LAST UPDATED ON December 2, 2020

Inventory Management: What You Need to Know Before Opening a Business

Opening an online or physical store entails more than just displaying products on a shelf. Entrepreneurs and retail operators must aim to have the right products...

Opening an online or physical store entails more than just displaying products on a shelf. Entrepreneurs and retail operators must aim to have the right products in the right quantity for sale, at the right time. All of this is possible through efficient inventory management – the supervision of the flow of goods from manufacturers to warehouses, shippers/deliverers to the customer’s hands.


Why is Inventory Management Important?

Without inventory, eCommerce or retail businesses are practically useless. eCommerce entrepreneurs and retail operators consider inventory an asset because it can convert to sales and be replenished several times within an operating cycle. 

To speed up the conversion of inventory into cash, businesses can: 

  • sell products at a discounted price 
  • prioritize the completion and sale of works in process
  • return raw materials to suppliers for credits 
  • sell materials to another company

Holding up inventory ties up a lot of cash and resources. So it’s in everyone’s best interest to manage inventory effectively to guarantee cash flow and save money.


Inventory Management Types

Inventory types can be grouped into four categories: raw materials, works-in-process, finished goods, and maintenance, repair, and operations (MRO) goods.

  1. Raw materials are any items used to manufacture components or finished products. These can be items produced directly by your business or purchased from a supplier. For example, a candle-making business could purchase raw materials such as wax, wicks, and decorative ribbons.
  2. Works-in-progress inventory refers to unfinished items moving through production but not yet ready for sale. In the case of a candle-making business, work-in-progress inventory might be candles that are drying and unpackaged.
  3. Finished goods are products that have completed the production process and are ready to be sold: the candles themselves.
  4. Maintenance, repair, and operations (MRO) goods are items used to support and facilitate the production of finished goods. These items are usually consumed as a result of the production process but aren’t a direct part of the finished product. For instance, disposable molds used to manufacture candles would be considered MRO inventory.


Stockouts: Inventory Management Fails

When you’re first starting out, it’s tough to avoid inevitable hiccups in inventory management. Businesses of all sizes have failed in efficiently handling their stock, much to the disappointment of their customers.

Small business owners, like Yiying Wang of Noodoll, started her company in 2009 to pursue her dream of creating characters and stories. Noodoll’s early business model was based solely on trial and error. 

Wang initially used a simple platform to create invoices for sales, but that solution was no longer viable. She found herself spending too much time on administrative tasks, running out of stock, and having difficulty keeping track of profits.

In December 2011, Best Buy issued a statement:

“Due to overwhelming demand of hot product offerings on during the November and December time period, we have encountered a situation that has affected redemption of some of our customers’ online orders. We are very sorry for the inconvenience this has caused, and we have notified the affected customers.”

Best Buy’s failure to manage its inventory was not only detrimental to sales, but it also eroded the consumer trust that’s central to any retailer’s success. With numerous articles titled “How Best Buy Stole Christmas”, the negative publicity was overwhelming.

Although Best Buy never released the details of what happened, it’s clear that information mismatch is to blame for their inability to deliver. Their solution of cancelling orders rather than delaying shipping seems to indicate that they oversold products they didn’t have in stock. 

You may not be operating at such a large scale as Best Buy, but know this: 91% of unhappy customers will unwillingly do business again if they’ve received bad customer service, according to Lee Resources Inc.

The nature of online business means that customers can move their business over to a competitor with just the click of a button – which many did after this fiasco.


Inventory Management Techniques for Those Starting Out

1. Consider the FIFO approach (first in, first out): We assume that inventory items are sold in the order in which they’re manufactured or purchased. In other words, the oldest inventory items are sold first. The FIFO method is widely used by companies as it best represents the actual flow of goods in a business.

2. Just in Time (or Toyota Production System): This is a type of lean methodology designed to increase efficiency, cut costs and decrease waste by receiving goods only as they’re needed. JIT was originally formed in Japan as a response to the country’s limited natural resources, leaving little room for wastage. With the right approach, utilizing a JIT inventory management strategy has a number of potential benefits for businesses:

  • Lower inventory holding costs. With inventory purchased or produced at short notice, there’s no need to have unsold inventory taking up valuable warehouse space.
  • Improved cash flow. Without the need to frequently store large volumes of inventory, capital expenditure is reduced and cash can be invested elsewhere.
  • Less dead stock. Because inventory levels rely on customer demand, there’s less risk of unwanted stock left sitting in your warehouse.

