A well-managed inventory plays a pivotal role in efficient business operations. If you aren’t careful, you may find yourself facing stockouts with no buffer stock or reserve inventory as a backup. These events are pretty common when you aren’t clear about terms and concepts related to different inventory types and can’t effectively manage one for your business.
In this article, we’ll discuss inventory types and management techniques that you can use to take your business to new heights.
What is Inventory Management?
Inventory management is the process of maintaining and controlling the amount of products, materials, and goods that a business stocks. The goal of the process is to make sure that there is an optimal amount of goods at any given time. Too much inventory would mean more storage costs, while an insufficient amount will cause your business to fall short of meeting consumer demands.
Proper inventory management involves inventory classification, tracking, lead time management, regular audits, and demand forecasting to improve optimization.
Inventory Management Techniques
Here are some common techniques used for effective inventory management:
ABC Analysis Method
The ABC analysis technique sorts all the inventory products based on their importance and business value. The items are divided into the following 3 categories:
A Items: These items bring the most money to the business and so need close monitoring and control to avoid running out of stock. They are frequently reordered and are located at the top of the list when it comes to inventory security.
B Items: B-items sell regularly but not as much as A-items. They are stocked in moderate amounts and are occasionally checked for reordering. Depending on any change in sales, these items can be transferred to the A or C category.
C Items: These comprise a low portion of the revenue. Their low demand means they end up stored in the inventory for long periods and aren’t given much attention.
With ABC analysis, you can prioritize high-value items in terms of security and storage conditions. This categorization also helps in the placement of products in your inventory. You can easily move them around in the warehouses based on their demand and value change over time.
Order Point Method
The order point method is used to make sure that a business restocks in time to maintain a continuous supply of goods to consumers and avoid stockouts. With this technique, you can calculate the inventory level at which reorders should be placed. Factors like lead time – the time taken for the restock to arrive, – buffer stock, and the expected demand for the products during the lead time, are also considered.
It’s calculated as = (Average lead time in days x Average daily sales) + Safety Stock
- Average daily sales are calculated by calculating the number of sales over a certain period and then dividing it by total days.
- Average lead time in days means the average number of days required for the arrival of fresh stock from the supplier. This is calculated from the time of placing the order with the supplier.
- Safety stock is actually the cushion or extra inventory kept to overcome fluctuations in sales and lead time.
Seems complex? Don’t worry. Let’s understand them by considering an example of an Organic Fertilizer business.
For instance, you have calculated your average daily sales as 100 bags.
It usually takes 10 days to restock the inventory after placing the order. So, your average lead time is 10 days.
Consider 50 bags of safety stock.
So, the order time or reorder time can be calculated as;
Order Point = (Average lead time in days x Average daily sales) + Safety Stock
Order Point = (10 days x 100 bags/day) + 50 bags
Order Point = (1000 bags) + 50 bags = 1050 bags
So, when your inventory stock falls below 1050 bags, it’s time to reorder.
The Economic Order Quantity (EOQ) method helps decide the number of units of product to order with each customer order. Knowing the optimal quantity of items needed helps cut down unnecessary inventory storage costs and frequent reordering costs. It also helps avoid under or overstocking products.
The EOQ formula takes into account factors like holding costs, reordering costs, product demands, etc.
EOQ = √(2DS/H)
- H is the per unit cost of holding stock. It mainly includes expenses like insurance, storage, and capital required. Let’s say it’s 5 dollars per bag of organic fertilizer for a year.
- D is the yearly demand for a product. It means how many units you’re expected to sell in a year. Let’s say 50,000 bags per year.
- S is the cost of placing one order with the supplier. It considers all expenses, including shipping, paperwork, etc. Let’s say it’s 100 dollars per order.
EOQ = √(2(50000 x 100)/5)
EOQ = 37.6 bags
After rounding off for clarity, you need to order 1414 bags of organic fertilizer per order to minimize inventory costs.
The Material Requirements Planning (MRP) method helps businesses decide the optimal quantity of materials that will be needed for manufacturing products. The formula uses demand predictions and production schedules to decide the timing by which the materials should be ordered to meet manufacturing schedules.
This technique is especially effective for businesses that deal with complex manufacturing processes of many components and products.
The Just-In-Time (JIT) system works by ordering and using inventory only when needed. This means that the businesses that use this technique only order material and manufacture products when a customer places and confirms an order. This saves them from wasting material and incurring unnecessary holding and storage costs.
A major downside of this technique, though, is the risk of not getting the material or being able to manufacture it on time. That’s why it depends on reliable suppliers, worker coordination, and efficient production.
Key Considerations in Inventory Management
If you want a successful business with a well-managed inventory, here are aspects that you absolutely need to consider:
- Always know how many products and materials your business needs to order or produce items at a given time to avoid falling short on demand.
- To minimize lead time and ensure supply chain operations run smoothly, know exactly when you need to place new orders or schedule production.
- Conduct regular checks of your business inventory to make adjustments according to ever-changing consumer demands.
Types of Inventories and Their Functions
Following are the different inventory types and the distinct purposes they serve in a business:
Did you know that 42% of disruptions faced by companies are due to supplier failure? This is what makes buffer stock so important. The stock consists of excess raw materials saved for later in case of an unexpected stock shortage or increased lead time due to supplier failure. This is not the same as a reserve inventory and is maintained strictly for unplanned, unfavorable situations.
For more clarity, consider the buffer stock of a bakery, which may contain extra flour, eggs, food coloring, etc. In the event of a delayed delivery of ingredients, the business can use the buffer stock to avoid losses caused by production delays.
A reserve inventory usually contains items that are not sold regularly by the business at the time but are part of a later sales plan, accounting for seasonal demand peaks or planned production suspension.
Imagine a business planning a back-to-school sale after a few months. So, they have a batch of relevant products manufactured and stored in a reserve inventory ahead of time. When schools start, and the regular productions fall short of meeting the high demand, products from the reserve inventory will come in handy.
Periodic Inventory to Lot Size Inventory
A periodic inventory check is one in which products are counted at predefined intervals, like monthly or annually. A lot-size inventory, on the other hand, is a more continuous form of inventory management. In this type, the inventory levels are monitored in real-time, and batches of materials are ordered as soon as the inventory level drops below the predefined limit.
Switching from periodic to lot-size inventory management can help secure economic purchase volume and save the business unnecessary inventory costs.
In-transit (Transportation) Inventory
Unlike buffer and reserve inventory, in-transit inventory deals with inventory items being transferred from one location to another. These locations, like warehouses, distribution centers, etc., are part of a bigger logistics network in the supply chain.
This inventory is monitored using efficient systems that track the location of each product until it reaches its final target destination.
The more inventory you have, the less efficient your business will run, so it's important you have high-tech inventory control software for small business inventory management. You could use Excel, but its complex formulae aren't for everyone and will soon have you pulling out your hair.
Instead, opt for software like BoxHero, which is user-friendly and designed to get rid of all your inventory management woes. Get the app to reach the pinnacle of inventory management and have effective control through just your device.