Inventory management is virtually inseparable from the ownership of a small business. It is a crucial part of a business's profitability. The inability to manage it properly can lead to too much or too little inventory, leading to increased costs and missing business opportunities.
If you’ve thought about an inventory management strategy but didn’t know where to start,
or if you have an inventory management process but you need to learn fresh inventory management techniques to update your current system, then you are in the right place.
We will walk through what inventory management is and what it looks like in practice, then share some insights into valuable inventory management techniques you can implement today for your small business.
What is Inventory Management?
Inventory management encompasses all the activities involved with tracking your products from creation to delivery. This is a critical component of your overall business strategy that needs to be handled successfully.
How you handle your business’s back-end supply-and-demand process can impact the perception of your entire brand. With the instant gratification of online sales at an all-time high, a customer will just move to the next business offering the same or similar product if your inventory can’t accommodate their immediate need. In today’s small business landscape, there is no question that inventory management is an important process that warrants closer scrutiny.
If you have an inventory management strategy, how effective is it?
If you don’t, consider this our word of caution, that you need to develop one.
Without a clear inventory management strategy, you:
could have little or no visibility into product demand to forecast correctly
could run the risk of lost business and revenue from supply chain issues
could waste valuable business capital on unsellable products, or product waste
could have difficulty scaling your operation past one location and one line of product(s)
With a solid inventory management strategy, you:
can track your product(s) all the way through your supply chain
can ensure you have enough product to meet future demand
can efficiently re-order to reduce waste
can improve your like, know, trust factor in the small business space
can improve your overall customer service by effectively managing supply and demand
Let’s dig deeper to see what an overall inventory management strategy looks like and what you should include in yours.
What is an inventory management strategy?
An inventory management strategy refers to the process or multiple processes you have in place to control the movement of products through your small business's supply chain.
As mentioned above, an inventory strategy is key to effectively managing your business's main assets – its products. By keeping a clear strategy on hand, you are well-equipped to complete your business accounting needs next tax season. Everything you need to have a smooth tax-filing experience will be up-to-date and accessible.
If you are a smaller business or start-up, it is likely you will not need a robust system at first, but make sure you implement strategies today that will grow with you tomorrow. Developing a strategy that works with you throughout the life of your business will serve you as well as your overall business strategy does.
Let’s look at how to create an inventory strategy for your small business.
How to create your own inventory strategy
To create an effective inventory strategy for your small business, you need to first consider what your business needs are and then implement strategies that best fit your needs. Here are a few ways to create the key components of an inventory strategy, broken down by the physical aspect and accounting aspect of inventory management.
Physical Inventory Management
Decide on Storage of Inventory: Whether you have $1,000 or $100,000 worth of inventory, where and how you store it, is a key consideration.
If you are a larger enterprise, you’ll likely choose in favor of a warehouse, which adds a small amount of complexity in your inventory strategy, since you will have to account for the flow of products in and out of the facility.
If you are a smaller company, even a garage or spare bedroom could be a suitable storage area. But even in this smaller case, a system for managing products in and out of the storage area needs to be established.
Create a Vendor Agreement with Your Suppliers: If your suppliers are online, they will likely already have policies in place for managing supply. Check your agreement for details and make sure you know how to handle your customers in the case of any supply issues.
If you have brick-and-mortar suppliers, draft an agreement with each supplier regarding shipping schedules, payment schedules, timetables and the like. This provides a valuable structure for dealing with slow-selling or non-selling products, and minimizes costly forecasting errors.
Plan for Waste or Freebies: Create a clear process for dealing with excess inventory. Stock that isn’t moving, or dead stock, costs you in carrying costs from a financial standpoint.
If your supplier agreements do not account for dead stock, you will likely need to donate any excess. Don’t forget, donating offers tax breaks for your business.
Plan for a Rainy Day: Just like in life, in business you need to plan for the unexpected. Plan for the “dream” scenario – that thousands of people rush to purchase your product(s), or plan for a shortage from economic supply-chain factors.
Whether big or small, developing a safety stock of extra product on hand in one or more locations is a great way to plan for a rainy day. The formula to figure out what that amount is and scale it for your business is below.
Safety Stock = (Max Daily Usage X Max Lead Time) – (Avg. Daily Usage X Avg. Lead Time)
Plan to Restock: Of course, the problem we would all love to see, is product flying off the shelf, but don’t let it distract to the point you are not prepared to refill those same shelves.
If you try and handle things as they come up, you will likely lose customers, or customer loyalty along the way. On the contrary, planning a reorder point based on historical market demand, turn-around time and lead time, can save you lost business in the future.
Accounting Inventory Management
Accurate inventory records help in completing end-of-period tax statements and make the accounting side of inventory management a much easier pill to swallow.
There are a few key metrics you should keep on your radar if you want to optimize your inventory control. They include:
Inventory Turnover: This is the amount of times your inventory is sold out and replaced within a specified time period, a good indicator of skill in forecasting
Gross Margin Percent: This is a key indicator of both cash flow and profitability for a business
Customer Order Fill Rate: This metric is a measure of how well your business can keep up with demand. If the ratio is low, your inventory is not performing well or your inventory management needs to be updated
Cost of Carrying: This is the amount of money it is costing you to hold an item on the shelf
Average Sell Out Days: This is how long it takes to sell your monthly inventory, a good measure of whether your inventory strategy is working
Examples of Inventory Strategies to Try
You’ve heard the old saying, “if it isn’t broke, don’t try and fix it,” and it rings true with inventory strategies as well. Here are a few time-honored, time-tested methods that are still relevant to businesses today. They are also the easiest to implement within an existing inventory system.
The Just-In-Time (JIT) Strategy
This strategy allows a business to receive goods as needed rather than stock-piling them.
This strategy is effective for business-owners who want to:
reduce storage costs
decrease wasted product
keep inventory on-hand, lean
keep products fresh
The First-In, First-Out (FIFO) Strategy
This strategy is just what it sounds like, as items come in, they are the first items out. When considering products with an expiration date, this is an effective method to use. This method also keeps your inventory valuation high and helps prevent wasted stock.
The Push Strategy
The Push Strategy relies on accurate market insights to forecast consumer demand. A business using this method would “push” the stock they already have on hand, with the benefit of cutting down on the manufacturing costs it would take to produce the product repeatedly or in smaller batches.
The Pull Strategy
With the pull inventory management strategy, businesses can keep their stock levels low, and only restock the shelves needed. This method is effective for businesses that want to both reduce the risk of overstocked or dead products and save on storage costs.
When it’s time to audit your business's inventory management strategy, go in armed with the information you need to plan effectively. Look at the cost and intrinsic benefits of both the physical and accounting side of inventory management to discover ways to better manage your assets. Decide on a mix of available strategies, if that works best for your business. But whatever you decide, make sure there is a plan. The future of your business demands it.