Inventory Management: A Complete Guide

Managing your stock

Inventory management is an essential activity for every retailer. Get it right and your customers will be happy, your sales will increase and your margins will improve. Get it wrong and you will experience stock-outs, inefficient picking, packing and delivery and customer backlash.

In this post, we take you through everything you need to know about managing inventory. From key inventory terms to stock management formulas, we cover it all. If you are an inventory manager in a large organisation or a small company trying to improve inventory management this guide will help you better understand how to improve your inventory management process.

Stock Management by Iconography

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What is inventory management?

The objective of inventory management is to buy the right products, at the right price and have them delivered at the right time so they can be sold at the highest margins

Let’s start by briefly covering what inventory management actually is. Inventory management is an umbrella term that covers all aspects of the inventory management process including purchasing, production, holding stock, sales and reporting.

One key aspect of inventory management is warehousing and stock control. To fulfil as many orders at possible at the highest price, and reduce warehousing costs, an optimum number of products must be in stock at all times.

Too much stock means and you could be sacrificing warehouse space that’s better-used storing more popular lines. Too little stock and you risk losing sales due to out of stocks. Finding the balance is critical.

Key inventory management terms

Before we get stuck into the details of inventory management let’s define some key terms commonly associated with this activity. Businesses have different stock management processes so some terms may be familiar and some won’t.

1. Stock levels

Stock levels, inventory levels, units in stock. These all refer to the amount of physical product you have on the shelves in your store and warehouse. For retailers, this would most likely be finished goods ready to be sold. For manufacturers, this would be the individual raw components used to make each product and the number of completed products in stock.

2. Cost of good sold (COGS)

The cost of goods sold is the total cost of buying or manufacturing products that have been sold within a certain period. These costs might include the purchase cost of stock or raw materials, the cost of currency conversion and labour costs. It does not include costs associated with selling products like shipping them to a retailer and labour used to sell products in a store.

3. Days in inventory

Days In Inventory can also be known as Inventory Days and Days Inventory Outstanding. It’s a formula used to calculate how many days the inventory you have in stock will last. Knowing this figure tells you how many days on average it takes for you to convert inventory into sales. This is useful because you can calculate how much of your cash is tied up in inventory. It’s a good indicator of how effective your inventory management is.

4. Reorder point

Reorder point is a simple calculation, but a useful one all the same. It provides a figure at which inventory must be reordered, a kind-of low stock threshold. Finding the right reorder point figure is important because it prevents you from holding too much stock, and reduces the chances of stock-outs. For fast selling products you would likely have a higher reorder point figure than a slower selling product.

5. Safety stock

Safety stock is additional stock on top of your normal inventory that is there ‘just-in-case’. Having safety stock can help to prevent stock-outs when issues arise that are beyond your control. These could be extended supplier lead times, delivery issues or unexpected increases in demand. It’s particularly useful for products where demand fluctuates throughout the year.

6. Lead time

Lead time is the time taken to complete an entire process from the point of product raw material acquisition through to the point it’s ready to be sold. This is applicable to both manufacturing and retailing. Manufacturers would consider lead time to be the time it takes to acquire raw materials and turn them into a product. Retail lead time is the time it takes between receiving an order and the customer receiving it.

7. Supply chain

Your supply chain is the network that links your company and the suppliers that produce the goods you sell. It covers the full process from product concept, design and manufacture to the customer receiving the finished product. A well-optimised supply chain results in reduced costs and faster times to market.

8. Inventory accounting

Inventory accounting specifically relates to valuing your inventory and accounting for changes in your inventory. The purpose of inventory accounting is to value your inventory at each stage of the production process which are raw-goods, in-progress goods and finished goods. Doing this can lead to identifying ways to increase profit margins at each stage of the production process.

9. Inventory carrying cost

This is an accounting term that includes all of the expenses involved in holding and storing units that have not been sold. It takes into account a lot of figures including but not limited to; depreciation, taxes, insurance, salaries, transportation, warehousing and opportunity costs.

10. Purchase order

All retailers with suppliers will be familiar with purchase orders. These are commercial documents that contain the details of an order including products, quantities, prices, discounts and delivery information.

11. Point of sale

Point of sale refers to the place at which a transaction is conducted between a customer and a retailer. This could be online or in-store. Modern retailers use Electronic Point of Sales (EPoS) software in physical locations, which is often part of a wider Unified Commerce platform that includes inventory management, CRM and eCommerce.

12. Sales channels

All retailers have at least one sales channel, be it a physical store or eCommerce website. Multichannel retailers have multiple sales channels which may be multiple physical stores or stores and a website. Online retailers tend to increase their sales channels by listing products on online marketplaces like eBay and Amazon.

13. Inventory management software

Inventory management software is the glue that bonds many retail operations together. It’s critical for ensuring that your stock levels are optimised and you can fulfil sales orders. Like EPoS, the modern approach for retailers is to buy a unified commerce suite that combines EPoS, eCommerce, CRM and inventory management giving them a 360° view of their retail operation.

