Inventory Management Techniques: A Guide for Small Business Owners

Published on Nov 9, 2020 | Small Business

One of the most important pieces of running a successful small business is having reliable inventory management in place. A company’s inventory is the goods it sells for profit, as well as the raw materials needed to produce those goods. It is literally how the company generates its revenue. Proper inventory management techniques will help business owners stay on top of their stock levels, and keep track of the products coming in and out of their warehouses.

In this article, we’ll discuss inventory management in greater depth and provide insight into some of the more popular methods for doing it effectively.

 

What is Inventory?

In the simplest sense, inventory is the physical goods or products that a business sells. This could be anything from clothes, shoes, beauty products, or cleaning supplies to paper goods, food products, or beverages. The goal of every company is to sell its products and thus convert its inventory into revenue.

When a company does sell its products, those products leave the warehouse and the inventory levels change. Business owners need to monitor these changes to know if and when more products need to be ordered. Companies will want to avoid running out of a high-performing product and disrupting the momentum of sales.

On the other hand, if a company fails to sell certain products, those items won’t leave the warehouse and inventory builds up. If the inventory remains unsold for long enough, it could become out of season or obsolete, depending on the products. A company in this case may have to sell the items at a much lower price or dispose of them altogether, which would result in a loss of profit.

This is why inventory management plays a direct role in a small business’ financial success.

Related: 3 Pros and Cons of Using Inventory Business Loans to Fund a Business

 

What is Inventory Management?

Inventory management refers to an important step in the supply chain process where inventories and stocks are tracked in and out of a company’s storage or warehouse. It involves overseeing the company’s purchases and orders from customers and suppliers to keep track of the number of items in stock – with the goal of maintaining ideal inventory levels – and to control the products for sale and in turn, order fulfillment.

With better inventory management techniques comes better visibility of the products a company has on hand. This makes it easier for business owners to make informed decisions when reordering stocks. So, how is this done effectively? Inventory levels can be tracked manually, but manually tracking is more susceptible to error, especially if the company is moving a significant number of products every day.

There are a number of inventory management software systems that not only streamline this process, but are more accurate, cost-effective, and time-saving. Through these programs, business owners can build a personalized integration stack fit for the unique needs of their company, and automate every procedure from stock monitoring and forecasting to end-to-end production. All of these features will improve the company’s bottom line.

 

Why Is It Important?

Any company that sells goods relies on its inventory to keep up with sales and gain profits. With proper inventory management in place, a business’ supply and demand chain will fall into place. With enough stocks on hand, a company can meet the supply and demands of its marketplace. Failure to properly manage inventory levels could 1.) result in a loss of profit if too much inventory goes unsold; or 2.) lead to a disruption of sales, if the product runs out and isn’t restocked on time. The latter could disappoint customers and potentially damage a company’s reputation.

Proper inventory management ensures that a business will have a sufficient quantity of its product when its customers are ready to purchase them. It will also prevent the company from getting stuck with excess stocks on hand when the industry demands are low.

Related: A Basic Guide to Investing in Small Businesses

 

6 Inventory Management Techniques

By now, we’ve hopefully communicated the importance of proper inventory management. Now we’ll breakdown the different systems available for effectively integrating it into your small business. Remember, finding the best system for your business will help you to track stock levels, calculate business profits, and measure other important financial metrics. A good inventory management system enables you to know if and when you need to replenish your stocks or cut back on the number of orders

Business owners should evaluate which inventory method and strategies work best for their business. Here are six methods to consider:

The Barcode System

Barcodes are one of the most popular tools for inventory management and control used today. You’ll see them in supermarkets, retail stores, and apparel shops, to name a few places.

When a company employs this method, it puts a barcode on all of its products. These products are then scanned with a digital scanner which is synchronized with the business’ inventory management software system. Barcodes essentially assign a number to every product they sell. Scanning the said barcode automatically generates any data points associated with that number. For instance, if the product is a t-shirt, the barcode will likely show its size, color, cost, and how many are left in stock. When an item is sold, the barcode will also factor that sale into the company’s inventory count to allow for real-time tracking. Assigning barcodes to products allows companies to track everything that comes in and out of their warehouses.

RFID Tracking

The RFID Tracking technique uses a microchip to store all product information, including the product’s weight, dimensions, and manufacturing costs. To read the chip, companies use a specialized radiofrequency-powered RFID scanner. When the specialized scanner reads the chip, it will show these details (without needing to connect to the internet).

