Inventory management is the process of organizing and managing stock throughout the supply chain.
The goal of inventory management is to minimize the cost of holding inventory, while keeping stock levels consistent and getting products into customers’ hands faster. Inventory management is the heart of a successful retail business.
Not sure where to get started with inventory management? This guide will walk you through the leading inventory management techniques and tips for managing stock and keeping your customers happy.
Table of Contents
- What is inventory management?
- Types of inventory management
- Benefits of inventory management
- Inventory management challenges
- Inventory management systems
- 11 inventory management techniques
- Apps for inventory management
- Inventory management on Shopify
- Inventory management tips for retail
- Future of inventory management
What is inventory management?
Inventory management is the process of efficiently overseeing and controlling the flow of goods within a business. It involves tracking inventory levels, monitoring stock movements, and optimizing replenishment to ensure adequate stock availability, minimize costs, prevent stockouts, and streamline operations in the supply chain.
The goal of inventory management is to minimize the cost of holding inventory by helping you know when it’s time to replenish products or buy more materials to manufacture them. This helps you maintain optimal inventory levels and minimize costs.
Different types of inventory you’ll manage are:
- Raw goods. Raw goods are materials or substances used in the early production or manufacturing of products. Raw materials can include wood, metals, plastics, or fabrics used to create finished goods. They come from one or more suppliers and producers.
- Work-in-progress (WIP). WIP describes a partially finished product awaiting completion. WIP represents all production costs: labor, machinery, raw materials, and other equipment for the product at this stage. Costs are then transferred to the finished goods account and attributed to the cost of sales.
- Finished goods. This type of inventory refers to the number of products in stock available for customers to buy. Once a WIP is complete, it becomes part of the finished goods inventory.
- Maintenance, repair, and operations goods (MRO). Maintenance, repair, and operation supplies (MRO) are materials and equipment used in the production process but not as part of the final product. These include personal protective equipment, cleaning supplies, office supplies, and tech equipment.
Inventory management looks different for every business and there are even different types to consider.
Types of inventory management
Retail inventory management
Inventory management for retailers refers to managing the stock you intend to sell to your customers. As a retailer, your main goal is to ensure you have enough stock to fulfill orders and customer demand. However, storing inventory is costly, so you also want to avoid overstocking your warehouse.
Multi-location inventory management
Multi-location inventory management adds further complexity as you’ll need to manage inventory across multiple stores, warehouses, or sales channels. This type of inventory management goes beyond a holistic view of all your inventory, and requires management at the location level as well, to ensure you have enough stock everywhere that you sell.
Maintaining an accurate, centralized view of inventory is essential within this system.
Benefits of inventory management
Whether you’re a small business or company using enterprise resource planning (ERP), inventory management helps your business do a number of important things:
1. Avoid spoilage
If you’re selling a product that has an expiry date, like coffee or tea, there’s a very real chance it will go bad if you don’t sell it in time. Managing inventory effectively helps you avoid unnecessary spoilage and improve inventory control.
2. Avoid dead stock
Dead stock is stock that can no longer be sold—not because it's expired, but because it may have gone out of season, out of style, or otherwise become irrelevant. By adopting a diligent strategy, you can address this costly inventory mistake.
3. Save on storage costs
Warehousing is often a variable cost, meaning it fluctuates based on how much product you’re storing. When you store too much product at once, or end up with a product that’s difficult to sell, your storage costs will go up. Avoiding this will save you money.
4. Improve cash flow
Inventory directly affects sales (by dictating how much you can sell) and expenses (by dictating what you have to buy). Both of these elements factor heavily into how much cash you have on hand. Better inventory management leads to better cash flow management.
5. Optimize fulfillment
Good inventory management can help improve order fulfillment in a few beneficial ways. You can use tactics like inventory distribution, which involves having inventory in multiple fulfillment centers to ensure your products are close to your customers. This speeds up delivery time while reducing shipping costs—both of which help keep customers happy.
Proper inventory management also means offering buyers a seamless return experience, while ensuring that usable inventory is quickly reentered into circulation.
Inventory management challenges
While effective inventory management offers many benefits, you must overcome some challenges to achieve efficiency.
