The A-Z of Inventory Management: Terms, Techniques, Process

“Inventory management is a continuous, concentrated effort – and a process that shouldn’t be handled solely at the operations level. A successful inventory plan should also involve your marketing, catalog, eCommerce, and merchandising departments”.

-Steve Warren

A systematic and simple approach to sourcing, storing, and distributing inventory is what we call inventory management. However, it’s not that simple. Without effective inventory management, streamlining any business becomes challenging which, in turn, leads to profit margins taking a hit.

There’s more to inventory management than just organized stocks. New entrepreneurs, business owners, and independent brands today compete with businesses all over the globe. Solid knowledge of inventory control and management goes a long way in the competitive curve. Here, we have compiled a comprehensive guide to the ins and outs of everything inventory management. By the time you finish reading it, we hope that you will know everything there’s to know about stocking your inventory right and ways to achieve that. Let’s get started with the basics of inventory management.

What is Inventory Management?

Inventory management is one of the core activities of all retail businesses. It is basically how you track and manage your business's inventory as it is procured, stored, and distributed. The primary objective of inventory management is to keep track of the inventory in such a way that it’s neither understocked nor overstocked. Managing accurate inventory levels ensures that the right inventory is available at the right time.

“Inventory management is a systematic approach of tracking the flow of inventory. It starts right from procurement and its storing and continues to distribution in the marketplace”.

Why is Inventory Management Important?

Inventory management is crucial for all businesses regardless of size. It strikes a balance between the amount of inventory going in and getting out. Furthermore, it regulates the costs of the items in stock along with the non-capitalized assets, allowing the business to gain maximum profitability.

Moreover, inventory and customer service go hand in hand. Inventory management is the best way to ensure constant customer satisfaction and minimize any losses. Additionally, inventory management also gives actionable insights into your financial standing and helps capitalize on business opportunities of all kinds.

In a nutshell, inventory management is important because of the following key reasons:

• Tracking your inventory gives a centralized view of the stock
• Control costs and empower sales teams by analyzing performance. These analytics could be  sales reports, margins reports, inventory forecasting, etc.
• Improve order fulfilment as per customer expectations
• Diffuse the situations that lead to lost stock, overstocking, and stockouts
• Cut down on time and manpower for day to day operations.

As mentioned before, businesses of all sizes need to manage their inventory effectively. The size factor comes into play while deciding how to go about the process. Every company has its own sets of requirements cut out for them and they should follow a system that suits those requirements. A newly set up small business can maintain a system using spreadsheets in the initial stages.

That said, working on spreadsheets can be a very time-consuming process in the long run and increases the risk of manual error. This creates a diversion from scaling strategies and focusing on overall business growth. As the business set up expands on different verticals, there will be a need for an omnichannel inventory management system that caters to the changing requirements and increasing demand.

Hence, investing in a good inventory management system (IMS) at the early stages is highly recommended so as to streamline the day-to-day operations and channelize the rest of the resources on growth opportunities.

For all intents and purposes, an inventory management system reduces the chances of:

-Mis-shipments

Due to mis-shipments, businesses incur losses on the following fronts:

• Pick-up time is doubled

• Charges for return shipping in case the items are not delivered or delivered at the wrong address.
• In case a business uses custom packaging, an additional cost has to be incurred in re-packing the product.
• Plus, if the business uses custom packaging, re-packing the product will be an additional cost.
• Additional incentives need to be provided to retain the dissatisfied customer.

-Understocking/Overstocking

Understocking

• Customer orders will not be fulfilled on time which will lead to customer dissatisfaction.
• Incur additional expenses of the workforce’s idle time.
• Lose chances of price negotiation, this is particularly true in B2B where the order quantity is huge.

Overstocking

• Increase in storage costs
• Increase working capital requirement
• Increase the probability of inventory loss due to theft, damage, pilferage, expiry, etc.

So, assess your requirements and look for an inventory management system (IMS) that goes well with your business objectives. Coming back to the importance of inventory management, let’s also look at the monetary aspects of it.

How does Inventory Management improve Cash Flow?

First and foremost, a good inventory management system is cost-efficient.

Secondly, you pay for the inventory you store which is later sold to generate revenue. While the inventory is stored in the warehouses, it is not minting any profits to the business but costing instead. Therefore, it is important to consider inventory while making cash flow management decisions.

