Comprehensive Guide to Understanding Inventory Management
Last updated: June 2024
Inventory management involves the systematic process of ordering, handling, storing, and utilizing a company’s non-capitalized assets—its inventory.
For some businesses, this includes raw materials and components, while others may only manage finished goods ready for sale.
Either way, inventory management all comes down to balance – having the right amount of stock, in the right place, at the right time. This guide will help you achieve that balance.
Table of Contents
Retail Inventory Management
Key Components of Inventory Management
Importance of Inventory Management
What are the Four Types of Inventory?
Inventory Tracking Methods
Effective Inventory Management Strategies
Inventory Management Techniques
Key Inventory Management Terms
Key Formulas in Inventory Management
Choosing Inventory Management Software
Retail Inventory Management
Retail businesses sell physical products to consumers and typically rely heavily on inventory management. This guide focuses on inventory management from a retail perspective.
Retail can be divided into several categories:
Offline: Sales via brick-and-mortar stores.
Online: Sales through ecommerce websites or marketplaces.
Multichannel: Sales through multiple platforms, combining online and offline channels.
Omnichannel: A unified customer experience across all sales channels.
Businesses may also trade via wholesale channels, selling inventory in bulk directly to other businesses (B2B) or through B2B ecommerce.
Further reading: Building a Smarter Future with IoT in Warehousing
Key Components of Inventory Management
We’ve covered the broad definition of inventory management. But what’s actually involved when it comes to making good inventory management happen?
Bottom line: You want to keep inventory levels balanced at all times without ever having too much or too little of each product in stock.
This sounds simple, but rarely is. In reality, good inventory management all comes down to understanding:
Types of inventory: Know what inventory you have and where it is.
Inventory forecasting: Predict how much stock is needed to meet future demand.
Purchasing inventory: Create purchase orders and re-order stock effectively.
Inventory storage: Determine suitable storage locations for each item.
Inventory analysis: Use metrics to make informed decisions.
Handling techniques: Efficiently book-in, put away, pick, pack, and ship inventory.
Multichannel tracking: Maintain visibility of inventory across all channels, usually using a multichannel inventory management software like Veeqo.
Inventory accounting: Properly record inventory on financial documents.
Inventory management systems: Automate inventory management processes.
These are the basic ingredients of quality inventory management. And you’ll need to take a systematic approach to them in order to best equip your business for long term growth.
Luckily, we expand on each of these points in depth within the different chapters of this guide.
The Importance of Inventory Management
Good inventory management is essential for retail businesses. It ensures a seamless customer experience, improves cash flow, maximizes profits, reduces shrinkage and waste, and optimizes the fulfillment process.
Key benefits include:
Customer Experience: Prevents overselling and ensures order fulfillment.
Cash Flow: Maintains liquidity by avoiding overstocking.
Shrinkage Avoidance: Reduces the risk of spoilage and theft.
Fulfillment Optimization: Ensures inventory is stored and handled efficiently.
Further reading: Inventory Reduction Strategies to Clear Excess Stock
What are the Four Types of Inventory?
There are several different types of inventory a company might come across while handling and controlling its stock, but four main types, as well as packing materials which we include as a fifth one.
The main types of inventory are:
Raw Materials: Basic materials used to produce goods.
Work-in-Progress (WIP): Items currently being processed.
Finished Goods: Completed products ready for sale.
Maintenance, Repair & Operations (MRO) Goods: Supplies used in production and maintenance.
Packing Materials: Materials used for packaging products for shipment.
How do You Track Inventory?
Inventory can be tracked using various methods, from pen and paper, to an Excel spreadsheet, to sophisticated cloud-based inventory management software.
As businesses grow and sales channels increase, automated systems become essential for accuracy and efficiency.
The more sales channels you sell on (and the more sales you make on each one), the tougher this practice becomes. So most growing multichannel retail businesses will be looking at some form of automated system to take care of inventory tracking for them.
