Your boutique coffee ecommerce business is booming. You decide to expand by creating your own machine for customers to brew the perfect cup with your beans. This leap transforms you from a retailer into a manufacturer, and it produces a new challenge: manufacturing inventory management.
Understanding manufacturing inventory management is a first step to scaling your production, controlling costs, and building a successful manufacturing business. Here are the core concepts, the main differences between retail and manufacturing inventory management, and strategies to master it.
What is manufacturing inventory management?
Manufacturing inventory management is the process of tracking, controlling, and managing all items that flow through a production process. This includes the necessary raw materials, the work-in-process (WIP) items on your assembly line, and the finished goods ready for sale. The primary goal of good manufacturing inventory management is to have a clear view of the various elements of your company’s inventory at every stage.
Effective manufacturing inventory management can help your business in the following ways:
-
Controls costs. Every item you hold is cash. Good management avoids excess inventory, reduces carrying costs for storage and insurance, and helps manage production costs by ensuring that raw materials aren’t overstocked.
-
Prevents bottlenecks. A proper inventory system ensures all components are available for production schedules, preventing costly assembly line disruptions.
-
Improves cash flow. Effectively transforming raw materials into sellable goods speeds up your cash cycle, freeing up capital for other parts of your business.
-
Enables quality control. Tracking inventory isn’t only about quantity. Lot tracking batches of raw materials lets you perform an inventory inspection and trace any defects back to the source, protecting your brand and ensuring customer satisfaction.
-
Promotes better forecasting. Accurate inventory data helps you analyze seasonal demand fluctuations and market trends. This improves production planning so you’re not caught with excess stock or sold out of a bestseller.
Manufacturing inventory management vs. retail inventory management
Retail inventory management tracks units of a single finished good across your sales channels. Manufacturing inventory management is more complex because it tracks the transformation of raw materials into finished goods.
For example, in retail inventory, you buy 100 t-shirts (one SKU) and sell 100 t-shirts. Your job is to track those 100 units. In manufacturing inventory, you buy 500 yards of cotton (SKU-A), 200 spools of thread (SKU-B), and 100 labels (SKU-C) to produce 100 t-shirts (SKU-D). Your job is to track the depletion of the first three SKUs and the production of the fourth, all while accounting for the labor and overhead costs that add value at every step.
Types of manufacturing inventory
It’s important to understand how inventory management applies at various stages of the manufacturing process. Several key inventory categories represent the various stages of value creation:
-
Raw materials. Raw materials inventory encapsulates the basic and natural materials and components you purchase from suppliers to make your product, and are foundational to the production process.
-
Work-in-process (WIP). This is inventory currently in the manufacturing process. WIP inventory includes items on the assembly line or moving between workstations. This category is critical for inventory accounting because its value includes not only raw materials but also the added labor and overhead costs.
-
Finished product. These are the completed items that have passed quality control and are ready for sale. For an ecommerce business, this is the inventory that shows up as “in stock” on your Shopify store.
-
Non-inventory items. This category includes items you need for your manufacturing operations that don’t become part of the final product. Some examples include machine lubricants, safety goggles, packing boxes, and shipping labels.
-
Consignment inventory. This is inventory you hold, but the supplier still owns. You, the manufacturer, pay only for consignment inventory once you use or sell it.
-
Vendor-managed inventory (VMI). In this supply-chain arrangement, your supplier takes responsibility for monitoring your inventory levels and sending replenishments. This form of vendor-managed inventory requires a trusting relationship, but it can help you avoid stockouts.
-
Goods-in-transit. Also known as in-transit inventory, this is inventory that has left your supplier’s facility but hasn’t arrived at your facility. It must be tracked for accurate production planning and supply chain management.
How manufacturing inventory management works
The manufacturing inventory management process is a continuous loop.
Here is an overview of the stages:
1. Planning and forecasting. Use demand forecasting based on sales data, market trends, and production planning to determine how many finished goods you need to produce.