Inventory management will lead to better cash flow management inventory directly affects a firm’s:

• Sales (By ensuring that the right quantity is available at the right time)
• Expenses (By ensuring that inventory purchasing is done timely and that the inventory is available at the right cost)
  

Both of these factors together play a significant role in determining the amount of cash that is available with a firm at any given point in time.

That about sums up the importance of inventory management. Now that we have covered the what and why of inventory management and you have also got a gist of how it is projected in the real world, let’s move back to exploring the terms and definitions associated with it.

Inventory Management Terms and Definitions

The first step to understanding the nitty gritty of inventory management is to know about the basic inventory management terms.

Read the complete glossary below.  

• Inventory- Inventory is a broad term that includes all products, raw materials, work-in-progress, and finished goods.
• Inventory Management Software- Inventory management software makes it easier for retailers to track their inventory on a real-time basis. A good inventory management software streamlines the entire process by recording, tracing, and tracking all items a retailer either receives or sends away. A good inventory management software will increase inventory visibility and improve overall efficiency.
• Activity-Based Costing- ABC allocates the cost of specific resources based on its actual consumption.
• Alerts- These are the reminders which an organization receives to better manage its inventory. It can either be based on type or due date.
• Inventory allocations- setting aside a specific inventory count for sales or manufacturing purposes.
• Annual Physical Inventory- It is the manual count of inventory on hand. Its results are then compared to the inventory system counts.
• Backorder- An order that a retailer can not fulfill currently, and it is requested by a customer who is willing to wait until it becomes available.
• Barcode Inventory- A barcode inventory system combines barcode technology and inventory management system. Its purpose is to increase speed and efficiency.
• Batch Picking- In batch processing or batch picklist, a bulk picklist of multiple orders is created. It is also known as consolidated picking.
• Bill of Material (BOM)- It is a list of items/materials which were used in creating an assembled item.
• Warehouse Bin Management-  Inventory is stored in bins/shelves so that it can easily be located.
• Cycle Count- Often termed as physical inventory count. It is performed to reconcile physical inventory count with the inventory count which is recorded in the inventory management software.
• Cross Docking- In cross-docking goods are unloaded from an inbound carrier and immediately loaded in an outbound carrier.
• Dispersed Acquisition- Inventory is acquired from numerous suppliers worldwide.
• FEFO- It stands for First Expiry First Out. It is an inventory management technique that makes it easier for retailers to manage products that have a limited shelf life.  
• FIFO- It stands for First In First Out. In this technique, the retailer first sells the product which was first manufactured/purchased by them.
• Forecasting- Predicting future demand based on past sales data and prevailing market changes.
• Integrated inventory management- In this inventory management system, all the business processes like the Accounting system, Finance system, Inventory system, etc are integrated across the organisation. An integrated inventory management solution makes information flow across all business processes easier.
• Inventory analysis- It is the process of determining the optimal level of inventory required.
• Inventory replenishment- It is the process of re-ordering inventory items when its stock is depleted.
• Kitting- Multiple inventory items are bundled together and sold as a single unit.
• Lot Number- The identification number assigned to products which indicates the lot or batch in which they are manufactured.
• Lot and Serial number management- It refers to tracking products by their lot numbers/serial numbers so that the lots can be traced back to its suppliers.
• Material Requirement Planning- It is a method applied to calculate the materials and components required to make a product.
• Maximum stock quantity- It is the highest count of an inventory item that an organization can have at any given time.
• Minimum order quantity-  It is the minimum quantity that can be ordered at a time.
• Minimum stock quantity-Also known as the reorder point is the lowest quantity of inventory that can be held. Once it is reached the stock needs to be reordered.
• Obsolete Inventory-The inventory that has not been sold for a long time and is expected not to be sold in the future also is known as obsolete inventory.
• Omnichannel fulfillment- It is the order fulfillment process that ensures that inventory is available across all channels from a single location. This means, irrespective of the channel that the user is using (online marketplace or brick-n-mortar store) his order will be fulfilled.
• Order Picking- It is the process of finding the right products from the warehouse to fulfill an order.  A picklist is created to ensure that the Order Picking process is right.
• Picking accuracy-  It is the level of accuracy achieved in the Order Picking process.
• Reorder Point- It is also referred to as minimum stock quantity. It is the point at which the minimum inventory level of a specific SKU is reached and a purchase order needs to be issued to order it.
• Replenishment- It is the process of reordering inventory once the stock has been depleted.
• Safety Lead Time- It is the process of placing a replenishment order while keeping into consideration the buffer lead time so that unexpected customer orders or any other problem can be easily managed.
• Shipping accuracy- It refers to the level of accuracy achieved with orders’ shipment.
• SKU- It stands for Stock Keeping Unit. It is a number or code that is used to identify products.
• Stock Control System- It is a system established for maximizing stock control by integrating inventory management, warehousing, and other business activities.
• Third-Party logistics- It is commonly referred to as 3PL. 3PLs provide outsourced logistics, warehousing, and distribution services.
• Trend Analysis- Analysing historical data to identify a pattern or trend in the information.
• Vendor Managed Inventory(VMI)-In VMI the inventory is managed by the supplier on behalf of the retailer, based on their predetermined minimum and maximum inventory level.
• Zone Picking- It is a warehouse practice in which orders are picked from specific zones or sections, and then finally grouped for the final order picking and fulfillment.

