great product. Strong inventory management boosts profits by increasing efficiency and reducing waste.

Principles of operations management for 2023 and beyond

Learn foundational principles that can guide your company to operational efficiency and competitive edge no matter the economic environment.

What is the process of managing inventory?

An inventory management process is the blueprint and guidebook for how your company manages inventory—the way you procure, receive, store, use, sell, and ship your inventory.

The process begins with the materials and products you buy and use to make your own goods and services and continues throughout the production cycle to sales and delivery to your customers.

Without an inventory management process in place, it’s impossible to begin improving it. And without a process, efficiency is out of the question. That translates into wasted spending, lost time, and dwindling to non-existent profits.

The 5-step inventory management process:

  1. Receive and inspect products. Establish a smooth and efficient process for receiving and inspecting shipments to help keep materials moving. Inspect your shipment to ensure that you’re using the highest quality materials and not paying for damaged or poor-quality products that will either need to be returned or thrown away, or, worst case, end up in your products.
  2. Sort and stock products. Pre-production, determine which products and materials need to be delivered to production and which need to be stored. Post-production, move finished products to the appropriate storage areas to away customer orders and order fulfillment.
  3. Accept customer order. Whether e-commerce, brick-and-mortar, or otherwise, take customer orders and ensure that all parties have visibility into the orders and information needed. Internally, make sure sales, warehouse, order fulfillment, and shipping know what’s going on.
  4. Fulfill, package and ship order. Ensure that the customer knows that you’ve received their order and can easily find out when it will ship and when it’s expected to arrive.
  5. Reorder new stock. Maintaining accurate physical inventory is vital. Knowing when and how much to order depends on accurate, current inventory data.

Types of inventory

  • Raw materials are the items, components, and products needed to make a product.
  • Work in process is your product being manufactured, when raw materials and components are combined with the labor of workers and machines to make what is sold.
  • Finished goods are the completed products ready for sale and shipment to customers.
  • MRO goods (MRO stands for maintenance, repair, and operating) are the materials you need to keep making products and doing business, a form of overhead that’s considered the cost of doing business.
  • Transit inventory describes finished products that have been sold and shipped to the customer, but yet not delivered. This stretch of the journey is also called transit, pipeline inventory, and transportation.
  • Buffer inventory is the same as safety stock, serving as an emergency reserve to avoid running out of inventory before stores can be replenished.
  • Anticipation inventory is similar to buffer or reserve stock, but is obtained and produced to meet a forecasted increase in demand, especially cyclical or seasonal increases.
  • Decoupling inventory is a strategy that sets aside certain quantities of product in various stages of the production process to keep manufacturing moving in case there’s a shortage or breakdown anywhere along the line.
  • Cycle inventory is kept on hand so businesses can maintain minimum production quotas. This also takes the form of raw materials and components needed to fulfill those quotas.

Overstock, under-stock, out of stock: Retail inventory management outlook

After two years of turbulence, retail inventory management remains a tough job. Find out how retailers can tackle the challenge.

Inventory management vs. inventory control

In business, smaller, more focused systems operate within larger, broader systems. The same applies to the relationship between inventory management and inventory control.

Within the greater inventory management process, inventory control—also often called stock control—oversees the logistics and movement of materials and products within a warehouse or system of warehouses.

Locating items quickly and moving them efficiently is essential to both production and order fulfillment and shipping, the foundation for achieving high customer satisfaction.

Inventory control involves the direct movement of materials and products within warehouses using everything from hand carts and forklifts to trucks, trains, and semi-trailers. But it also includes using software to track, trace, and manage the flow of materials and products into, out of, and within warehouses.

Along with inventory control, another piece of the inventory management ecosystem is order management. This is another area where the right software can make or break your business. As its name states, order management focuses on customer orders.

However, order management is more than taking customer orders. It involves receiving orders as well as processing and tracking each order. When you receive an order, inventory must be located, moved, processed, and shipped. All along the way, inventory must be updated as the order is processed and shipped.

