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What is Inventory Management?

Inventory management is a crucial component for businesses that oversee the ordering, storage, utilization, and sales of a company’s inventory. This encompasses raw materials, components, finished products, as well as their warehousing and processing. As businesses evolve, so does the complexity of managing their inventory, and thus, various methods and tools have been developed to ensure efficiency and accuracy.

Retail inventory management

Retail is the broadest catch-all term to describe business-to-consumer (B2C) selling. There are essentially two types of retail separated by how and where a sale takes place.

First, online retail (eCommerce) where the purchase takes place digitally.
Second, offline retail where the purchase is physical through a brick-and-mortar storefront or a salesperson.

Wholesale inventory management

Wholesale, on the other hand, refers to business-to-business (B2B) selling. Knowing the differences and best practices of retail and wholesale is critical to success.

Most businesses maintain stock across multiple channels as well as in multiple locations. The diversity of retail inventory management adds to its complexity and drives home its importance to your brand

Why is Inventory Management so important?

A company’s inventory stands as one of its most vital assets. In retail, manufacturing, and food services, where inventory plays a dominant role, having an apt stock quantity at the right time can make all the difference. On one hand, inventory shortage can affect sales and customer satisfaction. Conversely, an excess inventory is not without problems, such as the costs associated with storage, risks of damage, theft, spoilage, or even market demand shifts.

The importance of inventory management lies in its ability to maintain a delicate balance, ensuring there’s neither an inventory glut nor shortage. This balance is critical for businesses with intricate supply chains and manufacturing processes.

Key Components of Inventory Management

Visibility

In the age of digital transformation, spreadsheets and manual counts are becoming a thing of the past. Modern businesses leverage advanced inventory tracking software, enterprise resource planning (ERP) software, or even customized SaaS applications tailored for specific needs. These tools provide real-time inventory visibility across the supply chain, thereby guaranteeing customer order fulfillment, reducing shipping times, and minimizing stock discrepancies.

Accounting for Inventory

From an accounting perspective, inventory is a current asset. Before reflecting it on a balance sheet, physical counting or measurement is imperative. Companies typically adopt one of three methods: FIFO (First-In-First-Out), LIFO (Last-In-First-Out), or weighted-average costing. Inventory can be categorized into:

  • Raw materials: Essential materials required for the production process.
  • Work in process (or goods-in-process): Raw materials transforming into finished products.
  • Finished goods: Completed products available for sale.
  • Merchandise: Finished products acquired from suppliers for resale.

Inventory Management Methods

Various methods have been developed to address different inventory challenges:

  • Just-in-Time Management (JIT): This method focuses on maintaining just the needed inventory, reducing storage and associated costs. However, it can be risky in situations of unexpected demand spikes.
  • Materials Requirement Planning (MRP): This approach relies on sales forecasting to plan inventory requirements efficiently.
  • Economic Order Quantity (EOQ): EOQ calculates the ideal number of units a company should order in each batch to minimize total inventory costs, balancing between holding and setup costs.
  • Days Sales of Inventory (DSI): A financial ratio indicating the average duration a company requires to convert its inventory into sales.

Red Flags in Inventory Management:

Consistent switches in a company’s inventory accounting methods or regular inventory write-offs can indicate potential problems. It may reflect challenges with selling finished goods, issues with inventory becoming obsolete, or even the company’s competitiveness in the market.

Tim Cook’s statement that “Inventory is like dairy products. No one wants to buy spoiled milk,” succinctly captures the essence of inventory management. Efficient inventory management, such as Apple’s JIT system where goods are received as closely as needed, can save companies millions. Properly managed inventory ensures that businesses remain competitive, meet customer demands promptly, and maintain a healthy financial outlook.

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