Well, that was a lot of terms. But, that’s all you need to know. Now, let’s take a look at the process involved.

Inventory Management Process

The first and one of the most important steps is to make a flowchart for your inventory management process. This gives detailed instructions that the workforce needs to follow for smooth inventory management.

However, the exact method may vary from business to business, and from industry to industry. In general, inventory management process for all businesses will include the following major steps:

A good inventory management process involves a top-notch IMS and effective techniques that together streamline the entire affair. Here are some of the important techniques that you should know about.

Inventory Management Techniques

There are plenty of techniques that retailers can apply to improve their inventory management activity. The most common and effective techniques are:

1. ABC Analysis

It is an inventory categorisation technique, in which a “class” is assigned to every SKU.  

A- 20% of items with 80% of total revenue

B- 30% of items with 15% of total revenue

C- 50% of items with 5% of total revenue

By performing the ABC Analysis, retailers can decide what items to buy and in what quantity.

The A stock is the most valuable for the retailer and he should ensure that he has adequate quantity so that customer demand can be fulfilled.

The C stock is the least valuable for the retailer and is often termed as dead stock.

Note that the percentage of figures will vary across industries, but retailers can perform the ABC Analyse to efficiently categorize SKUs based on their profitability level.

2. Have a Contingency Plan

Contingency planning is of utmost importance for a company’s survival and growth.

Companies need to pre-plan their course of action in case a problem arises. To do so they need to first analyse what are their potential risks.

These can be:

• The supplier runs out of stock, therefore orders can’t be fulfilled on time.
• The inventory count was wrong, this means you have either understocked/overstocked your SKU.
• The company is falling short of cash and can not purchase inventory.
• The inventory forecast was wrong.
• The warehouse is not properly organised. For example, a dead-stock has occupied a lot of your storage space and there isn’t sufficient space available to store products that have a higher demand.

When a company makes a contingency plan they are better able to cope with these situations swiftly without having a major effect on their business operations.

3. Just-in-Time (JIT)

Just-in-Time, or commonly referred to as JIT is an inventory management strategy in which retailers keep a very minimal stock of inventory in hand to fulfill the customer orders and replenishes it before SKU goes out of stock.  This is a great way to reduce inventory costs.

JIT can be applied when:

• When producers can forecast demand accurately
• There is a steady production
• High quality of workmanship and no machine break-down.
• The company has reliable suppliers.

Just-in-Time strategy is the opposite of Just-in-Case strategy, in which companies store sufficient inventory stock with them to absorb the maximum market demand.

4. Consignment Inventory Management

In this technique, the retailer stores goods with him and pays the supplier only when the goods are purchased by the end customer.

When a retailer makes a consignment inventory agreement, he enjoys the benefit of:

• Improved Cash Flow-as he will only pay the vendor after the goods are sold to the customer.
• Low Risk-  as retailers don’t pay for the inventory upfront the risk involved in buying the stock is significantly reduced.

5. Lean Manufacturing

Lean manufacturing aims to reduce the wastage and non-value adding activities from the business operations. The lean manufacturing philosophy includes 7 types of wastages, inventory is one of them.

When inventory is moving through the production process it is adding value, and at whatever production stage it stops moving it is a non-value adding activity.