Inventory management process

The process of inventory management has 5 key stages. Each stage of your supply chain will be involved in one of the five processes from your suppliers to your customers.

Purchasing - For manufacturers and DTC retailers this means buying the raw materials that are used to make the final product. For traditional retailers, this is buying stock that is ready to be sold straight away. It could also mean buying made to order items directly from the manufacturer like sofas.

Production - As a retailer, you may not be involved in this part of the process, which is concerned with turning raw materials into saleable products.

Holding Stock - For manufactures this means holding both raw materials and finished goods until they are shipped to the end-customer or the retailer. For a retailer, this is stock on your shelves or in your warehouse.

Sales - The process of completing a transaction for the goods you are holding.

Reporting - Often overlooked by many businesses, reporting is critical for understanding which products sell best, who your top customers are and where improvements can be made, including in the inventory management process.

10 techniques for managing inventory

Having passed through stages one and two of the inventory management process you will now be holding stock that’s ready to be sold to your customers. This is a critical stage of the process and one that needs to be managed effectively. There are a number of techniques that businesses use to manage their inventory, and we have listed ten common techniques below.

1. Economic order quantity

To minimise the total costs of inventory, companies will often calculate the Economic Order Quantity. This figure determines the number of units that should be added to an order to minimise costs including holding costs, order costs, delivery costs and shortage costs. It’s useful for calculating the reorder point and optimal reorder quantity.

2. Minimum order quantity

This is the smallest amount of stock that a supplier will sell to you. For smaller retailers, minimum order quantities can be problematic, which is one reason that buying groups are popular.

3. ABC analysis

This is a way to identify which items are impacting most on the overall inventory cost. Category A items are the biggest contributors to your overall profit. Category B items are consistent, regular contributors and sit between A and C. Category C is for products that are essential for profit when grouped together but individually have little impact on the company. For a furniture retailer a category A product may be a sofa, category B a footstool and category C, cross-sell products like lamps, cleaning kits and insurance.

4. Just-in-time

Most commonly associated with the automotive industry just-in-time relies on a highly optimised supply chain so that raw materials arrive just before they are used on the product line. When done well it’s one of the best ways to reduce inventory costs.

5. Backordering

This is a technique used by retailers when they don’t have products in stock but know they’re available. It means that you can continue to sell products and fulfil orders at a later date. Sometimes backorders may be fulfilled directly from the supplier.

6. FIFO & LIFO

FIFO is ‘first-in, first-out’ and is used for cost flow assumption and assumes that the oldest items in your inventory have been sold first. LIFO is ‘last-in, first-out’ and records the most recently bought products as being sold first.

7. Batch tracking

This has become very popular with fashion brands recently who are selling sustainable and fairtrade products. Batch tracking enables each product to be tracked across the whole supply chain from manufacturer to the end customer.

8. Consignment inventory

Consignment inventory shifts the cost of inventory from the retailer to the manufacturer. The retailer does not pay for the product from the supplier until a customer has bought the product from the retailer. Unsold stock can be returned to the supplier without incurring losses.

9. Dropshipping

Dropshipping allows retailers to sell products without ever having to hold stock themselves. A great example in the furniture industry in Baumhaus. Many retailers will sell products online and automatically route orders to suppliers who fulfil the order for them, often as Whitelabel. There are pros and cons to this approach and it’s becoming increasingly popular with eCommerce entrepreneurs.

10. Cross-docking

This inventory management technique involves minimising storage, and in some cases eliminating it completely. The supplier will deliver products as required to a retailer who will immediately ship them to customers. Sometimes suppliers will fulfil orders directly to the customer too.

Formulas for managing inventory

As you can see there are many techniques for managing inventory. From low risk, low margin options like drop shipping to high-risk techniques like just-in-time. For any of these techniques to work effectively, inventory managers must create forecasts using formulas to identify how much stock is required and when it should be delivered. These formulas are commonly used to work this out.

1. Inventory turnover ratio

Inventory turnover is the number of times a business has sold and replenished inventory over a certain time period. It’s a good way to calculate how efficient your inventory management process is with a higher inventory turnover rate indicating more efficient inventory management.

Inventory turnover = cost of goods sold / average inventory

2. Cost of goods sold formula

This is the total costs associated with manufacturing and selling goods within a certain period. Having a high COGS can have a big impact on profits as it is subtracted from a company’s gross income. The calculator for COGS will be easier for some retailers over others.

COGS = starting inventory + purchases - ending inventory

3. Average inventory

Average inventory is a useful calculation for comparing overall sales volume and tracking inventory losses that may have been caused by shrinkage, theft or damaged goods. It enables companies to determine inventory turnover and identify where optimisations can be made in the inventory management process.

Average inventory = (beginning inventory + ending inventory) / number of months

4. Sell-through rate (percentage)

This is a great calculation for identifying which products are working well for you and which could perform better. Low sell-through rates can be caused by a number of reasons including too much stock (overestimating demand) and prices that are too high. It can be used to determine suitable order quantities for particular products and suppliers.

