Put simply, inventory management is how a company keeps a record of what goods are in stock, what they are, how many, and where they’re located. The aim of inventory management is to lower the number of products a business (needlessly) hangs onto, thereby incurring costly storage fees.
If a company keeps on top of inventory management, not only does it lessen their storage costs, but it also helps them to stay on top of restocking. As such, they should never run out of merchandise to sell or raw materials to manufacture new stock.
Why Inventory Management is Important
Efficiently managing your inventory allows your business to remain as cost-effective as possible. After all, if you spend too much on stock, you might not have enough to cover your operating costs. Or, you could be throwing money away on products that could otherwise have been re-invested into growing your business.
But, ordering the right amount of stock is a careful balancing act. Yes, you don’t want to throw money down the drain but you also need to meet customer demand. You want customers to return to you again and again, but they won’t do that if your items are always out of stock or if they have to purchase too far in advance of delivery.
If your business sells fresh produce or items with a sell-by or expiry date, you need to shift your inventory promptly. Regular inventory management will help you do that and (potentially) stops you from having to offer substantial discounts on products going out of date.
Inventory Management = Improved Cash Flow
If you’ve paid in advance for your inventory and you haven’t sold it yet, it’s not making you any money. It’s that simple. If your stock is languishing in a warehouse somewhere, you’re laying out cash and not getting any money in return. This isn’t good for cash flow. Not to mention, having too much inventory increases the risk of it being damaged, stolen, or no longer needed by consumers. Again, this isn’t helping your bottom line.
Accounting for Inventory
Since inventory is an asset, it has to be counted before your accounts can put it on your balance sheet. Typically inventory is accounted for using inventory management software that integrates with other programs used to run your business. Such software offers you real-time inventory management. It gives you an accurate insight into when inventory flies out the door and when it doesn’t.
Typically, three ways are used to account for inventory:
- First-in-first out (FIFO)
- Last-in-first out (LIFO)
- Weighted average costing
Methods Used to Manage Inventory
Depending on which type of company you are, you may choose a variety of methods to manage your inventory. Popular ones include just-in-time, days sales of inventory (DSI), economic order quantity, and materials requirement planning (MRP).
The just-in-time method originates from Japan and was used by Toyota for car manufacturing. Using this method, you only keep the inventory you need to produce and sell items. It reduces insurance costs, storage expenses, and there’s no need ever to get rid of anything.
The days sales of inventory method shows the average number of days your company takes to sell its inventory. This includes items that are a work in progress. This also takes into account the age of your inventory. The shorter the time you have the product, the better.
The economic order quantity method is used by companies to try and ensure they order the right amount of inventory each time. This prevents them from having to keep reordering small amounts, which could cost more in the long run.
Last but not least, materials requirement planning is a system used in tandem with sales figures. In other words, if you know how much you’re selling and going to sell, you can plan the number of inventory materials you’ll need to manufacture products to sell. If you can’t forecast your sales, and subsequently plan production, you face being unable to fulfill orders.