Therefore to ensure that the inventory is not a waste the following lean manufacturing practices should be deployed:

• Have an accurate inventory record
• Manage supplier relationships
• Keep safety stock
• Perform Cycle Counts

6. Dropshipping

It is an inventory management fulfillment method in which the retailers do not buy the inventory that they are selling. This means that whenever they get a sales order, they purchase the inventory from a third-party and then ship it to the customer.

7. Two-Bin Method

As the name suggests, the SKU is stored in two bins or locations. When the first bin is empty, the stock is moved from the second bin. The stock is replenished when the second bin is also empty.

8. KPI Analysis

KPI stands for Key Performance Indicators. KPIs in inventory management can help in improving production and purchasing process, cash flow, and profitability.

Companies can compare their KPIs with the industry standards, however when external industry standards are not available, businesses have to set their own KPI goals and use them to monitor their growth.

Here are the common KPIs in Inventory Management:

9. Invest in a Cloud-Based Inventory Management Software

Managing inventory management manually or even by using spreadsheets can be a hectic task for companies. Plus the credibility of the inventory data will also be low. It is a smart option for companies, thus, to invest in inventory management software.

A good inventory management software should be able to do the following for the companies:

-Run Cycle Counts for them

-Help in Inventory Forecasting and Planning

-Minimize losses due to understocking or overstocking

-Alert business when they have reached the Reorder Point

-Make it easier for them to track inventory across multiple locations, and platforms like storefronts, e-commerce channels, warehouses, etc.

- Provide companies reports which improve their inventory analysis

If you run a business or planning to start one soon, you need to know your way around all these terms and techniques. If your business spreads across geographies, you definitely need to have an inventory management system to handle large volumes of orders for customers across the globe. As for the small business owners, it is important to set up a system at an early stage to gain a competitive advantage over big businesses when you expand.

We have covered everything there is to know about effective inventory management to streamline your business. If you still have some doubts, check out the following FAQs that might help.

FAQ

How to improve the inventory management system?

To improve your inventory management system you can practice multiple tools and techniques.

All these techniques can be really helpful in improving your inventory management and should be followed according to your business and the industry you are working in.

One technique that I will suggest to all businesses, irrespective of their size or the sector they are working in is to invest in a good inventory management system. This will help you in reducing your costs and improve your productivity.

How can a business measure whether they are successfully managing their inventory?

To measure their success rate in managing inventory, companies should compare their data after they have implemented a new inventory management technique.

If the following have reduced they are successfully managing inventory:

• Stock-outs
• Mis-shipments
• Obsolete Inventory

Which department or personnel should be accountable for an efficient inventory management system?

The burden of implementing an efficient inventory management system can not be held solely by a single department.

The purchase department needs to closely monitor the purchasing activity, the warehouse department needs to properly conduct all the warehouse operations like receiving and storing goods, correct shipments, etc, the sales department needs to provide the purchasing department with a sales forecast so that purchase planning can be done accordingly.

Information needs to be shared between all these departments regularly for an efficient inventory management system.

How should retailers prepare for peak seasons?

Preparing for peak seasons is a complex process for retailers. There is an increase in customer orders which needs to be fulfilled in a short deadline. To efficiently manage peak season sales a retailer needs to:

• First, analyse the sales forecast and all your further decisions like inventory purchase, or hiring temporary sales staff depend on it.
• Conduct a cycle count to ensure that the inventory level is correct. If there is a mismatch between physical stock and stock count in inventory management systems, take steps to reconcile it on an immediate basis.
• Improve your supply chain so that you can fulfill the customer orders. Make sure that your suppliers can provide you with the raw material or finished product timely and that your shipping management system can efficiently fulfill the order as quickly as possible.  

What is FIFO perpetual inventory?

FIFO stands for First-In-First-Out. In a perpetual inventory system the stock movement (whether it is received from a supplier or sold to the end customer). Therefore, in a FIFO Perpetual Inventory Management system, the stock which is inwarded first is sold out first, and this stock movement is tracked and recorded on a real-time basis using an inventory management software.

Differences and Similarities between Warehouse Management System and Inventory Management System

The below infographic talks about the similarities and differences between a Warehouse Management System and Inventory Management System.

(source: EasyEcom)

If you are interested in knowing more about the Warehouse Management system please click here.

Are you looking for an omnichannel inventory management solution with integrated B2B order management for your eCommerce business? Drop us a line at care@easyecom.io or directly sign up for a demo here.