Although these challenges arise in different ways, they all lead to one of three costly problems: too much inventory, not enough inventory, or lost inventory.
Let’s look at each of these challenges more closely.
1. Phantom inventory
One of the primary challenges of inventory management is dealing with phantom inventory.
Phantom inventory refers to a situation where your point of sale system is reporting available inventory that doesn’t actually exist in your store. This situation can be costly, as it will lead to inaccurate stock levels that can impact your decisions regarding your product offering and reordering.
2. Changing demand
Shifts in demand can also cause challenges with inventory management. For example, the pandemic led to radical changes in demand almost overnight, causing many stores to quickly experience shortages of multiple products.
3. Supply chain issues
Similar to demand, another external factor that can greatly affect your inventory management is the global supply chain. Supply chain constraints will cause stockouts at your store if you don’t have enough safety stock on hand.
4. Difficult counting processes
Counting inventory is a difficult and time-consuming process. Since counting inventory takes so long, you’ll likely need to either close down your store for a day or ask staff to come in outside of operational hours (which costs overtime). On top of this, manual inventory counts are prone to errors that can cause further issues.
5. Disorganized stockrooms
Maintaining an organized stockroom is another inventory management challenge. A messy stockroom will make it difficult for associates to find inventory for customers when they need it—which hurts customer experience—and can even lead to inventory shrinkage.
Inventory management systems
An inventory management system (IMS) is the program (typically software) that monitors and organizes all the elements involved in inventory management. This includes tracking orders all the way from suppliers through to customers.
Perpetual inventory system
A perpetual inventory system is viewed as the most accurate option for inventory management. Perpetual inventory systems are the most accurate because they continuously track inventory in real time, and are usually supported by powerful software.
Periodic inventory system
Within a periodic inventory system, you take physical counts of inventory at the beginning and end of a specific period. While this system is not as accurate as a perpetual system, it can be done without having to purchase software.
Manual inventory system
A manual inventory system is the old-school pen-and paper-approach. While this might be a viable option if your monthly sales are in the single digits, most businesses require something more robust.
11 inventory management techniques
Regardless of the system you use, the following will improve your inventory management—and cash flow.
1. Implement Six Sigma
Six Sigma is a method and tool set for business process improvement. It’s used in inventory and supply chain management to reduce excess and obsolete inventory write-offs. This inventory is often sold below cost or donated, which costs small business owners cash.
Edwin Garro, founder of PXS School of Excellence, a Six Sigma certification and training company, recommends a five-step process he calls DMAIC to solve these issues using the Six Sigma model:
- Define the problem you’re going to solve. It needs to have a clear metric. For example, if your problem is inconsistent tracking, the metric could be productivity.
- Measure the current state using simple stats. How much input is turning into useful outputs? This will give you an idea of the problem’s root cause.
- Analyze the root causes and create an action plan to eliminate them. From the example above, the root cause could be that tracking procedures are spread across different software and spreadsheets. The action plan could be to create a centralized inventory tracking system.
- Implement your inventory management plan by running pilot tests to see if it eliminates the problem. Maybe you can try a new inventory management tool or test a hub-and-spoke model to move products faster.
- Control the new process. Track a metric to verify that the inventory management process works and that you’re seeing consistent results. Then celebrate!
2. Set par levels
Par levels are the minimum amount of product that must be on hand at all times. When your inventory dips below these predetermined levels, you know it’s time to order more.
Ideally, you’ll order the minimum quantity that will get you back above par. Par levels vary by product and are based on how quickly the item sells and how long it takes to get it back in stock. (Discover this data in your Shopify Retail sales reports.)
Check your par levels a few times throughout the year to confirm they still make sense. If something changes in the meantime, don’t be afraid to adjust your par levels up or down. That way, you can set reorder points that keep the amount of inventory in your store just right.
3. Follow the first in, first out principle
First-in, first-out (FIFO) is used to determine Cost of Goods Sold (COGS). It means your oldest stock (first in) gets sold first (first out), not your newest stock. This is especially important for perishable products so you don’t end up with unsellable spoilage.
