Managing your inventory
Managing and tracking your inventory is an important area in your business operations, as high levels of inventory stock which stand for long periods in warehouses have a direct effect on your cash flow. Inventory management matters because owners need to know what stock they have, where it is, and to make sure that this information is accessible throughout the business. If your inventory management system does not provide the information accurately or in real-time, this could result in misdistribution of your stock.
Effective inventory management involves procurement of:
the right supplies
in the right quantities
from the right suppliers
in the given timeframe
at a reasonable price.
In order to achieve better inventory management, you first need to improve your inventory (stock) control.
• Inventory control means regulating the inventory – the items you sell, use or manufacture – you have at your premises, typically in a warehouse. This means knowing what products are being stocked, where they are, and how many of a particular item you have available.
• The inventory control checklist will help you cover all relevant aspects.
Good inventory control can improve your cash flow and profitability. Clear visibility of your inventory will help you to:
• minimise costs
• optimise order fulfilment
• provide better customer service
• prevent loss from theft, spoilage and returns.
• Holding onto inventory is costly and can tie up cash that could otherwise be invested elsewhere. Holding some inventory is unavoidable. However, the levels should be optimised to reduce the burden on your cash flow.
• The common inventory formulas explained below and summarised in this template can be very useful for keeping inventory levels optimised, so make sure you familiarise yourself with them.
• Economic order quantity (EOQ) = the square root of (2 x D x K ÷ H), where:
— D is the setup or order costs (per order, generally including shipping and handling)
— K is demand rate (quantity sold per year)
— H is holding or carrying costs (per year, per unit).
The economic order quantity helps you better plan production as it defines inventory order quantities that minimise relevant costs.
• Inventory days outstanding = (average inventory ÷ COGS) x 365 or 365 ÷ inventory turnover
The average inventory is calculated by adding together the beginning and end inventory balances for a month and dividing by two. The inventory days outstanding gives the number of days an item is held as inventory before it is sold. A lower value indicates an efficient inventory management system for the business.
• Reorder point = (lead time in days x average daily usage) + safety stock. This formula helps you define the best time to order new materials.
• Safety stock = (maximum daily usage x maximum lead time in days) – (average daily usage x average lead time in days). Safety stock is your buffer inventory that will enable you meet your current demand.
A lack of accurate and up-to-date inventory management affects all aspects of a business. Some businesses have detailed plans for their operating model but cannot enact them due to poor inventory systems. Poor inventory management can also cause visibility issues and hidden costs.
• Visibility issues – for many businesses, manual inventory counts are the only time when they know what stock they have and where it is in their network. Without the ability to instantly see and update inventories, retailers can miscalculate their online inventories and advertise stock that is not actually available. This can lead to customers placing orders that cannot be fulfilled. The business then has to inform the customers and potentially issue refunds.
• Hidden costs – online sales often involve hidden costs businesses are not aware of. For example, as goods move through the value chain, their cost can be inflated due to duty, freight or handling charges, and additional shipping and return costs charged by courier services. Without accurate inventory management, these costs are not properly managed and the true item profitability is unknown.
It's important to monitor your inventory, especially what you sell. You could use spreadsheets in Excel, simple databases, or dedicated tools and programs to help you make decisions about ordering. You can also invest in more advanced inventory management systems that will pay off in the long run as they can enable you to analyse sales patterns and predict future sales. For example, some common supply planning and inventory management software systems are SAP Supply Chain Management, Oracle Supply Chain Management and the Blue Yonder platform.
Pay special attention to slow-moving, perishable and seasonal inventory items.
• Perishable goods should be sold in the order that they come in, on a first in, first out principle, to avoid inventory deterioration.
• When you are managing your inventory, consider quantities, sales and storage. If you have slow-moving or seasonal inventory, consider reducing your inventory levels by returning items to suppliers if permitted under your agreement. This is a useful option to include in your contract. Alternatively, sell slow-moving items with a discount. Even though it will impact your profitability, it will free up your storage space and improve cash flow.
An inventory count should be an essential part of inventory control as it helps you track each item in your warehouse and identify lost, stolen or damaged goods.
• Some businesses may be obliged by law to conduct an annual inventory count, depending on their nature and size.
• Here is an inventory count sample template to help you in the process.
Inventory management covers activities including:
• controlling and overseeing procurement
• warehouse management
• controlling the amount of product for sale
• order fulfilment.
In case of inventory shortage, prioritise your demand. Map critical sourced materials to high value products and revenue streams.
• Identify the components and raw materials that have the highest impact on your revenue stream and allocate scarce capacity wisely. You can also reconfigure supply chain flows. Be proactive in addressing any anticipated shortages.
• Determine the business’s exposure to your largest suppliers and customers by identifying current and buffer inventory, and build short-term action plans to be able to fulfil demand.
Implement a warehouse management system to optimise your inventory and avoid unnecessary additional costs.
• Assess risk factors that may increase costs or reduce service quality or inventory capabilities.
• Revise cash flow, working capital management and inventory forecasts alongside supply and demand predictions.