What Is Inventory Management? (A 2024 Guide)

Ryan Patrick

Sep 20, 2024 • 17 min read

What is inventory management? Inventory management is about buying, storing, and using the inventory.

Manufacturing professionals and supply chains need to manage inventory to effectively ensure the constant availability of goods. However, proper inventory management can help businesses avoid running out of stock, overstocking, and a spike in operational expenses. As a result, such mishaps can affect a company's profit margins and customer satisfaction.

Learning the effective way to manage inventory is vital for any business that deals with physical goods. Inventory management is about any activity in gaining your products, from placing timely orders to receiving, monitoring, and storage. Getting these matters right can help your entire business.

But how do you ensure inventory management is effective? You can ensure effective inventory management by limiting lost sales, missing stock, and surplus ordering. Proper inventory management widens your profit margins while lowering your taxes.

Depending on your business, inventory can be raw materials, pieces, parts, or finished goods. The inventory is tracked from its initial purchase to the final sale.

Insufficient inventory management and increased inventory distortion cause significant losses to a business.

Inaccurate supply chains, inventory levels, and inadequate inventory tracking are common business problems. Incorpuk in this guide unpacks inventory management from sourcing, storing, and selling goods at the right price and also discuss the best practices for inventory management and why it’s crucial to any business.

What is Inventory Management?

Inventory management is mainly about managing order placement, storage, and the proper use of the product a company sells. Failure to treat inventory organisation with priority inventory can damage any business's success. The damage can happen regardless of a company’s reputation, title, or size.

The process involves controlling the flow of goods from manufacturers to warehouses and then from these storage facilities to the point of sale.

What are the objectives of inventory management?

The goals of inventory management are to ensure:

There’s always sufficient stock to meet customer demand
Cut back on costs associated with stocking inventory and
Optimise the supply chain for overall efficiency

How can a business achieve all the above goals? You can achieve the above objectives by balancing the ordering costs and stocking inventory to ensure enough supply to meet customer needs. What are the different types of inventory a business needs to manage?

Raw Materials are what manufacturers use to produce or make goods. The proper management of raw materials ensures that goods are produced uninterrupted, which can happen due to insufficient materials.
Work-in-progress (WIP) refers to the items being manufactured but not completed. Keeping WIP in check helps monitor the production progress to ensure production schedules or deadlines are met.
Finished Goods are final products that are ready for sale. Efficient management of finished goods inventory ensures sufficient stock to match customer demand without overproducing.
Maintenance, Repair, and Operations (MRO) Supplies are the items manufacturers use in the production process. However, MRO supplies aren’t part of the end product; they include maintenance, production equipment, and tools. Effective management of MRO supplies ensures that production processes run smoothly without interruptions.

Why is Inventory Management Important?

The main objective of inventory management is to have the right products available at the right time in sufficient quantities to meet customer needs. Proper inventory management and control will help a business achieve all that ensures profit loss curbing and keeps the business thriving. Inventory management is beneficial to large and small businesses in the following ways:

Better planning and forecasting help a business to analyse and distinguish products as good performers and shelf-eaters. Additionally, inventory management also improves revenue generation and liberates cash flow.
Enhanced delivery time is possible with proper arrangement and tracking of inventory to avoid mismanagement. As a result, there’s quick delivery, which increases customer satisfaction.
Lower inventory costs allow you to order and reorder materials accurately, lowering backstock and storage expenses.
Higher efficiency comes when a business has effective systems prioritising systemic management to track the products and their quantities efficiently.
Strengthened trust internally and externally due to updated stock and inventory numbers. The increase in trust is due to providing dependable information to manufacturers, workers, and customers. When a company is reliable during the entire sourcing, storing, selling, and levels process.

Challenges of Inventory Management

With so much happening to ensure inventory management, it’s no surprise there are challenges associated with the practice. These are the most prevalent challenges:

1. Inventory shrinkage is an unforeseen situation where errors like theft or vendor mistakes can lead to inventory loss or stockouts. The possible solutions for inventory shrinkage include:

Protect expensive inventory
Install security systems in the warehouse.
Tighten the process to ensure inventory isn’t overlooked.

2. Deadstock is caused by inaccurate forecasting and loss of interest in products that lead to never selling. When a company faces demand dips, the products are known as deadstock, occupying warehouse space, cluttering inventory systems, and blocking cash flow. Here are some practical solutions:

Understand market trends
Offer discounts when selling time-sensitive goods.
Engage your supplier regularly to stay afloat of changing trends.