Further reading: Here's Why You Need to Ditch Excel for Inventory Management in 2024
Effective Inventory Management Strategies
Effective inventory management is crucial for maintaining the delicate balance between meeting customer demand and minimizing costs.
Implementing the right strategies ensures that your business operates smoothly, with sufficient stock levels to fulfill orders promptly without overstocking or tying up too much capital.
The below strategies are designed to improve efficiency, reduce waste, and ultimately support the long-term growth and profitability of your business.
Regular Forecasting: Plan inventory needs based on sales projections.
Timely Purchasing: Reorder stock based on specific reorder points.
Optimal Storage: Organize your warehouse to minimize shrinkage and expedite fulfillment.
Automated Systems: Use technology to manage inventory across multiple channels
Further reading: How to Design Your Warehouse Layout for Maximum Efficiency
Inventory Management Techniques & Methods
Methods are something we explore specifically in our chapter on inventory management techniques. But here are a few high-level examples of methods to control inventory:
Fulfillment Options: Choose the best methods for order fulfillment.
Reorder Points: Set specific levels to trigger reordering.
Economic Order Quantity (EOQ): Calculate optimal order quantities.
ABC Analysis: Prioritize inventory based on value and turnover.
Regular Counts: Verify inventory accuracy with periodic counts.
Automation: Use software to streamline inventory processes.
Further reading: 5 Ways Inventory Control Software Can Help Your Business
Key Inventory Management Terms
Inventory management is a complex subject. And there’s a lot of systems, processes and general pieces that go into the puzzle.
Here’s a glossary of key terms you’re likely to come across:
Average inventory | The average inventory on-hand over a given time period, calculated by adding Ending Inventory (EI) to Beginning Inventory (BI) and dividing by two. |
Average inventory cost | An inventory valuation method that bases its figure on the average cost of items throughout an accounting period. |
Back order (BO) | An order for a product that is currently out of stock, and so cannot yet be fulfilled for the customer. |
Barcode scanner | A device used to digitally identify items via a unique barcode, then perform inventory and fulfilment tasks like booking-in, picking, counts, etc. |
Beginning Inventory (BI) | The value of any unsold, on-hand inventory at the start of an accounting period. |
Bundles | A group of individual products in an inventory that are brought together to sell as one under a single SKU. |
Carrying costs | The total costs associated with holding and storing inventory in a warehouse or facility until it is sold on to the customer. |
Cost of goods sold (COGS) | Direct costs of purchasing and/or producing any goods sold, including everything that went into it – materials, labour, tools used, etc. Does NOT include indirect costs – like distribution, advertising, sales force costs, etc. |
Dead stock | Inventory that remains unsold for a long enough period of time for it to be deemed outdated and virtually unsellable. |
Ending Inventory (EI) | The value of any unsold, on-hand inventory at the end of an accounting period. |
First-in-first-out (FIFO) | An inventory valuation method that assumes stock that was purchased first, is also the first to be sold. |
Inventory count | Also known as a stock take, this is the systematic process of taking a physical count of inventory in order to verify accuracy. |
Inventory shrinkage | Inventory shrinkage is an accounting term to indicate inventory items that have been stolen, damaged beyond saleable repair or otherwise lost between the point of purchase and point of sale. |
Inventory valuation | The process of giving unsold inventory a monetary value in order to show as a company asset in financial records. |
Inventory variant | The variations of a single product that a company may hold in its inventory. For example, stocking a t-shirt in various colours and sizes. |
Inventory visibility | The ability of a person or business to see exactly where its inventory is and how it is being used. |
Last-in-first-out (LIFO) | An inventory valuation method that assumes the most recent products added to your inventory are the ones to be sold first. |
Lead time | The time it takes for a supplier to deliver new stock to the desired location once a purchase order has been issued. |
Multichannel | A retail model that sells in multiple different places, usually online via a combination of websites and marketplaces. |
