Ever heard of a successful business that became successful while mismanaging its inventory?
We haven’t either. They don’t exist.
Sure, there are plenty of mammoth companies that mismanaged their inventories and lost billions after becoming successful. Walmart losing $3 billion because of out of stocks is a prime example of inventory mismanagement.
But if they want to continue being successful, they’d have to implement better inventory management techniques.
The same is true for you.
If you want to remain profitable and competitive (or get to this point in your business), then you need to know and use as many cost-saving and profit-boosting inventory management techniques and tools as possible.
You can’t afford not to.
To help you out, we’ve listed a variety of different techniques of inventory management. By the end of this post, you’ll be able to use at least a few of them to improve your business operations.
But before we get to the inventory management techniques, let’s quickly define inventory management itself.
What is Inventory Management?
Inventory management is a collection of tools, techniques, and strategies for storing, tracking, delivering, and ordering inventory or stock.
A large amount of capital, if not the majority of a company’s capital is wrapped up in their inventory.
For that reason, it’s incredibly important to control the coming and going of inventory as best you can to minimize losses and maximize profits – which is where inventory management techniques come into play.
Inventory Management Techniques
Below is a list of some of the most popular and effective inventory management techniques you can use to improve your business.
Economic Order Quantity
Economic order quantity is the lowest amount of inventory you must order to meet peak customer demand without going out of stock and without producing obsolete inventory.
Its purpose is to reduce inventory as much as possible to keep the cost of inventory as low as possible.
To help you calculate EOQ, here is the formula from Kenneth Boyd, author of Cost Accounting for Dummies:
Economic order quantity uses three variables: demand, relevant ordering cost, and relevant carrying cost. Use them to set up an EOQ formula:
– Demand: The demand, in units, for the product for a specific time period.
– Relevant ordering cost: Ordering cost per purchase order.
– Relevant carrying cost: Carrying costs for one unit. Assume the unit is in stock for the time period used for demand.
Note that the ordering cost is calculated per order. The carrying costs are calculated per unit. Here’s the formula for economic order quantity:
Economic order quantity = square root of [(2 x demand x ordering costs) ÷ carrying costs]
That’s easier to visualize as a regular formula:
Q is the economic order quantity (units). D is demand (units, often annual), S is ordering cost (per purchase order), and H is carrying cost per unit.
Minimum Order Quantity
Minimum order quantity (MOQ) is the lowest set amount of stock that a supplier is willing to sell. If you can’t purchase the MOQ of a specific product, then the supplier won’t sell it to you.
The purpose of minimum order quantities is to allow suppliers to increase their profits while getting rid of more inventory more quickly and weeding out the “bargain shoppers” simultaneously.
A minimum order quantity is set based on your total cost of inventory and any other expenses you have to pay before reaping any profit – which means MOQs help wholesalers stay profitable and maintain a healthy cash flow.
ABC analysis of inventory is a method of sorting your inventory into 3 categories according to how well they sell and how much they cost to hold:
– A-Items – Best-selling items that don’t take up all your warehouse space or cost
– B-Items – Mid-range items that sell regularly but may cost more than A-items to hold
– C-Items – The rest of your inventory that makes up the bulk of your inventory costs while contributing the least to your bottom line
ABC analysis of inventory helps you keep working capital costs low because it identifies which items you should reorder more frequently and which items don’t need to be stocked often – reducing obsolete inventory and optimizing the rate of inventory turnover.
Just In Time Inventory Management
Just-in-Time Inventory Management is simply making what is needed, when it’s needed, in the amount needed.
Many companies operate on a “just-in-case” basis – holding a small amount of stock in case of an unexpected peak in demand.
JIT attempts to establish a “zero inventory” system by manufacturing goods to order; it operates on a “pull” system whereby an order comes through and initiates a cascade response throughout the entire supply chain – signaling to the staff they need to order inventory or begin producing the required item.