Sell through rate = number of sales / stock on hand x 100

5. Safety stock formula

Safety stock is additional stock that you hold on top of regular inventory just in case there is a surge in demand or supply chain problems. Holding too much safety stock will cause problems with additional storage and holding costs which is why it’s best to use a formula to calculate the correct amount of safety stock you should hold. All you need are your purchase and sales order history.

Safety stock = (maximum daily usage x maximum lead time in days) - average daily usage x average lead time in days)

6. Reorder point formula

The reorder point formula is essential as it tells you when you will need to reorder stock. Many businesses tend to rely on gut feeling or previous quantities which can be risky. Given that it’s easy to calculate it’s useful to know, especially if you;re planning to grow your business.

Reorder point = (average daily usage x average lead time in days) + safety stock

Managing inventory for multiple sales channels

For multichannel retailers, inventory management is more complex. The data sets are usually larger so making calculations takes longer, and there are more of them. It’s often a point at which inventory management forecasts become less accurate and mistakes occur. It’s a risk that needs to be carefully managed by growing businesses.

One of the reasons for this is retailers tend not to have a complete view of their inventory. Different sales channels may have different systems for tracking sales and inventory. If these systems aren’t connected, gaining a 360°of what you have in stock and where there is a struggle, and trying to find this out in real-time is near impossible.

It’s for this reason that multichannel retailers must implement unified software that houses sales, inventory and product information for every channel. Doing this not only makes for more accurate ordering and inventory management because everything is updated in real-time, it means orders can be fulfilled from any location. That’s because you have complete visibility of your stock. This reduces the chances of stockouts and keeps everything running smoothly.

10 benefits of inventory management

Improving inventory management has many benefits to your customers and staff and ultimately leads to greater margins and profits. While these are top level benefits, some of the day to day benefits of inventory management include:

1. Fewer missed sales - with a better grasp of your stock requirements you are more likely to have stock when you need it leading to fewer stockouts and fewer missed sales

2. Better invested cash - When you know which products move slowly, and which perform best you can optimise your warehouse space and invest your money in products that have a facts inventory turnaround time.

3. More accurate reports - Using a unified system that gives you a 360° view of your inventory enables you to run more accurate reports which leads to better forecasting, less stokouts and reduced overstocks.

4. Early problem detection - Real-time reporting across all channels enables you to identify potential problems before it’s too late. Sometimes old system don’t update until the end of the day or even week, by then any opportunity to prevent or react to a problem has passed.

5. Happier customers - optimised inventory management will help you to keep customers happy by reducing fulfillment time and keeping your fast-selling products in stock.

6. Efficient re-ordering - The best inventory management solutions will make re-ordering much more efficient with features like automated purchase order creation. When stock hits a low threshold a PO is sent directly to the supplier with no manual intervention required. Systems can also alert you when you hit low stock thresholds so you never have stockouts.

7. Theft and loss reduction - When you manage inventory effectively you account for every item. This means you can identify where problems are occurring in the inventory management process and address them quickly and accurately.

8. Trusted information systems - With all of your product, sales and inventory information in one system you have one source of truth. This means everyone in the business has access to the same information making your inventory management system your trusted source of information.

9. Reduced warehouse costs - Optimising the amount of stock you hold and when it’s delivered will help to reduce your warehouse costs. Calculating the inventory carrying cost will tell you which problems and which products are costing the most.

10. Better supplier relationships - Using features like batch tracking will enable you to implement much better product traceability and analyse and compare your suppliers. With this information you are better positioned to negotiate favourable terms and deals.

Improving your processes

Inventory management is an essential activity for all retailers, especially those selling through multiple channels. Improving your inventory processes will help you to reduce your costs and increase your margins as you free up warehouse space to sell greater quantities of your most popular products.

Aside from your processes, the software you use to manage your inventory is critical too. You must implement software that gives you a 360° of your stock at every location. Doing so enables better reporting of sales and stock leading to better forecasting and more efficient inventory management.

Upgrading your software

If you’re interested in upgrading your inventory software to a complete unified commerce solution, that contains eCommerce, EPoS, CRM and inventory management, get in touch with a member of our team to find out more.

OMNIS was born out of the needs of a leading direct to consumer brand to support their online and instore retailing formats in the UK market. They were facing the same problems and challenges that present obstacles for any retailer.

As a progressive and forwarding thinking brand, our client wanted to remove the limitations, constraints and operational inefficiencies associated with integrating an eCommerce website with offline EPoS and legacy back office retail software.

We quickly saw the vast potential OMNIS possessed. It’s a need we’ve recognised with many other retailers and DTC brands that have similar aspirations and want to remove the restrictions of old retail technology and software.

In OMNIS you can create multiple warehouses with any number of locations, place purchase orders and complete stock transfers. We have a full range of reporting and administrative control suite. Together, these give you complete control and oversight over your stock across all channels.

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