3. Out-of-stock inventory occurs when a business runs out of stock and cannot meet customer demand. Being out-of-stock means a company has exhausted its valuable products, leading to decreased revenue and credibility. Here’s how to fix out-of-stock inventory:

Have a restock alert in place.
Implement demand forecasting
Provide a stock reserve after restocking a product.

4. Demand changes for a particular product can lead to deadstock or stockouts. Here are the ways to fix a shift in demand:

Regularly analyse current stock and supplier needs.
Implement strategic management of demand patterns.
Have a safety stock.

5. Poor use of warehouse space leads to inefficient warehouse layouts, which can negatively impact supply chain performance, workflows, and delivery times. Here’s how to ensure proper use of warehouse space:

Put in place an inventory organisation system.
Map out the workflow between departments.
Upgrade the picking process.

Although these challenges can exist in any business, minimising or finding solutions to most inventory management roadblocks is possible. How can you reduce or fix these challenges? You can mitigate these challenges by integrating organisational systems into the business and affecting the recommended solutions for each challenge.

Simple Steps on Inventory Manage

If you notice that inventory-related tasks take up much time daily, it’s time to review them and make necessary adjustments. Good inventory management practice goes beyond increasing stock accurately to make your daily business operations efficient.

Good processes and procedures allow you more time for other business-building activities. The seven-step approach below will guide you to create an effective inventory management plan to meet your business needs:

1. Define Product Sourcing and Storage

How you source and store the products you sell will determine how you manage your inventory. If you acquire and stock all products in your facility, your team handles inventory controls and processes internally. So, how effective are the processes?

However, those who store goods externally (in fulfilment centres, supplier warehouses, or dropship suppliers) need data tools and systems tied to their inventory processes. By doing so, they get real-time inventory data to ensure enough supply to meet customer demands.

2. Find Ways to Track Inventory Data

Whether your inventory is internal or external, you should always keep close tabs on the inventory data to ensure proper inventory management. To help you get it right, you need spreadsheets and inventory management systems, which are invaluable tools. Here’s what you need to record and track as your inventory data.

Internal and supplier product numbers or stock keeping units (SKUs) or Universal Product Codes (UPCs).
Quantities on hand (QOH) refer to the current amount of stock for each item in your facility.
The product storage location is where items are stored or displayed for sale.
Supplier information includes contact information, case quantities, order minimums, and delivery times (lead times).
Product costs are the wholesale expenses per supplier and any applicable discounts
Retail pricing is the current and promotional sale prices for your goods.

Depending on the number of items in your inventory, a spreadsheet can be a simple inventory tracking tool for about 100 items. However, if you deal with more diverse inventory, integrating inventory management systems can be cost-effective and make handling inventory tasks a breeze.

Inventory systems streamline customer orders, monitor inventory, and keep supplier data, purchase orders, and stock receipts in a single system. Plus, the inventory management system can seamlessly be linked to:

A retail Point-of-Sale (POS) system
Online sales channels Fulfilment centres
Dropship partners for real-time inventory updates

3. Design an Internal SKU System

An internal product SKU system is handy as it quickly identifies and tracks products during daily activities. Generally, SKUs combine letters and numbers arranged to deliver an item's critical details.

At a glance, the SKU will tell your employees what item they’re handling, where it’s stored, and other vital details like its display and shipping details.

4. Arrange Inventory Storage Areas

Organising your inventory storage area is essential, making every inventory task simple and quick. You should have a place for everything and place everything in its place to ensure getting them is easy. If your business handles inventory internally, you organise and identify storage areas like racks, shelves, or bins and label them. Assigning each product to a specific area means there will be no time wastage when getting or taking stock.

5. Use Forecasting to Place Inventory Orders

Forecasting is making predictions on how much inventory you'll have in the upcoming order to meet customer demand. Typically, forecasting involves different factors like:

Product sales velocity
Upcoming promotions
Market trends
Seasonality and
Business growth

The primary goal of forecasting is to ensure the inventory at hand is sufficient to cover predicted sales for a specified period. For forecasting to be effective, you must understand the sales velocity for products in your inventory. Management systems and tools can help significantly in purchasing the correct orders.

Another critical area to understand is supplier lead times, which are crucial in forecasting. If you’re working with reliable suppliers who ship quickly, you stock fewer items and order regularly, which regulates cash flow. With slower shipping suppliers or seasonal purchases, you make fewer and larger orders. Hence, more cash is tied up in inventory.

6. Inventory Receiving Procedures

Another critical element of inventory management is the prompt receiving of inventory shipments. It’s unwise to sell or ship unchecked inventory as it can lead to inaccurate data. And check the receipts, too. Ensure that every inventory shipping you receive is checked and confirmed as per the orders placed, then display it on the right shelves or bins.

