What is inventory management?
Last updated on: February 10, 2023
The business world as we know it today is highly competitive, always striving to find new methods to attract clients and follow market trends.
The main goal is to provide clients with impeccable service in the blink of an eye. This is most obvious in the retail industry.
In order to achieve their goal, businesses turn to lean management and are more heedful of their inventory management.
In this article, we will explain in detail what inventory is and what techniques and systems are used to manage it.
So, let’s dive in.
What is inventory?
Inventory (also called stock) refers to all the finished goods, parts, crops, and materials a company sells or uses in manufacturing.
Accountants consider inventory to be an asset which is supposed to be sold and then bring profit to a company. Unless it is sold, it reduces cash flow.
But, there is more to inventory than this. For starters, there are many different types of inventory. So first, let us see what exactly we think about when we refer to inventory.
13 Types of inventory
It is important to mention that, depending on the business, finished goods for one company might be raw materials for another. Inventory can be literally anything — from bales of cotton to washing machines.
Therefore, for better understanding, we are going to classify inventory according into the following types:
- Raw materials,
- Work in progress,
- Maintenance, Repair and Operating (MRO),
- Finished goods,
- Decoupling inventory,
- Safety and anticipated inventory,
- Cycle inventory,
- Packing materials,
- Service inventory,
- Theoretical inventory,
- Transit inventory, and
- Excess inventory
Type #1: Raw materials
Raw materials are the materials needed to make finished products. Companies may buy them or produce them. These items are waiting to be used in production.
Raw materials can be:
- Direct — used as a part of a final product, but can’t be recognized in the product itself (e.g. cocoa mass used for chocolate), and
- Indirect — used in the process of making a final product, but not a part of the product itself (e.g. praline molds).
Type #2: Work in Progress (WIP)
This inventory type includes all items that are in progress, i.e. partially completed. It applies to raw materials, electricity, packaging, and other.
An example of WIP would be a chocolate box waiting to be filled with chocolates.
Type #3: Components
These items are, unlike raw materials, identifiable in the final product. Examples of this inventory type would be the thread on your jeans or the legs of your bed.
Type #4: Maintenance, Repair, and Operating (MRO)
MRO is also known as overhaul. It includes all items that support the manufacturing process or keep the business running efficiently.
These items are used to assemble parts and repair machinery and equipment. Also, they enable commercial and business activities.
The MRO category includes:
- Safety equipment,
- Industrial equipment,
- Janitorial supplies,
- Office supplies, and
- Computer systems.
Type #5: Finished goods
Finished goods refer to the inventory that is introduced to the public, whether online or in shops.
That watch you have seen in a shop window or those leather boots you plan to order from Italy belong to this group.
Type #6: Decoupling inventory
Decoupling inventory is a sort of safety belt for the manufacturing process.
In case of unpredictable situations — such as shortages of raw materials, fluctuating demand, or shipping issues — items from decoupling inventory are used to save the day.
This is why manufacturers should keep limited stores of raw materials or machine parts that often break down. When you have the solutions ready on standby, you won’t have to halt production for every bump on the road. This will buy you more time to deal with the root of the problem.
While waiting for a delivery of new cones for their ice cream parlor, the owners can use the cones they have left as decoupling inventory and continue selling ice cream to their customers.
Type #7: Safety and anticipated inventory
Safety and anticipated inventory are very similar to the above type.
To deal with any stock-outs or price rises, managers often insist on having safety stock. This means that there are always extra raw materials or components to avoid stoppages in manufacturing.
It is a fact that having a safety inventory bears a considerable cost. But, if you understand market trends and learn how to optimize this inventory, it can certainly pay off.
Anticipated inventory is slightly different. You can anticipate higher demand for ski boots before winter or for cinnamon cookies before Christmas. Therefore, in order to be on the safe side and satisfy customers, managers increase the number of necessary items — in this case, ski boots and cinnamon cookies.
These items are anticipated inventory.
Type #8: Cycle inventory
Stores of milk in a cheese factory or paper cups in a takeaway restaurant are examples of cycle inventory.
These are used in cycles — when you spend the amount you have, you add a new amount straight away.
Type #9: Packing materials
Packing materials are a crucial type of inventory for any company that packs its products. A variety of boxes and packaging are used to protect goods at storage spaces or during transportation.
For example, any food processing plant that makes jam needs jars to pack the jam.
Type #10: Service inventory
Service inventory is the capacity to provide service to customers for a particular time period.
If a cinema has 100 seats, and 6 movies are shown during working hours, the cinema’s service inventory is 600.
Type #11: Theoretical inventory
Theoretical inventory represents the minimum amount of inventory that a company needs in order to keep its production at a regular level. This inventory type is also known as book inventory and is mostly used in the food industry.