Here are some of the benefits of just-in-time inventory:
– Minimize costs such as rent and insurance by reducing your inventory
– Less obsolete, outdated, and spoiled inventory
– Reduce waste and increase efficiency by minimizing or eliminating warehousing and stockpiling, while maximizing inventory turnover
– Maintain healthy cashflow by ordering stock only when necessary
– Production errors can be identified and fixed faster since production happens on a smaller, more focused level, allowing easier adjustments or maintenance on capital equipment
Safety Stock Inventory
Safety stock inventory is a small, surplus amount of inventory you keep on hand to guard against variability in market demand and lead times.
Safety stock plays an integral role in the smooth operations of your supply chain in various ways.
Here are just a few:
– Protection against unexpected spikes in demand
– Prevention of stockouts
– Compensation for inaccurate market forecasts
– And a buffer for longer-than-expected lead times
You probably noticed that the benefits of safety stock are all tied to mitigating problems that could seriously harm your business.
That’s because without safety stock inventory you could experience:
– Loss of revenue
– Lost customers
– And a loss in market share
A safety stock formula is relatively straightforward and requires only a few inputs for calculation.
Here’s the formula we recommend using if you’re just starting out:
(Max Daily Sales x Max Lead Time in Days) – (Average Daily Sales x Average Lead Time in Days) = Safety Stock Inventory
FIFO and LIFO
FIFO and LIFO are accounting methods used to value your inventory and report your profitability.
FIFO (first in, first out) is an inventory accounting method that says the first items in your inventory are the first ones that leave – meaning you get rid of your oldest inventory first.
LIFO (last in, first out) is an inventory accounting method that says the last items in your inventory are the first ones that leave – meaning you get rid of the newest inventory first.
If you handle food inventory management or operate any business with perishable items, then you pretty much have to use FIFO. Otherwise, you’ll end up with obsolete inventory that you’ll have to write-off as a loss.
With that said, LIFO is a great method for non-perishable homogeneous goods like stone or brick. So, if you get a fresh batch of items like these, you don’t need to rearrange your warehouse or rotate batches since they’ll be the first ones out anyway.
Reorder Point Formula
A reorder point formula tells you approximately when you should order more stock – that is, when you’ve reached the lowest amount of inventory you can sustain before you need more.
Here’s the reorder point formula you can use today:
(Average Daily Unit Sales x Average Lead Time in Days) + Safety Stock = Reorder Point
This equation can help you stop being a victim to market spikes and slumps and instead, consistently order the right amount of stock each month.
Batch tracking is sometimes referred to as lot tracking, and it’s a process for efficiently tracing goods along the distribution chain using batch numbers.
From raw materials to finished goods, batch tracking allows you to see where your goods came from, where they went, how much was shipped, and when they expire if they have an expiration date.
What are the benefits of batch tracking?
– Easy and Fast Recall
Streamlined Expiry Tracking
– Improved Relationships with Suppliers
– Fewer Accounting Errors from Manual Tracking
Consignment Inventory is a business arrangement where the consignor (a vendor or wholesaler) agrees to give their goods to a consignee (usually a retailer) without the consignee paying for the goods up front – the consignor still owns the goods, and the consignee pays for the goods only when they actually sell.
This inventory management technique creates a win-win partnership between suppliers and retailers as long as they’re both willing to share the risks – and rewards.
Pros for Vendors:
– New Markets
– Low Inventory Carrying Costs
– Direct-to-Retailer Shipping
Pros for Retailers:
– Lower Cost of Ownership
– Minimal Risk
– Improved Cashflow
Perpetual Inventory Management
A perpetual inventory management system is also known as a continuous inventory system.
Here’s how it works:
Perpetual inventory systems track sold and stocked inventory in real-time; they update your accounting system whenever a sale is made, inventory is used, or new inventory has arrived.
All of this data is sent to one central hub that any authorized employee can access.
These are the advantages of perpetual inventory:
– Proactive monitoring of inventory turnover
– Manage multiple locations with ease
– More informed forecasting
Dropshipping is a business model that allows you to sell and ship products you don’t own and don’t stock.