Once the stock is delivered, ensure it’s checked for accuracy, as errors directly impact the Quantities On Hand (QOH) product. As a result, you may order more, place false backorders, and have unsold stock. Together, all these factors can negatively impact your business.

So, what's the best procedure for receiving inventory? The best way to receive your stock is to cross-check the delivery against your purchase order. You should also open all cases to ensure they contain everything as described and avoid relying on labels or packing slips since anyone can make mistakes.

Once the goods are received in good shape and quantity, quickly organise them in their classified areas. When shelving new inventory, use methods like First in First Out (FIFO) or Last in First Out (LIFO). The FIFO method is more reliable in keeping the new stock behind the old stock so that old goods are sold first, especially perishable goods or those with close expiration dates.

7. Keep Track of Inventory Levels

Auditing is vital in inventory-driven businesses. It involves a regular annual inventory count for tax purposes. The data records indicate that it compares to a physical stock count of all goods in stock in the inventory quantity on hand (QOH).

Some businesses conduct stock inventory audits quarterly and others every six months. Regular audits ensure mistakes are handled or corrected immediately in annual counts.

It may be impossible to trace when they happened, not to mention the inability to account for them. You can avoid such scenarios where you can’t account for lost stock; it’s vital to have interim counts and spot checks for accuracy and accountability. These two remedies can help you resolve inventory inaccuracies before they escalate:

Cycle counts are where you break down your entire inventory into small segments that are easy to count on a rotating schedule. The supplier can do these counts based on item category, stock location, or whatever method works for your business.
Spot checks are periodic item counts to spot random stocking errors, ordering, storage, or losses by theft.

Simply put, count when you’re in doubt about your inventory data. Close inventory monitoring will help boost your cash flow, spot theft, or other loss issues to boost your bottom line operations.

The inventory management process

Although managing inventory might not be the glamorous part of running a successful business, it’s crucial. Most enterprises manage stock levels and product movement on spreadsheets, but as the companies outgrow manual tools, they invest in inventory management tools.

It may surprise you that manual inventory tracking doesn’t cut back on costs, and you may waste a lot of time and make more errors. Hence, investing in an inventory system will give you instant solutions while fuelling growth.

Regardless of your inventory management process, investing in software is vital for all businesses. It simplifies product and material tracking and gives you more business control.

How Inventory Management Systems Function

An inventory management system is an automated, all-in-one system that provides real-time visibility into your inventory. The data from such systems enhance your supply chain, satisfy customers, and minimise inventory loss.

Inventory management systems handle inventory-related tasks efficiently across different inventory management methods. The system allows for convenient back-end management on numerous locations, channels, and currencies. These inventory management systems can automate an entire e-commerce operations process and make your business effortless.

Inventory Management Methods

Choosing an inventory management method isn’t a one-size-fits-all approach because you must select a method that suits your business needs. Inventory management can be done in various ways depending on a company’s goals. They include:

ABC analysis. Also known as the 80/20 rule, it divides inventory into three categories depending on the revenue required and control measures.
Based on historical data, demand forecasting predicts future customer demand for goods or services.
The economic order quantity (EOQ) formula is designed to avoid overstocking or under-stocking. It also minimises capital investments in purchasable goods.
Fast, Slow, Non-moving (FSN) inventory method sets apart products based on quantity, consumption, quantity, and the rate of inventory use.
First-in-first-out (FIFO) is a popular inventory valuation method that seeks to sell the older stock first. When new inventory is received, it’s packed behind the old stock and sells last.
Just-in-Time (JIT) inventory refers to having inventory ready at the right time and in the right place as per customer demand without overstocking it.
Last-in-first-out (LIFO) works on a reverse principle as FIFO. The inventory or goods that are produced or purchased last are sold first.
The perpetual inventory method monitors inventory throughout the supply chain.
Periodic inventory management is a technique that monitors inventory at certain intervals during an accounting period.
Two-bin inventory control is where two identical bins are fitted with components to be fitted onto the final product. The items in the second bin can’t be used until the first is fully utilised. The empty bin is a signal for replenishment.
Vendor-managed inventory (VMI) is a model where a vendor or supplier takes full responsibility for maintaining agreed inventory levels. They request specific information from a buyer about preferred locations or stores.

Components of Inventory

For supply chains to be efficient, they rely significantly on proper management of inventory levels. The components of inventory management include:

Demand forecasting
Inventory tracking
Reorder points and safety stock, and
Inventory turnover

Let’s discuss each component independently.

1. Demand Forecasting

Demand forecasting predicts future customer demand based on previous sales data and market trends. Accurate forecasting helps businesses plan inventory levels and ensure sufficient stock to meet customer demand without overstocking.