What makes RFID different from barcode or QR code systems is the technology used in them. For barcode scanners, you can only scan one item at a time and you have to place the barcode as close to the scanner as possible to read it. RFID scanners can read multiple chips at once, even if they are covered with layers of packaging. You can scan the chip even if the scanner is a few inches or meters away (approximately 12 meters). This saves staff a lot of time and effort since they don’t have to go through boxes to scan each individual item.

The RFID tracking system is best for tracking large volumes of products. You can place different RFID scanners in your warehouse, specifically the entry and exit points, and the scanner will automatically scan the products as they go through. With an RFID system, there will be fewer human errors, and your staff will be more efficient in processing orders.

Just-in-Time (JIT) Reordering

With the Just-in-Time inventory reordering strategy, businesses keep their inventory on hand at a minimum. The company only orders new products to replace those the amount they have already sold. This method involves using smart inventory forecasts to schedule the reordering of the inventory only when needed. The idea behind this strategy is that reordering your inventory too soon could lead to excess stocks that aren’t being sold. In this case, a chunk of your capital gets tied up in your inventory unnecessarily. With the JIT reordering method, you’ll have your inventory shipped just in time when your stocks are starting to run out.

When implemented the right way, the Just-in-Time reordering system can help business owners keep their storage costs low and ensure that they will always have fresh inventory. This will lead to better customer satisfaction and improved business profitability in the future.

Economic Order Quantity (EOQ) Reordering

The main goal of Economic Order Quantity (EOQ) Reordering is to reduce or minimize your inventory costs. Typically, when a business has a lot of inventory, the storage fees tend to increase. With EOQ reordering, you can determine when the best time is for reordering to minimize your overall inventory costs (product ordering costs and inventory holding costs).

The EOQ method allows for better inventory management because you can calculate how much inventory to reorder so you don’t end up paying more than you need in storage fees. The lower your storage costs are, the lesser your opportunity costs.

To calculate for your EOQ, you can use this formula:

Total Costs (TC) = (P x D) + [(H x Q) / 2] + [(S x D) / Q]

Where,

    • P is for price per unit or the total cost of the item or unit you’re going to reorder;
    • D is for the number of units needed or the number of products you’re expecting to sell for that specific period or quarter in question.
    • H is for the holding cost per item or how much it costs to store the item.
    • Q stands for quantity ordered, which refers to the number of quantity of units you plan on reordering. This factor is the one you’ll manipulate to determine the most economical way of lowering your inventory costs.
    • S stands for the fixed cost per order. It’s the fees you have to pay for the orders you have placed, regardless of how many units you’ve ordered.

The ABC Method

The ABC method is another one of the most common inventory management techniques used today. Through this method, business owners prioritize the products that bring in the most profit for their company. This requires categorizing products into three groups: A, B, and C, where:

    • Category A contains the most valuable products to your company, thus bringing in the most profit. The company should always have stocks of category A on hand. Products in Category A contribute at least 70% to 80% of your company’s revenue.
    • Category B covers the products that are valuable but not as valuable as category A.
    • Category C contains the least valuable products but are still vital to the company’s overall profit.

Products can move from category B to category A or C to B, which is why it’s important to conduct a regular analysis of your products.

FIFO and LIFO Method

FIFO stands for the first-in, first-out method of inventory control. Through this method, the store has to sell and get rid of the oldest stocks in their inventory first to avoid products sitting around for too long and becoming unsellable. The focus of this method is to ensure that inventory is staying current and fresh and never getting too stale with old product.

On the other hand, the LIFO or Last-in, First-Out method assumes that the newest inventory is sold first. This helps prevent the products from becoming obsolete. However, the LIFO method is considered unethical in certain countries outside the U.S. because of tax issues. If you’re running an international business, this method may not be the best for your company.

 

Conclusion

It’s worth noting that there is no one-size-fits-all type of strategy when it comes to inventory management. That is why it’s important to evaluate your business’ needs and do your research on the different inventory management techniques available out there.

Choosing the best inventory management strategy for your business can be overwhelming, especially if you’re just starting out. Start with one technique. As you go on, you may be able to slowly integrate other techniques into your business and strengthen your inventory management strategies.

When integrating inventory software into your business, it’s always best to ask for help from people who have expert knowledge of it. Working with them will help you to learn the proper techniques and understand the features of the system you’re implementing. This will let you maximize the benefits of your inventory management system and, in turn, improve your business’ bottom line in the long run.

ABOUT AUTHOR

Dane Author SMB Compass
Dane Panes
Dane Panes started freelance writing in 2017. Since then, she has written about a lot of topics for different businesses. She started writing for SMB Compass in March 2020 and has been a full-time content writer ever since. Now, she focuses mostly on topics related to entrepreneurship and business financing.

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