Inventory Management Basics

Inventory management is the management of inventory and stock. As an element of supply chain management, inventory management includes aspects such as controlling and overseeing ordering inventory, storage of inventory, and controlling the amount of product for sale.

Inventory management is all about having the right inventory at the right quantity, in the right place, at the right time, and at the right cost.

A company’s inventory is one of its most valuable assets. In retail, manufacturing, food service and other inventory-intensive sectors, a company’s inputs and finished products are the core of its business, and a shortage of inventory when and where it’s needed can be extremely detrimental. At the same time, inventory can be thought of as a liability (if not in an accounting sense). A large inventory carries the risk of spoilage, theft, damage, or shifts in demand. Inventory must be insured, and if it is not sold in time it may have to be disposed of at clearance prices – or simply destroyed.

For these reasons, inventory management is important for businesses of any size. Knowing when to restock certain items, what amounts to purchase or produce, what price to pay – as well as when to sell and at what price – can easily become complex decisions. Small businesses will often keep track of stock manually and determine reorder points and quantities using Excel formulas. Larger businesses will use specialized enterprise resource planning (ERP) software. The largest corporations use highly customized software as a service (SaaS) applications.

Appropriate inventory management strategies vary depending on the industry. An oil depot is able to store large amounts of inventory for extended periods of time, allowing it to wait for demand to pick up. While storing oil is expensive and risky – a fire in the UK in 2005 led to millions of pounds in damage and fines – there is no risk that the inventory will spoil or go out of style. For businesses dealing in perishable goods or products for which demand is extremely time-sensitive – 2017 calendars or fast-fashion items, for example – sitting on inventory is not an option, and misjudging the timing or quantities of orders can be costly.

For companies with complex supply chains and manufacturing processes, balancing the risks of inventory gluts and shortages is especially difficult. To achieve these balances, firms have developed two major methods for inventory management: just-in-time and materials requirement planning.

Decisions regarding the amount of inventory that a company should hold and its location within a company’s logistics network are crucial in order to meet customer service requirements and expectations.

The Inventory Management Process

Inventory management is a complex process, particularly for larger organizations, but the basics are essentially the same regardless of the organization’s size or type. In inventory management, goods are delivered into the receiving area of a warehouse in the form of raw materials or components and are put into stock areas or shelves.

Compared to larger organizations with more physical space, in smaller companies, the goods may go directly to the stock area instead of a receiving location, and if the business is a wholesale distributor, the goods may be finished products rather than raw materials or components. The goods are then pulled from the stock areas and moved to production facilities where they are made into finished goods. The finished goods may be returned to stock areas where they are held prior to shipment, or they may be shipped directly to customers.

Inventory management uses a variety of data to keep track of the goods as they move through the process, including lot numbers, serial numbers, cost of goods, quantity of goods and the dates when they move through the process.

Inventory Management Techniques

Inventory management uses several methodologies to keep the right amount of goods on hand to fulfill customer demand and operate profitably. This task is particularly complex when organizations need to deal with thousands of stock keeping units (SKUs) that can span multiple warehouses. The methodologies include:

• Stock review, which is the simplest inventory management methodology and is generally more appealing to smaller businesses. Stock review involves a regular analysis of stock on hand versus projected future needs. It primarily uses manual effort, although there can be automated stock review to define a minimum stock level that then enables regular inventory inspections and reordering of supplies to meet the minimum levels. Stock review can provide a measure of control over the inventory management process, but it can be labor-intensive and prone to errors.
• Just-in-time (JIT) methodology, in which products arrive as they are ordered by customers, and which is based on analyzing customer behavior. This approach involves researching buying patterns, seasonal demand and location-based factors that present an accurate picture of what goods are needed at certain times and places. The advantage of JIT is that customer demand can be met without needing to keep quantities of products on hand, but the risks include misreading the market demand or having distribution problems with suppliers, which can lead to out-of-stock issues.
• ABC analysis methodology, which classifies inventory into three categories that represent the inventory values and cost significance of the goods. Category A represents high-value and low-quantity goods, category B represents moderate-value and moderate-quantity goods, and category C represents low-value and high-quantity goods. Each category can be managed separately by an inventory management system, and it’s important to know which items are the best sellers in order to keep quantities of buffer stock on hand. For example, more expensive category A items may take longer to sell, but they may not need to be kept in large quantities. One of the advantages of ABC analysis is that it provides better control over high-value goods, but a disadvantage is that it can require a considerable amount of resources to continually analyze the inventory levels of all the categories.

Inventory control is the area of inventory management that is concerned with minimizing the total cost of inventory, while maximizing the ability to provide customers with products in a timely manner. In some countries, the two terms are used as synonyms.

Importance of Inventory Management

Scientific inventory management is an extremely important problem area in the materials management function. Materials account for more than half the total cost of any business and organizations maintain huge amount of stocks much of this could be reduced by following scientific principles. Inventory management is highly amenable to control. In the Indian industries there is a substantial potential for cost reduction due to inventory control. Inventory being a symptom of poor performance we could reduce inventories by proper design of procurement policies by reduction in the uncertainty of lead times by variety reduction and in many other ways.

Just-in-Time

Just-in-time (JIT) manufacturing originated in Japan in the 1960s and 1970s; Toyota Motor Corp. (TM) contributed the most to its development. The method allows companies to save significant amounts of money and reduce waste by keeping only the inventory they need to produce and sell products. This approach reduces storage and insurance costs, as well as the cost of liquidating or discarding excess inventory.

JIT inventory management can be risky. If demand unexpectedly spikes, the manufacturer may not be able to source the inventory it needs to meet that demand, damaging its reputation with customers and driving business towards competitors. Even the smallest delays can be problematic; if a key input does not arrive “just in time,” a bottleneck can result.

Materials Requirement Planning

The materials requirement planning (MRP) inventory management method is sales-forecast dependent, meaning that manufacturers must have accurate sales records to enable accurate planning of inventory needs and to communicate those needs with materials suppliers in a timely manner. For example, a ski manufacturer using an MRP inventory system might ensure that materials such as plastic, fiberglass, wood and aluminum are in stock based on forecasted orders. Inability to accurately forecast sales and plan inventory acquisitions results in a manufacturer’s inability to fulfill orders.

Inventory Management Software Systems

Inventory management software systems generally began as simple spreadsheets that tracked the quantities of goods in a warehouse, but have become more complex. Inventory management software can now go several layers deep and integrate with accounting and ERP systems. The systems keep track of goods in inventory, sometimes across several warehouse locations. The software also calculates the costs — often in multiple currencies — so that accounting systems always have an accurate assessment of the value of the goods.

Some inventory management software systems are designed for large enterprises, and they may be heavily customized for the particular requirements of those organizations. Large systems were traditionally run on premises, but are now also deployed in public cloud, private cloud and hybrid cloud environments. Small and midsize companies typically don’t need such complex and costly systems, and they often rely on stand-alone inventory management products, generally through SaaS applications.