The best order management software is integrated into the overall inventory control and inventory management digital infrastructure. Not only is physical inventory counted, moved, tracked, and updated, but the organization has visibility into this movement. Visibility allows for smarter forecasting and overall greater efficiency.

What is logistics: Definition, types, examples

Man sitting on shipping containers, looking at his laptop, with a location pin next to it, representing what logistics is in business.
Logistics is a vital aspect of competing and winning in global markets. Learn the main types and functions of logistics and its benefits.

What are the primary inventory management techniques?

Similar to operations management, one size does not fit all when it comes to managing inventory. Let’s take a look at the four most popular methods.

  1. Just-In-time management (JIT): Running a ship so tightly that materials and components arrive as they are needed (just in time) for production reduces the need for storage and paying for parts that will not be used immediately. This Japanese method made popular by Toyota Motor cuts a lot of fat. But as seen in recent years, JIT depends heavily on a smooth-running global supply chain. Sharp increases in demand, small disruptions in the supply chain, or even labor disputes can upset this fragile ecosystem.
  2. Materials Requirement Planning (MRP): Demand and sales forecasting drives this method. As with inventory management in general, accurate records for sales and inventory play an essential role. Volatility in demand or supply chain can also leave a business either under- or over-prepared, losing sales because of a lack of available inventory, or losing money on excess unsold inventory.
  3. Economic Order Quantity (EOQ): This method operates on the premise of saving money by ordering larger quantities of inventory fewer times. Inventory needs are calculated to enable the fewest orders to procure the necessary amount of materials or components for anticipated production needs. When ordering larger quantities, a company accepts that holding costs will be higher. This method involves using EOQ formulas to estimate order costs and holding costs, which are considered on an annual basis to determine optimal quantities.
  4. Days Sales of Inventory (DSI): Another approach considers how long on average it takes to move inventory. This takes into account inventory of finished product as well as what’s in progress and awaiting production; inventory managers gain insight into how long current inventory levels are likely to last. The goal is to keep this ratio—aka days inventory outstanding (DIO), days in inventory (DII), and average age of inventory—as low as possible.

Other inventory management techniques include:

  • ABC analysis is based on the Pareto principle that 80% of your revenue comes from 20% of your products. ABC analysis helps  determine your most and least valuable goods and services.
  • Batch tracking groups products with similar lot characteristics, such as manufacture date, location, and expiration dates as well as products with common raw materials. This helps prioritize shipping and, in the unfortunate event of a recall, enables tracking products and tracing any issues back to the source.
  • Bulk shipments usually reduce the cost of shipping an individual item, as used in the EOQ inventory management method. Buying in bulk can present other challenges like storage space, spoilage, and possibly ordering more than needed to meet demand.
  • Consignment means that the manufacturer sends a retailer goods to sell without making the retailer buy products up front. This avoids potentially ordering too much of a product by paying only for what products are sold.
  • Cross-docking minimizes movement and storage of inventory by loading inbound inventory directly onto outbound shipping vehicles.
  • Demand forecasting uses market research, past sales, and other data to forecast how much product customers will buy. This informs how much inventory to keep on hand as well as how much will need to be produced.
  • Dropshipping allows a retailer or sales agent to sell products without holding the actual products in inventory. Instead, the order goes to the manufacturer to process and fulfill, shipping directly to the customer without the seller having to do any shipping or handling.
  • FIFO and LIFO are prioritization of shipping products by either a first-in-first-out (FIFO) or last-in-first-out (LIFO) order.
  • Lean manufacturing seeks to maximize productivity and efficiency by eliminating what does not add value.
  • Minimum order quantity (MOQ) is the least amount of a product that a supplier or manufacturer will allow to be ordered. This is the amount needed to sell to still make a profit or at least break even.
  • Reorder point formula calculates the point at which more inventory must be ordered. The reorder point formula multiplies daily unit sales by lead time (in days) from order to arrival, including a margin of safety stock to account for possible delays or spike in sales.
  • Perpetual inventory management uses software to track inventory levels in real time, recording every unit of inventory that comes in and every sale that goes out.
  • Safety stock is a quantity of extra inventory held as a buffer against running out of stock should an unexpected jump in sales occur before reordered stock arrives.
  • Six Sigma uses statistics and data analytics to improve efficiency while reducing errors and waste in manufacturing processes.
  • Lean Six Sigma seeks to eliminate waste and inefficiencies in manufacturing processes and inventory management, especially by finding and correcting root causes of flaws and inefficiencies.