The prediction limits the risk of stockouts, reduces holding costs, and boosts overall customer satisfaction. Advanced forecasting techniques like series analysis, machine learning algorithms, and regression models, enhance the accuracy of demand predictions.

2. Inventory Tracking

Inventory tracking is the process of monitoring and controlling inventory levels in real-time. Some effective tracking methods include Radio Frequency Identification (RFID), barcoding, and Internet of Things (IoT) sensors.

Other terms associated with Inventory tracking:

Barcoding is when an item is assigned a unique barcode scanned at the time of sale for inventory records.
RFID is an automated technique that uses radio waves to identify and track tags attached to individual items. The method provides real-time visibility into inventory levels.
IoT sensors monitor environmental conditions, like temperature and humidity, to ensure inventory is stored correctly.

Incorporating the above tracking methods into business makes it easy to maintain accurate inventory records, minimise human errors, and enhance overall inventory management.

3. Reorder Point and Safety Stock

The reorder point is the time for replenishing stock before it runs out. The inventory level signals a top-up at the reorder point and is calculated based on the supplier's lead time and daily usage rate.

Safety stock is the extra inventory stored to protect the seller against uncertainties in demand and supply. It’s a buffer stock to prevent stockouts when there’s a spike in unexpected demand or during supply chain disruptions.

Appropriate reorder points and maintaining safe stock empower businesses to ensure continuous product availability, preventing stockouts.

4. Inventory Turnover

Inventory turnover is a performance metric that measures the frequency of selling inventory and its replacement over a specific period. How do you calculate inventory turnover?

Cost of Goods sold (COGS) / by the average inventory level

A high inventory turnover rate indicates that products are selling fast and is also a sign of proper inventory management.

Conversely, a low turnover rate suggests overstocking or slow-moving inventory. Slow-moving inventory and overstocking mean a lot of capital is tied up.

Close monitoring of inventory turnover helps businesses assess the efficiency of their inventory management practices. It also helps business owners to make informed decisions about production, purchasing, and sales strategies.

Why Effective Inventory Management is Important

Effective handling of inventory is crucial to every business’s success. It’s a factor that touches all elements of a company, from customer experience to finances. To better understand the importance of effective inventory management, let’s discuss its impact on your business:

Less human error. Having adequate and automatic data inputs eliminates the risk of human error, rampant in manual data input. Human errors can lead to stockouts, inventory loss, and other mistakes.
Decreased manual work. Inventory management software ensures the elimination of manual work, freeing up time for your team to concentrate on other growth aspects.
Simplified scaling. Efficient inventory management eliminates complex logistical issues, increasing growth chances.
Positive customer experience. With effective inventory management systems, manual errors decrease, including late, missing, or inaccurate orders. It also ensures products are available for customers, increasing consumer trust.
Supported finances. Accurate visibility into stock levels can prevent stockouts and deadstock, which reduces inventory sourcing and storage costs.

However, inefficient inventory management stagnates your business, whereas a slow manual process consumes your team’s time, leading to errors. As a result of such mistakes, the company can lose credibility and customers, while a streamlined and automatic process increases trust, efficiency, and revenue.

The Role of Inventory Management in the Supply Chain

Effective inventory management plays a vital role in the supply chain. It is a buffer against uncertainty in demand shifts, facilitating seamless production processes and supporting sales and marketing efforts. These roles are crucial in maintaining smooth business operations, and here is an in-depth look at the critical roles played by inventory management in the supply chain.

1. Buffer Against Uncertainty

Demand variability isn’t uncommon due to factors like seasonal changes, market trends, or unexpected customer order increases. Likewise, interruptions in the supply chain, like supplier delays, transportation issues, or termination of production, can affect the availability of materials.

Maintaining sufficient inventory levels allows companies to withstand these fluctuations by ensuring enough stock to meet customer needs without interruption. The buffer prevents stockouts, leading to lost sales and customer dissatisfaction. As a result, production processes can go on smoothly even when disruptions occur in the supply chain.

2. Facilitating Production

Production lines usually function when necessary components, raw materials, and work-in-progress (WIP) inventory are on hand. It ensures production lines function without delays, especially in production environments where Just In Time (JIT) management methods apply.

JIT minimises inventory levels by receiving enough materials only as needed in the production process. However, there’s still a need to stock up a certain inventory level to facilitate production when there’s an interruption in the supply chain. Here’s how maintaining optimal inventory levels benefits companies:

Preventing production stoppages
Reduce downtime
Boost efficiency

3. Supporting Sales and Marketing

Inventory management promotes confidence in the sales and marketing team because products are readily available. The marketing team can promote and sell the products with the surety of meeting or fulfilling customer orders on time.