Omnichannel | A retail model that goes beyond multichannel to integrate all of a company’s online and offline sales channels into one, unified customer experience. |
Order fulfilment | The process of getting a customer’s sales order from your warehouse or distribution centre to it being in their possession. |
Order management | The systematic order management process behind organising, managing and fulfilling all the sales orders coming into a business. From receiving orders and processing payment, right through to picking, packing, shipping, handling returns and communicating with customers. |
Overselling | Taking online orders for a product that turns out to be out of stock (usually through poor inventory management). Preventing overselling is key to providing a high-quality experience for online customers. |
Periodic inventory management | A type of inventory system that involves using manual processes to periodically count and update on-hand stock levels. |
A type of inventory system that involves automating your inventory tracking so it stays perpetually updated in real-time. | |
Pipeline inventory | Any inventory that has not yet reached its final destination of a company’s warehouse shelves, but is currently ‘en route’ somewhere within their supply chain – e.g. currently being manufactured, or being shipped by the supplier. |
Purchase order (PO) | A commercial document created by a business to its supplier, detailing quantities, items and agreed prices for new products to add to on-hand inventory. |
Sales order (SO) | A document created when a customer makes a purchase, detailing which products are to be received and how much has been paid or is owed. |
Stock-keeping unit (SKU) | A SKU is a unique alphanumeric code applied to each variant in a company’s inventory, helping to easily identify and organise a product catalogue. |
Supply chain | The complete flow a product or commodity takes from origin to consumer – including raw materials, to finished goods, wholesalers, warehouses and final destination. A retailer might only be directly responsible for certain chunks of this supply chain, but should still be aware of it in its entirety for the products they sell. |
Third-party logistics (3PL) | Refers to the use of an external third party to handle warehousing, inventory, fulfilment and/or customer service on behalf of a retail company. |
Further reading: How to Set-up Your Warehouse Inventory
Key Inventory Management Formulas
It’s not just common terminology you need to know when it comes to inventory management. There are some specific formulas to take note of too.
Here’s a quick run through to use as a reference point:
Inventory Turnover: Measures how often inventory is sold within a period.
Formula: COGS / Average Inventory
Sell Through Rate: Compares received inventory against sold inventory.
Formula: (Sold Inventory / Received Inventory) x 100
Days of Inventory Outstanding (DIO): Days it takes for inventory to turn into sales.
Formula: (Average Inventory / COGS) x 365
Safety Stock: Backup stock to meet unexpected demand.
Formula: (Maximum Daily Usage x Maximum Lead Time) - (Average Daily Usage x Average Lead Time)
Reorder Point: Triggers new inventory orders.
Formula: (Average Daily Usage x Lead Time) + Safety Stock
Economic Order Quantity (EOQ): Optimal order quantity.
Formula: √((2 x Demand x Ordering Cost) / Carrying Cost)
Further reading: EOQ - Benefits and Challenges in Ecommerce Inventory Management
Choosing the Best Inventory Management Software
An inventory management software automates the tracking of inventory, ensuring accuracy and efficiency. Features of a good system include:
Real-time Tracking: Synchronizes live inventory across channels.
Forecasting: Projects future inventory needs.
Purchasing: Manages suppliers and purchase orders.
Automation: Streamlines inventory rules and processes.
Cloud-based: Accessible from anywhere, with collaborative features.
Choosing an inventory management system that’s right for your business can be a tricky process - read our guide to find out more about choosing the right inventory management software.
Free Inventory Management Software
Veeqo is an Amazon-owned inventory management and shipping software that provides powerful but easy-to-use multichannel inventory management software, and is free no matter how large your business and how many shipments you send.
Sign-up now to access Veeqo's powerful suite of tools, as well as the lowest commercially available rates, based on our pre-negotiated pricing from UPS, USPS, FedEx, and DHL and up to 5% back with Veeqo Credits*.
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