Forget perfection, focus on reducing supply chain risk in 2023

Parachute balloons carrying and dropping boxes on maps with location pins, representing supply chain risk.
Rather than trying to perfect the supply chain, a better approach is to focus on risk, then build out the capabilities needed to manage it.

Complex process poses many challenges

It’s no surprise that a complex function like inventory management presents challenges at every turn.

  • Variables like demand spikes, supply chain issues, or stoppages of production can leave inventory levels too low. On the other hand, lower demand or overproduction can lead to a glut of unsold inventory. Such scenarios lead to lost revenue through missed sales or money wasted on unsold products.
  • Inaccurate data throws off demand forecasting.
  • Avoiding inventory shrinkage (maintaining inventory accuracy). Sometimes, as a temporary cost-cutting measure, inventory levels sink and not replenished. But this reduces buffer inventories, increasing the risk of running out of stock and disappointing customers.
  • Customer demand can change overnight.
  • Managing stock outmodedness requires balancing the need to sell existing less-wanted inventory while changing direction to meet new customer needs.
  • Managing multiple locations and suppliers.
  • Integration with other systems presents another potential headache when businesses try to update software and inventory management systems only to find that they’re not all compatible with each other.
  • Keeping up with innovation and technology.

What is an inventory management system?

An inventory management system (IMS) governs and executes your process for tracking products from input inventory of raw materials and information through the manufacturing, storage, sales, and shipping processes.

Here are three IMS types:

  • Manual inventory systems are the old-school way, counting each item and updating locations by hand.
  • Periodic inventory systems have the team count physical inventory every month or quarter. Bar code systems can be a quicker, easier, and more efficient way to count and track inventory by scanning the barcode on a product.
  • Perpetual inventory systems count and track inventory automatically using software to update inventories when materials, components, and products are purchased or sold. RFID systems use radio frequency identification tags to record and track inventory coming in or going out, automatically updating the system.

What to look for in an inventory management system

Your IMS handles everything you need to make your inventory management, and by extension your business, successful. Companies investing in the right software to facilitate an IMS gain a competitive advantage.

Here are some features and functionality an effective IMS should have:

  • Automated inventory tracking makes speeds and simplifies work, reducing repetitive tasks that are prone to human error.
  • Real-time data access provides visibility for smarter and more profitable inventory management decisions.
  • Demand forecasting uses the real-time data and the analytic power of machine learning to help inform inventory decisions that can reduce waste and boost revenue.
  • Multi-channel integration allows you to focus on actual inventory management rather than fighting with incompatible systems. Additionally, greater visibility into real-time data across the business ensures that everyone is seeing the same data and can easily access information from anywhere at any time.
  • Barcoding and scanning enable more efficient inventory management with more accurate data.
  • Alerts and notifications push important information to the people who need it to make better decisions and take quick action.
  • Mobile access expands the reach of an IMS to crews in the field, enabling quicker response times from anywhere.
  • Supplier management allows for a seamless experience when working with suppliers and managing orders, shipments, tracking, and approvals.
  • Inventory optimization is the crux of inventory management; an IMS should help you strike the balanced inventory that minimizes waste and maximizes profit.
  • Reporting and analytics are essential tools for monitoring performance, to see what’s working and where improvements can be made.

Having the best inventory management methods and systems in place can make the difference between struggling to survive and a long-lasting business. Will you be left wondering how the competition does it, or enjoy satisfied customers and profitability despite a struggling economy?

In 2023, supply chain challenges can make for a wild ride.
Get advice, best practices, + predictions from top experts HERE.

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