The availability of enough products ensures customer satisfaction and loyalty because customers are sure the supplier will meet their needs. Plus, having sufficient inventory allows them to respond fast to market opportunities like promotional campaigns or sudden spikes in demand.

Effective inventory management also ensures the right products are available at the right time. Thus, sales and marketing teams can execute their tactics successfully to generate income.

Inventory Management Software System

An effective inventory management system will help to maintain the following

Optimal stock levels
Reducing expenses and
Ensuring smooth business functions

An inventory management software is essential in achieving the goals above by offering advanced tools and features that make the inventory process graceful.

Essential Features of an Inventory Management System

Acquiring an inventory software system with efficient features is suitable for your business. To help you choose a software system that serves your business needs, ensure you keep an eye on the following features for optimal performance:

Inventory tracking is possible if your software has tools like barcode scanning to help you purchase, store, and track the items in stock.
Supplier management features like auto-fill for purchase orders, and purchase histories help classify supplier data for more efficient purchasing.
Point-of-sale (POS) and e-commerce integration ensure customers can check out fast, giving them a good experience since the inventory data is in a central place connected to e-commerce and POS systems.
Procurement automation helps streamline low-stock alert reorder points for smooth purchasing and stocking to satisfy customer demand.
Inventory reporting keeps track of all inventory reports: inventory turnover rate, COGS, inventory forecasting, sales reports, inventory value, and stock age.
Usability is key in any software. Hence, you should choose user-friendly software and use these factors to compare systems:

Ease of use
Customer support
The onboarding process, and
Learning resources

Advantages of an Automated Inventory Management System

You can scale up your business by thinking past the basics of inventory management. Integrating automated inventory management in your business gives an advantage to leverage many automation benefits that include:

Real-time data access means you have real-time data and know what items are available and their location. The real-time data ensures you have accurate and up-to-date inventory data.
Reduced manual errors mean you know the accurate product orders and when to reorder them.
Efficiency is almost guaranteed with an automated inventory management system as it offers near-immediate access to inventory numbers. It also simplifies order fulfillment and enhances warehouse locations and layouts.
Sales tracking and forecasting are easier with inventory management software as it monitors supply and demand trends. Product orders are placed according to these predictions, boosting demand and sales predictions.
Partnership support is reliable with inventory management as it offers shoppers access to accurate information on product availability. They also provide accurate data on past, current, and future transactions, including potential vendor deals.
Scaling support from features like stock alerts, asset tracking, reorder points, and inventory data management enables businesses to minimise complications.
Reduced cost in all business operations prevents stockouts, deadstock, overhead, and customer loss expenses with real-time visibility into inventory numbers.

Frequently Asked Questions

How can I describe inventory in simple words?

In simple words, inventory refers to goods, merchandise, and materials a business holds for selling to make profits. For instance, if you’re delivering newspapers to customers using your vehicles, the newspapers are your inventory, while the car is an asset.

What is inventory management?

Inventory management is the process of sourcing, storing, placing orders, and selling goods or services. It also involves the management of different supplies and processes, with one of its most vital aspects being managing raw materials from sourcing them to the end product.

What are inventory management principles?

There are five inventory management principles: accurate forecasting, adequate replenishment, proper storage and handling, effective communication, tracking, and analysis. By optimising procurement strategies, businesses can achieve more efficiency in inventory management.

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In Summary

Startups can source and sell products without thinking about an inventory plan. However, if they don’t pay attention to inventory management fast enough, they become victims of unnecessary customer expenses and profit losses. Therefore, it’s crucial to understand inventory management, how it can benefit your business, and the best practices for optimal control of business operations.

But what is inventory management? Inventory management is the acquisition of goods and storing them for sale. Any business that deals with tangible products must have a management plan to survive and be successful. You'll have no earnings without an inventory that adequately meets customer needs.

Your business will likely have deadstock or stockout without proper inventory management strategies. What are the consequences? If customers can’t find what they’re looking for in your store consistently, they lose trust in you and the business. If you’re not monitoring your sales flow and making timely orders, you’ll be making losses in the bottom line.

However, if you can set up an inventory management strategy, you’ll make the correct orders at the right time and accurate quantities. When inventory flows smoothly, you can order based on the sales history. But if your inventory is held up in deadstock, it means the business has no cash flow, or you’ll be disposing of expired goods, leading to huge losses that can cost you the entire company.

So, an inventory management strategy is necessary to ensure your business operations are running smoothly and you’re making profits. Integrating inventory management automation software into your business is even better to help automate all production processes.