Your suppliers – wholesalers or manufacturers – produce the goods, warehouse them, and ship them to your customers for you.
The process is simple:
– You receive an order
– You forward the order to your supplier
– Your supplier fulfills the order
Here are the benefits of dropshipping:
– Low startup costs
– Low cost of inventory
– Low order fulfillment costs
– Sell and test more products with less risk
Lean Manufacturing System
The Lean Manufacturing System, often referred to as lean manufacturing, lean production, or simply “Lean” is a system for maximizing product value for the customer while minimizing waste without sacrificing productivity.
This system originated in the Toyota Production System (TPS). There were 3 things TPS attempted to prevent:
– Muda – Everything in your manufacturing process that creates waste or causes constraints on creating a valuable product.
– Mura – Everything that creates inconsistent and inefficient work flows.
– Muri – All tasks or loads that put too much stress on your employees or machines.
There were also 5 principles that every Lean manufacturing system adhered to:
1. Value – A company delivers the most valuable product to the customer.
2. Value Stream – Map out the steps and processes required to manufacture those valuable products.
3. Flow – Undergo the process of ensuring all of your value-adding steps flow smoothly without interruptions, delays, or bottlenecks.
4. Pull – Products are built on a “just-in-time” basis so that materials aren’t stockpiled and customers receive their orders within weeks, instead of months.
5. Perfection – Make Lean thinking and process improvement a core part of your company culture.
By minimizing or eliminating Muda, Mura, and Muri while adhering to the 5 principles, the proponents of Lean Manufacturing believe this inventory management technique can produce the highest-quality products while increasing your revenue and productivity.
6 sigma, or Six Sigma is a data-driven process that seeks to reduce product defects down to 3.4 defective parts per million, or 99.99966% defect-free products over the long-term.
In other words, the goal is to produce nearly perfect products for your customers.
By using statistical models, 6 Sigma practitioners will methodically improve and enhance a company’s manufacturing process until they reach the level of 6 Sigma.
The first and most-used method in Six Sigma is a 5-step process called DMAIC:
The DMAIC process uses data and measured objectives to create a cycle of continuous improvement in your manufacturing methods.
While DMAIC is useful for improving your current processes, DMADV is used to develop a new process, product, or service.
DMADV stands for:
The DMADV process uses data and thorough analyses to help you create an efficient process or develop a high-quality product or service.
Through intensive training, focused projects, and effective statistical analyses, 6 Sigma could save your business a lot of money.
Fortune 500 companies have saved an estimated $427 billion <>after implementing the 6 Sigma methodology, according to iSixSigma magazine.
<>Lean Six Sigma
Lean Six Sigma is the fusion of Lean Manufacturing with Six Sigma to create a complete system that removes waste and reduces process variation for streamlined manufacturing and optimal product output.
Lean Six Sigma primarily uses Six Sigma processes and methods as the backbone of the system – such as DMAIC and the belt system – to drive focused improvements in manufacturing while incorporating many techniques and tools from Lean to reduce wasteful steps and processes
Demand forecasting is a process of predicting what your customers will buy, how much they’ll buy, and when they’ll buy it.
You can use informal methods such as guessing, or quantitative methods such as analyzing past sales data.
From production planning to inventory management to entering a new market, demand forecasting will help you make better decisions for managing and growing your business.
Here are some demand forecasting best practices:
– Create a repeatable monthly process
– Determine what to measure and how often
– Integrate data from all of your sales channels
– Measure forecast accuracy at the SKU, location, and customer planning level
– Maintain real-time, up-to-date data
The Inventory Management Tool That Puts These Techniques into Action
We’ve given you many inventory management techniques and tools but to make most of them work, and work well, you need cloud-based inventory management.
Software like DEAR Inventory can track, forecast, analyze, calculate, and control your stock in real-time, from anywhere in the world, regardless of how big or small your business is.
If you’re serious about upgrading, enhancing, and optimizing your inventory management, then DEAR Inventory is the tool for you.