4. Manage relationships
Whether you need to return a slow-selling item to make room for a new product, restock a fast seller very quickly, troubleshoot manufacturing issues, or temporarily expand your storage space, it’s important to have a strong relationship with your suppliers. That way, they’ll be more willing to work with you to solve problems.
With solid supplier relationships, minimum order quantities are often negotiable. Don’t be afraid to ask for a lower minimum so you don’t have to carry as much inventory.
A good relationship isn’t just about being friendly—it’s about clear, proactive communication. Let your supplier know when you’re expecting an increase in sales or generating a lot of purchase orders so they can adjust production and lead times. Ask them to notify you when a product is running behind schedule so you can pause promotions or look for a temporary substitute.
5. Make contingency plans
A lot of issues can pop up related to inventory management that can cripple unprepared businesses:
- Your sales spike unexpectedly, and you oversell your stock.
- You run into a cash flow shortfall and can’t pay for product you desperately need.
- Your warehouse doesn’t have enough room to accommodate your seasonal spike in sales.
- A miscalculation in inventory means you have less product than you thought.
- A slow-moving product takes up all your storage space.
- Your manufacturer runs out of your product, and you have sales orders to fill.
- Your manufacturer discontinues your product without warning.
It’s not a matter of if problems arise, but when. Figure out where your risks are and prepare a contingency plan. How will you react? What steps will you take to solve the problem? How will this impact other parts of your business? Remember that solid relationships go a long way here.
6. Conduct regular auditing
Regular inventory reconciliation is vital. In most cases, you’ll be relying on software and reports from your warehouse management system to know how much product you have in stock. However, it’s important to make sure the facts match up. There are several methods for doing this.
- Physical inventory. A physical inventory count, or stock take, is the practice of counting all your inventory at once. Many businesses do this at their year end because it ties in with accounting and filing income tax.
- Spot checking. This means choosing a product, counting it, and comparing the number to what it's supposed to be. This isn’t done on a schedule and is supplemental to physical inventory.
- Cycle counting. Rather than a full count at year end, cycle counting spreads reconciliation throughout the year. Each day, week, or month a different SKUs is checked on a rotating schedule.
7. Prioritize with ABC
Categorize your inventory using ABC anaylsis. Prioritizing your products into groups helps you understand which need to be ordered frequently and how slowly they move out of your inventory.
You can use an ABC analysis report to grade the value of your stock based on a percentage of your revenue:
- A = % of stock that represents 80% of your revenue
- B = % of stock that represents 15% of your revenue
- C = % of stock that represents 5% of your revenue
Your A stock represents your most profitable and valuable products. You’ll want to make sure you always have these products on hand so you don't miss out on future sales.
Your C stock is your slow-moving or dead stock. This is stock you might want to sell at a discount, so you can get it off your shelves and free up cash from your inventory.
8. Practice Accurate forecasting
A huge part of good inventory management comes down to accurately predicting demand. Make no mistake, this is incredibly hard to do. There are countless variables involved and you’ll never know for sure exactly what’s coming—but you can try to get close.
Here are a few things to look at when projecting your future sales:
- Trends in the market
- Last year’s sales during the same week
- This year’s growth rate
- Guaranteed sales from contracts and subscriptions
- Seasonality and the overall economy
- Upcoming promotions
- Planned ad spend
If there’s something else that will help you create a more accurate forecast, be sure to include it.
9. Apply the last in, first out (LIFO) method
The last in, first out, or LIFO, inventory management method assumes that the merchandise you acquired most recently was also sold first. The last to be bought is assumed to be the first to be sold. It’s essentially the opposite of FIFO.
This works under the assumption that prices are steadily rising, so the most recently purchased inventory will also be the highest cost. That means that higher inventory costs will yield lower profits, and, therefore, lower taxable income, which is pretty much the only reason it makes sense to use LIFO.
10. Try the just-in-time (JIT) approach
Just-in-time, or JIT, inventory management is for the risk takers out there, though effective inventory management mitigates a lot of that risk. With JIT, you keep the lowest inventory levels possible to still meet demand and replenish before a product goes out of stock.
This requires careful and accurate planning and forecasting, but works well for rapidly growing brands with scheduled launches and product line extensions.
💡 TIP: If you need to receive direct notifications of low stock levels, install an inventory alert app from the Shopify App Store.