For example, a pizza parlor orders 50 kg of tomatoes for their homemade tomato sauce. This is their theoretical inventory, i.e. the minimum amount of tomato they need to make the predetermined amount of sauce without delay. Therefore, they may order more for a safety stock because some of the items may go rotten while still in transport.
Type #12: Transit inventory
Transit inventory or pipeline inventory is, as the name suggests, inventory that is in transit.
It is transferred from the manufacturer and warehouses to distribution centers. From here, it can be transported to stores or online buyers.
Type #13: Excess inventory
All the items that are not sold or remain unused during the planned sales period are considered excess inventory. You can often find unsold swimsuits and flip-flops on sale at the end of summer.
Companies try to reduce the amount of excess inventory through sales, discounts and even by offering gifts when purchases are made.
All the inventory types we have just covered need to be managed in some way, and this is where inventory management and its techniques come into play.
What is inventory management?
Inventory management is the strategy used to control the mechanism of inventory flow.
It refers to the organization of all the stages of inventory movement — from ordering goods to selling them to the final customer.
Good inventory management recognizes market trends and ensures that orders are fulfilled and shortages prevented. This is vital for the success of retail businesses.
Retail inventory management
Customer satisfaction is the prime mover in retail business. Inventory management is, therefore, very significant in this industry because the aim is to meet customer demands all the time while minimizing out-of-stocks and overstocks.
Experience helps managers find the best practice to offer attractive prices, ensure sufficient supply of goods, and increase profits.
Efficient retail inventory management takes the following aspects into consideration:
- What products sell best and in what locations,
- What the optimal number of items per store is,
- When to order new supply of goods,
- What items are best sold online and in stores,
- How to reduce costs of transportation and warehouses, and
- How to plan a discount scheme.
5 Stages of inventory management
The inventory management process has 5 stages, and each entails strict control and organization. These stages are:
- Purchasing — the purchase of raw materials that will be used in production or purchase of finished goods ready for sale or shipment,
- Production — the process of making products,
- Inventory holding — storing raw materials, components, or finished goods and checking their quality until they are sold,
- Sales — the act of selling products and receiving payment, and
- Reporting — documenting what was sold and how much was earned.
Benefits of inventory management
We have seen so far that management of inventory is a highly complex process since it deals with buying, storing, selling, and distribution of goods.
Good inventory management, which is essential for this field, has the following benefits:
- Detailed insight into the amount of available stock — it allows you to order the amount you really need.
- Better planning — its aim is to avoid stockouts and excess stock.
- Money saving — you always know how much stock you have and at what location, which means that you don’t have to keep all items in each store or a warehouse.
- Understanding of trends and demand — it enables inventory turnover and higher profits.
- Better warehouse organization and supervision — it allows faster item location.
- Secured customer satisfaction — they have a great buying experience because they don’t wait too long to get their orders.
Challenges of inventory management
Inventory management can face certain challenges. Some of the most common challenges are:
- Changing customer demand — a challenge that calls for constant understanding of trends.
- Getting precise data of available inventory — having this enables you to avoid stock-outs and overstocks.
- Warehouse management — allows similar items grouping and better coordination.
- Poor procedural strategy — if the system for documenting inventory is outdated, it can lead to mistakes and cause delays.
13 inventory management techniques
Any business that involves inventory management chooses the techniques of inventory control that suit it best. The techniques of stock organization used by one retailer or manufacturer might not be right for their partners or competitors.
There are many techniques at managers’ disposal, hence they will choose the one or ones that address the company needs and are applicable to the right inventory type.
Let’s have a look at some of these techniques.
Technique #1: ABC analysis
ABC analysis is based on the status of a particular item i.e its level of popularity. Items are divided into A, B, and C categories, so that:
- Category A includes items that sell best and are most popular,
- B includes less popular items, and
- C includes the least popular items.
It is estimated that category A represents 20% of the inventory and categories B and C have equal share of the rest.
Technique #2: Just-in-time (JIT)
Just-in-time (JIT) is the method that implies keeping low levels of stock and making new orders just in time when you need them for production.
This way, you keep minimal inventory, need less storage space, and bring down waste levels.
Techniques #3: Dropshipping
This model is usually applicable to smaller businesses, which means that ordered items are sent to customers directly from warehouses, wholesalers, or bigger suppliers.
A retailer represents an intermediary between the customer and the supplier.
Technique #4: Batch tracking
Batch tracking is a technique that enables grouping of items and tracking them in matters of expiration date and defectiveness.
This technique is widely used in the food industry because many food items have expiration dates or decay rapidly.
Technique #5: Bulk shipments
Bulk shipments are considered a cheap method of transporting goods as goods are directly packed into trucks or ships.
It is a great solution for managing goods with long service life.