3. Set a reorder point: When is it the right time to order more stock? You’ll need to know the lead time demand (in days) or how long you’ll have to wait before new stock arrives. This ensures having enough inventory to satisfy customers while waiting for stock to come. You’ll also need to know your safety stock (in days) because that’ll protect you against any unexpected occurrences. Add your lead time demand to your safety stock… and voila! Total your lead time demand and your safety stock to determine your Reorder Point. This is the time to place a new order to replenish your supply.

4. Manage relationships: Building healthy long-term relationships based on trust and timely payments really increases the efficacy of your inventory management. Therefore, the entire supply chain. Communicate quickly and efficiently with your customers through setting up 10 min check in meetings using Calendly or another alternative, especially when out-of-stock goods will be available again (send an automatic message) or if there’s a delay in delivery. Give B2B customers more details and technical information than they ask for. Get ready for a long commitment and focus on multiple, repeat purchases. When it comes to your suppliers, keep a clear and proactive line of communication. Give them a heads up when you’re expecting a bump in sales so they can adjust production.

5. Don’t forget your ABCs: ABC inventory management is an inventory optimization approach that’s based on putting products into categories in order of importance. A is the most valuable of products while C is the least valuable. It’s derived from the Pareto Principle (or the 80/20 rule) which states that 20% of activities generate 80% of a company’s profit/output. In other words, an ABC analysis of inventory assumes that not all products are of equal value and more attention should be paid to critical products.
While there are no hard-and-fast rules for dividing products, categories typically look something like this:

  • A items: 20% of products, which accounts for 70% to 80% of consumption value
  • B items: 30% of products, which accounts for 10% to 20% of consumption value
  • C items: 50% of products, which accounts for up to 10% of consumption value.

6. Fine-tune your forecasting: Forecasting models such as determining reorder points and economic order quantities can help ensure optimal inventory control. But first, certain boundaries have to be set to give the most accurate outcome:

  • Forecast period: a specific amount of time which decides the forecast quantity.
  • Trend: an increase or decrease in demand over a certain period of time. Identifying one such trend makes it easier to project future sales.
  • Base demand: the starting point for a forecast (i.e. current demand).

Forecasting is linked to determining reorder points and order quantities, both of which are critical to optimizing inventory control.

7. Use cloud-based inventory management software: Cloud software covers everything a small or medium business needs to get off the ground: accounting, inventory management, shipping and fulfillment. Moving to the cloud will help you avoid stockouts, make prompt reorders and get automatic stock level updates after a sale. But most importantly, using a cloud-based inventory management software will save you loads of time and reduce the likelihood of costly human errors. All of this leaves you with more time and energy to spend on growing your business.


Why Cloud-Based Inventory Solutions Are a Good Option for SMBs

If you’re on the fence about moving your inventory management and operations to the cloud, consider these five benefits:

  1. Better visibility: With cloud-based inventory software, you can track inventory movement across all sales channels. You won’t need to manually manage your inventory and you won’t need staff keying in sales orders every day. You can work on creating an across-the-board quality control system that alerts both you and the supplier to any possible issues.
  2. Real-time updates: Wherever you are, you’ll be able to add products to your shop. All you need to do is take a picture, update the product description, and you can create a purchase order. The “plug-and-play” nature of cloud software also lets you consolidate all your sales channel through integrations. This allows you to avoid the hassle and risks of setting aside inventory for an online store.
  3. Safety and security: Safety of valuable information is guaranteed when cloud-based inventory management is used. Data backup on storage devices isn’t needed as all data is kept securely in the cloud remotely. Any changes are saved and security is taken care of by the service provider who constantly updates the software to avoid cyber attacks.
  4. Automation: A cloud-based approach automates the supply chain so that the execution of an order can be done without involving human labor. In the end, it frees your team’s time for higher-level decisions and priorities.
  5. Business intelligence: Demand forecasting is one of the trickier aspects of running an eCommerce business. Knowing how much stock to order in the future based on how much it’s selling now is a fine art. Cloud-based inventory management systems analyze your data and create automated reports so you can make data-informed business decisions.
    Inventory management also tells you a story about your business. Unless you have records of the amounts of products you’ve bought, amounts you’ve sold and amounts you hold, you won’t know what sells well. You also won’t know what doesn’t and how you can change this to grow your business. Cloud-based inventory management software allows you to see historical data at hand.

The move away from pen-and-paper inventory management is a huge step toward success. The above features are foundational pillars to consider with any inventory management system. 

While each business is different, the right inventory management solution can help reduce the amount of stock takes, reduces warehouse costs and gets you back to your core business tasks. Isn’t it time to master your inventory management?

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