2. Bill of materials (BOM). A detailed list of all raw materials establishes exactly what you need to purchase for production.
3. Procurement. Issue purchase orders to your suppliers for the required raw materials inventory.
4. Receiving and inspection. Once materials arrive, conduct an inventory inspection for quality control and log the items in your inventory management software.
5. Production. A work order starts production. Send raw materials to the production floor; at this stage, they officially become WIP inventory.
6. Tracking and value-add. As items move through the manufacturing processes, your inventory tracking system monitors their progress and the value added from labor and overhead.
7. Finished goods. The items pass a final quality control check and are received into finished goods inventory, becoming available for sale.
8. Fulfillment. A customer places an order. Fulfillment team members pick, pack, and ship items.
9. Analysis. Conduct physical inventory counts to ensure your inventory records are accurate. Analyze inventory data to spot inefficiencies and restart the planning cycle.
Manufacturing inventory management strategies
For manufacturing businesses, the right inventory strategy is critical to your financial health, unlocking benefits like improved cash flow and increased profitability. Manufacturing companies rely on various combinations of inventory management methods to track and control the movement of goods through the production process.
Here are a few manufacturing inventory management strategies to know:
-
Push strategy. A production planning strategy where you manufacture goods based on demand forecasting, “pushing” products to the market. This is common for high-volume, predictable consumer staples, such as soft drinks, canned goods, or toilet paper.
-
Pull strategy. The opposite of a push strategy, you only manufacture a product after a customer places an order, which “pulls” the raw materials through the production process. This minimizes excess inventory because you are producing only what has already been sold, rather than forecasting future demand.
-
Just-in-time (JIT) manufacturing. A manufacturer receives raw materials precisely when needed for production instead of stockpiling for future use. Just-in-time manufacturing is highly efficient but requires an incredibly reliable supply chain.
-
ABC inventory analysis. Involves categorizing your company’s inventory based on its value, which is divided into categories ABC: A (high-value, low-quantity items that require tight inventory control), B (moderate value, moderate quantity items), and C (low-value, high-quantity items that require less stringent control).
-
Economic order quantity (EOQ). The economic order quantity is a formula used to calculate the ideal order size. It finds the perfect balance between purchasing costs and carrying costs, helping to keep your total inventory costs low.
-
FIFO and LIFO. First-in, first out (FIFO) is an inventory accounting method that assumes the first items added to inventory are the first ones sold—essential for perishables. Last-in, first-out (LIFO) assumes the last items purchased are the first sold.
-
Weighted average cost (WAC). One of the key inventory valuation methods, weighted average cost averages the cost of all identical inventory items in stock. This smooths out cost fluctuations in your inventory accounting.
-
Safety stock and reorder points. Safety stock is a small buffer of excess stock kept on hand to prevent stockouts from unexpected demand or supplier delays. A reorder point is the specific stock level that triggers a new purchase order.
Implementing these methods requires inventory management software. Spreadsheets can’t keep up; you need inventory management tools that provide real-time inventory data and automate these complex inventory processes.
Manufacturing inventory management FAQ
What is the 80/20 rule in inventory management?
The 80/20 rule, or Pareto Principle, is the concept behind ABC inventory analysis. It suggests that 80% of your results, such as sales, tend to come from 20% of the products you sell. This rule helps you focus your inventory control efforts on the high-value A items that matter most, rather than investing too much time in low-value C items.
What are the three types of inventory in manufacturing?
The three main types of inventory that define the manufacturing process are raw materials, work-in-process (WIP), and finished goods. Raw materials are the basic components and supplies purchased for production, and WIP items have entered the production line but are not yet complete. Finished goods are products that are ready for sale.
What are the five principles of inventory management?
Although there are many inventory management tips and strategies, most are built on five core principles: accurate demand forecasting, detailed inventory tracking, warehouse organization, strategic supplier management, and continuous improvement.