Technique #6: Consignment
Consignment technique refers to the situation where goods are sent to a company by a wholesaler, but those goods are not paid to a wholesaler until they are sold to customers.
It is usually used with seasonal goods and those liable to rot.
Technique #7: Six Sigma
The Six Sigma method is one of the project management techniques that can also be applied to inventory management. Based on data, this method can help improve services and eliminate defects in the inventory management process.
Principles of Six Sigma are usually applied to production, product development, and many other areas.
Technique #8: Cross-docking
The cross-docking technique is used to avoid holding inventory in a warehouse for days.
When goods arrive at a warehouse, they are immediately rearranged and loaded into other trucks or ships. This minimizes transportation costs and the number of warehouse workers.
Technique #9: FIFO and LIFO
FIFO stands for first in, first out, and this method is used if you tend to sell the oldest items first. LIFO stands for last in, first out, and this method strives to sell the newest inventory first because it is the most expensive.
Both techniques are used in inventory valuation.
Technique #10: Demand forecasting
Demand forecasting or demand planning is a highly useful technique which requires the analysis of past trends based on previous sales figures.
Generally, forecast intervals are 30 days, 3 months, and one year.
Technique #11: Economic order quantity
Economic order quantity (EOQ) is one of the methods that uses a special formula to find out the optimal amount of inventory that should be ordered and thus cut costs of overhead and storage. This technique, however, assumes that demand and holding costs remain stable.
Technique #12: Backordering
Backordering represents a management technique that enables customer orders even though some items are currently unavailable or will be available for the first time in the near future.
This technique is effective because sales go up and customers remain loyal.
Technique #13: Minimum order quantity
According to this model, a company orders minimum amounts of a certain product. The minimum order can have its set price or a certain number of items.
This technique is a great choice for small businesses, especially when it is used in the long run.
2 Types of inventory management systems
Now that we are familiar with types of inventory and inventory management techniques, it is time to discuss inventory management systems and the ways managers maintain control.
It is difficult to handle raw material purchase, follow trends, respond to customer demands, and organize distribution of goods. This is where inventory management systems come to play. They are essential for any business and managers choose them depending on the needs and cost.
There are two main types of inventory management systems:
Type #1: Periodic inventory management system
This system is usually used by smaller businesses that don’t have loads of inventory. It is based on the manual counting of items and recording on a spreadsheet or some other document. This is done at specified intervals, such as monthly, quarterly, or annually.
This system is very simple, but it isn’t the right fit for larger businesses. Also, it is error-prone, and it is advisable to do the counting more often to avoid mistakes.
Type #2: Perpetual inventory management system
This system is ideal for large businesses and corporations that have warehouses and serious transportation logistics. It involves the use of software. Items are constantly tracked and information about them is real-time. The software is often connected to points of sale, and it immediately sends data on the item availability and location. These systems require special equipment, such as barcode scanners or radio frequency identification systems (RFID), which use fixed tag readers.
Inventory management software streamlines organization
Whatever inventory you have, it is a good practice to keep track of it. Regardless of how much inventory you have, it is vital to document each item, know where it is, and how many items you have left.
For example, Plaky is a customizable and secure inventory management software.
Plaky helps you manage your inventory, provides end-to-end tracking, and categorizes your stock according to relevant columns. What is more, this tool sends notifications on any status change so you and your team members are always up to date.
Retailers might also find Plaky useful for their operations. As project management software for retail operations, Plaky provides many features such as:
- Resources allocation,
- Unlimited number of files to share,
- Unlimited users,
- Tracking shipments, and other.
It can be adjusted to your needs, and you can keep data on product IDs, prices, invoices, and suppliers. And if creating a board from scratch sounds like too much work, you can make use of Plaky’s customizable inventory management template to get you started.
As you can see, inventory management software can be useful in many ways. It offers tools that can help you optimize your inventory type, deliver tasks, manage orders, and analyze financial data.
Conclusion: The type of inventory determines an inventory management technique
In this article, we’ve covered inventory types, explained what inventory management is, and what techniques managers use to keep track of goods.
Also, we’ve mentioned inventory management systems and their features, as well as a tool that can be used to organize inventory and retail businesses.
All in all, successful inventory management relies on the:
- Understanding of supply chain,
- Choosing an inventory management technique according to the type of inventory,
- Choosing an inventory management system that suits your needs, and
- Keeping track of all the stages of inventory flow, from purchase to sale.
So, in order to improve your inventory management, think about the company needs and goals, choose (a) suitable technique(s) to keep track of inventory, foster cooperation with your suppliers, and have real-time data using modern tools.
✉️ Have you ever had the opportunity to manage inventory? Have you used any of the techniques mentioned in this article? Or, maybe you have your own tips and tricks for inventory control? If so, feel free to share your experience with us at firstname.lastname@example.org, and we may include your ideas in this or any other future blog posts.