Tracking your inventory is a critical activity that helps you keep an eye on how your company is doing overall. Every business — big or small — that manufactures, stores, ships or sells a physical product needs to know the status of its inventory. And it’s not just for the departments directly involved in the manufacturing and shipping; it also impacts sales, accounting, taxes and virtually every aspect of your company.
What Is Inventory?
According to Dictionary.com, inventory is defined as “a complete listing of merchandise or stock on hand, work in progress, raw materials, finished goods on hand, etc., made each year by a business concern.” That definition covers the entire range of items that are included in a company’s inventory process. What is considered “inventory” falls under several categories:
- Raw Materials: The materials, supplies and/parts used to create your products.
- Unfinished Products: Your products that are in the manufacturing stage and are not ready to be sold.
- Finished Products: Products in the warehouse, ready to be shipped or sold.
- In-Transit Goods: Finished products en route to a customer or retailer.
- Anticipation Inventory: Excess items in storage or held back in anticipation of a surge in sales.
- Decoupling Inventory: Supplies and components held in inventory in anticipation of a slowdown or disruption in the purchasing process.
- MRO Goods: MRO is an acronym for “Maintenance, Repair and Operating” supplies. These are items that are necessary for the running and maintenance of the equipment that creates the finished goods.
- Buffer Inventory: A “cushion” of product in the event of an unexpected development or disruption in the purchasing process.
What Is Inventory Management?
Inventory management is the method a company uses to source, store and sell inventory. This covers both the raw materials and components required to produce your product as well as the finished goods. The scope of inventory management goes beyond knowing what’s in your warehouse; it provides vital data to the sales professionals, accountants and virtually every other department in your company.
Best Practices for Inventory Management
Understand that inventory management isn’t a luxury; it’s a vital component to any company’s success. Knowing how much stock you have on hand is one of the most important factors in planning. For example, if you know that Q4 sales are likely to dwarf the other three quarters in the year due to the holidays, then having access to this data is critical. Not knowing how much of the raw materials you require to meet demand can be highly detrimental. Similarly, not anticipating demand for your finished product ahead of a seasonal surge will also yield negative effects for your bottom line.
Types of Inventory Management
Like so many other business processes, there are multiple types of inventory management. The most common are Just In Time Management (JIT), Materials Requirement Planning (MRP), Economic Order Quantity (EOQ) and Days Sales Inventory (DSI). Each of these types has its own sets of pros and cons, and, of course, different types of companies will likely use the inventory management that best suits it.
Just In Time Management
This is a style of inventory management developed by Japan and made popular by the Toyota Motor Company in the 1960s and 1970s. It was a cost-saver by limiting the amount of inventory held at any one time. The goal was to only keep the inventory on hand required to manufacture and sell its vehicles. The advantage of JIT is that it saves by not tying up capital in inventory. However, the downside of this method is that either a sudden disruption in the supply chain or a surge in demand can adversely affect output; not only impairing the company economically, but also damaging its goodwill as well as its overall good reputation.
Materials Requirement Planning
This is a type of inventory management more dependent on reports and data. This method is focused on historical sales data, as past records will dictate the amount of supply required to produce its products. With that information on hand, inventory is procured based on sales forecasts.
Economic Order Quantity
This is kind of a hybrid model of inventory management, walking the fine line between making fewer purchases and not holding excess inventory. In short, it’s the perfect mix of how much a company should purchase in order to meet projected demand, but yet not be saddled with excess inventory. It is highly dependent on sales projections and the EOQ formula assumes that not only demand remains constant, but that the ordering and holding costs also hold steady as well.
Days Sales Inventory
This is another inventory management strategy that is dependent on a formula. The factors in play are the time it takes to convert inventory, which includes goods that are a work in progress, into sales. A lower DSI is favored, as inventory moves through the pipeline faster and is converted into sales more quickly. Of course, the DSI duration will vary greatly from industry to industry.
A good inventory management strategy is an important process for any company to take seriously. Knowing that it increases overall efficiency, it paints an accurate picture of how much certain assets are worth and having a grip on sales figures and projections is important for any company that is focused on keeping an eye on its bottom line.
Chris Capelle is a technology expert, writer and instructor. For over 25 years, he has worked in the publishing, advertising and consumer products industries.
The Blueprint – 4 Types of Inventory Management Systems for Small Businesses
Investopedia – Inventory Management
Business News Daily – 10 Essential Tips for Effective Inventory Management