11. Outsource your inventory storage and fulfillment
One of the most common reasons for poor inventory management is simply a lack of resources for inventory storage and fulfillment. You might not have the time or manpower to ensure your inventory is properly distributed or to deal with an influx of returns.
That’s why outsourcing fulfillment is an inventory management strategy all its own. Though it might come at a cost, using a fulfillment partner can help you generate business and keep customers happy.
Shopify Fulfillment Network, a Shopify-built and -managed fulfillment service, will distribute your inventory across a network of US warehouses on your behalf. This ensures that you can offer two-day delivery to the majority of your customers at an affordable rate.
Shopify Fulfillment Network will also receive your customer returns and re-enter usable inventory into circulation. And, in doing so, provide you with more free time to manage other important aspects of your business.
Apps for inventory management
Stocky is a Shopify app that helps you manage your store’s inventory. It offers powerful and detailed real-time inventory tracking, an organized product database, and easy access to analytics.
Use Stocky to:
- Lower risk of overselling
- Improve cost savings
- Avoid excess stock and stockouts
- Improve inventory accuracy
- Provide greater insights into your business
With Stocky, you can track inventory from multiple locations, stores, and warehouses, and set custom alerts when stock levels reach a certain level. It also helps quickly and easily see items that are out of stock, low in stock, and need reordering.
Stocky made it simple to move a lot of our inventory from the retail store to our warehouse and then distribute it through our online channel. Our online business increased by 500% for several months.
Thrive by Shopventory
Thrive by Shopventory is another excellent Shopify app for inventory management. It offers real-time stock updates and centralized inventory management for multi-location and ecommerce Shopify sellers. You can connect multiple Shopify accounts, automate purchase orders, and access data-rich reporting by location and sales channel.
ShipHero is an inventory software that offers a comprehensive suite of tools to help you manage inventory. It helps automate the tedious and time-consuming processes associated with managing product inventory, letting you free up time for other business activities.
Features include inventory tracking, demand forecasting, purchasing automation, stock optimization, and more. The app empowers retailers with the ability to accurately track inventory across multiple stores and warehouses, customize workflows and store processes, automate stock replenishment, and provide accurate demand predictions.
Cloud-based inventory management software Zoho helps retailers keep track of stock, manage orders, and fulfill shipments. You can monitor order statuses, monitor stock levels, and receive alerts when stock runs low with its customizable dashboard and inventory tracking tools.
You can streamline operations by automating order and shipment management. Zoho Inventory integrates with other Zoho apps, including Zoho CRM and Zoho Books, making it easy to manage customer orders and orders.
Inventory management on Shopify
Every business should strive to remove as much human error from inventory management as possible, which means taking advantage of inventory management software. If you run your business with Shopify, inventory management is already built in.
You can set up inventory tracking, view your inventory, and adjust your inventory levels in the Inventory area of your Shopify admin. You can also view the history of inventory adjustments and transfers for variants tracked by Shopify.
Shopify also provides Inventory reports which show you a month-end snapshot of your inventory. You can access various reports like:
- Average inventory sold per day
- Percent of inventory sold
- ABC analysis by product
- Product sell-through rate
- Days of inventory remaining
To find these reports:
- From your Shopify admin, go to Analytics > Reports.
- Click Categories.
- Click Inventory to filter the reports to show only inventory reports.
Inventory management tips for retail
Whether you’re a new business or opening yet another retail store location, keep these inventory management tips in mind:
- Update inventory records in real time. Access to fresh, correct inventory data is key to moving products quickly and efficiently.
- Audit inventory regularly. Run monthly and annual audits to ensure accuracy between your stock quantity and financial records.
- Go over supplier performance. Identify where suppliers can improve or when to cut them off.
- Put one person in change of inventory management. Hire an inventory management to be first-in-charge when it comes to ordering restocks, negotiating with suppliers, and paying invoices
- Invest in inventory management software. Look for a software that can integrate with your business tools and handle your future multi-channel sales.
Future of inventory management
Technology continues to grow and develop at an incredible pace, and many of these new and emerging technologies have applications for inventory management.
Radio frequency identification or RFID technology certainly has a place in the future of inventory management. In fact, RFID tags are already being used by many companies to search for and find inventory, and they can be used to combat phantom inventory and decrease excess inventory.
Artificial intelligence continues to develop and gain new applications within inventory management. Self-correcting AI solutions can empower businesses to automate inventory decisions and react to customer demands in real time.
Internet of Things or IoT devices can reduce the time it takes associates to find inventory by providing real-time location data. This data can also help you make more informed inventory decisions by knowing exactly how much stock you have and where.
Taking control of your inventory
Remember that with a proper inventory management system in place you can help reduce holding costs, improve your bottom line, analyze sales patterns and predict future sales, and prepare for the unexpected. With proper inventory management, a business has a better chance of profitability and survival.
It’s time to take control of your inventory management and stop losing money. Choose the right inventory management techniques for your business and start implementing them today.
Inventory management FAQ
What is the meaning of inventory management?
Inventory management is the process of tracking and controlling the ordering, storage, and use of parts, materials, and finished products within an organization. It ensures that companies have the right products in the right quantities at the right time and in the right place.
What are the four types of inventory?
The four main types of inventory are Raw Materials, Works-In-Process, Maintenance Repair and Operations (MRO), and Finished Goods.
What is an example of inventory management?
Inventory management involves keeping track of inventory levels and the movement of goods throughout the supply chain. It should track how much inventory is available, the time and cost associated with each order, and where each item is at any given time.
An example of inventory management is a retail store using a barcode scanning system to track product stock levels. The store utilizes demand forecasting to predict sales trends and determine optimal stock quantities. They employ an automated replenishment system to reorder products when stock reaches a predetermined threshold. The store also maintains an organized warehouse, ensuring efficient order processing and fulfillment. Finally, they analyze sales and inventory data to make informed decisions on product assortment, pricing, and promotions, ultimately optimizing their inventory management process.
What is the main purpose of inventory management?
The main purpose of inventory management is to avoid stockouts, minimize surplus inventory, and maximize efficiency in operations. In the long run, this saves companies time and money.
What are the 5 stages of the inventory management process?
The 5 stages of inventory management are:
- Demand forecasting predicts future demand to optimize stock levels
- Replenishment ensures timely product restocking
- Order processing streamlines order fulfillment
- Storage and organization maintains an efficient warehouse
- Reporting and analysis informs data-driven inventory decisions
What is the best way to manage inventory?
The best way to manage inventory is by implementing a comprehensive inventory management system that combines demand forecasting, efficient replenishment strategies, streamlined order processing, organized storage, and data-driven reporting and analysis, all while utilizing technology and automation to optimize stock levels and reduce costs.
What is vendor-managed inventory?
Vendor-managed inventory (VMI) is a business model where the supplier or vendor takes responsibility for managing and replenishing the inventory of their products at the customer's location. In VMI, the vendor monitors the inventory levels, forecasts demand, and initiates the replenishment process without relying on the customer's input. This approach allows for better coordination between the vendor and customer, reducing stockouts and excess inventory while improving overall supply chain efficiency.
What is the first step of inventory management?
The first step of inventory management is to accurately assess and analyze the current inventory situation. This involves conducting a comprehensive inventory audit, which includes gathering data on existing stock levels, categorizing inventory items, and evaluating their value and demand patterns. By understanding the current inventory status, businesses can identify areas of improvement, set realistic goals, and develop effective strategies for inventory control, such as optimizing reorder points, safety stock levels, and replenishment methods.
What is EOQ in inventory management?
EOQ stands for Economic Order Quantity and is a formula used in inventory management to determine the optimal order quantity that minimizes total inventory costs. EOQ takes into account factors such as ordering costs, carrying costs, and demand rate to find the quantity that balances the cost of holding inventory and the cost of ordering new inventory. The EOQ formula is calculated as follows:
EOQ = √((2 * D * S) / H)
- D represents the annual demand for the product
- S represents the ordering cost per order
- H represents the holding cost per unit per year
By calculating the EOQ, businesses can make informed decisions about how much inventory to order at a time, striking a balance between minimizing holding costs (costs associated with storing inventory) and ordering costs (costs associated with placing orders).