What Is Inventory Management | The Complete Guide To Inventory & Stock Management

Run Your Business Jul 30, 2020

Did you know that the total manufactured and traded inventory in the month of May 2020 in the US alone was $1,933.7 Billion?

Chances are, if you are in the US, and inventory is a part of your business, then you are overstocking!

Stats show that inventory to sales ratio at the end of May 2020 was 1.51, i.e. for every $1 of sales, the inventory stocked was $1.51.

Given the importance of inventory to your business, and its impact on your financial health (inventory assets and cost of goods sold are important factors in your income statement and balance sheet), it is imperative that as a business owner, you understand all about inventory and stock management.

In this comprehensive guide to inventory management, we have explained all the basics of inventory management, inventory processes, inventory accounting, and the importance of inventory management software.

We will cover the following topics related to stock, inventory and inventory accounting in this guide.

What Is Inventory?
Why Do You Need Inventory?
What Are The Different Types of Inventory?
What Is Inventory Management?
What Is Inventory Accounting?
What Is Inventory Valuation?
What Are the Different Types of Inventory Systems?
Inventory Management Process
Key Inventory Management Terms & Techniques You Need To Know
What Does an Inventory Manager Do?
Why Do You Need Inventory Management System?
Benefits of Inventory Management Software

What Is Inventory?

Inventory is goods that your purchase or manufacture and sell to your customers. Inventory can be your raw material, as well as the finished products that you sell to your customers in the market. Read more on what is inventory?

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Why Do You Need Inventory?

In today’s market, all businesses are trying very hard to keep up their customer’s satisfaction level. The main reason why companies maintain inventory is to be able to fulfill customer’s demands on time and avoid dependency on vendors.

Having your inventory helps to handle the uncertainty in your consumer behavior. Also, if you buy stock in bulk, you will get discounts and offers on your orders, which will reduce your inventory cost. Maintaining your inventory reduces your dependency on suppliers and allows you to reduce the time spent between sales order and delivery.

Maintaining inventory on hand allows you to:

  • Fulfill customer demand immediately
  • Optimize fulfillment
  • Reduce delivery cost
  • Deal with seasonal demand
  • Provide better customer service
  • Bulk buy and store at cheaper rates.
  • Prevent loss from theft, spoilage, and returns

What Are The Different Types of Inventory?

Following three types of inventory are most commonly used:

Raw Materials

Raw materials are used to make your finished goods. Raw materials can be purchased or manufactured by a business. Read more about raw materials here.

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Work-In-Progress

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Work-in-progress refers to the unfinished goods in the process of making finished goods. This includes all the items made by your company but yet to be assembled or finished. Read more about work-in-progress inventory here.

Finished Goods

Finished Goods are final products ready for sale in the market. All retailers only store and sell this type of inventory. Read more about finished goods here.

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What Is Inventory Management?

Inventory Management refers to the process of purchasing, receiving, storing, controlling, tracking, and fulfilling of stock. Inventory Management covers all aspects of stock management right from the purchasing of raw material to the final sale in the retail store.

The process of inventory management starts from raising a purchase order to your vendor and ends when you fulfill or deliver goods to your customers. The inventory management process also includes the handling of sales and purchase returns.

What Is Inventory Accounting?

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Inventory accounting refers to calculating the total value and costs of your inventory. Inventory is listed as an asset on your business balance sheet. Inventory accounting calculates the value and cost of items in all the stages of the manufacturing process. Your inventory value can change due to different reasons such as depreciation, deterioration, change in customer demand, increased or decreased market supply, etc. Inventory accounting helps you to keep track of these changes at different production stages and adjust company asset value and the costs accordingly.

What Is Inventory Valuation?

Inventory valuation is the calculation of the total value of the inventory owned by a company at any particular time. The inventory value is calculated by summing up the total cost incurred in the procurement of the raw material and the cost incurred in getting it ready for sale in the market.

Inventory valuation is critical in accounting as the valuation of inventory plays a part in calculating the Cost of Goods Sold(COGS) and has an effect on the Income Statement & Balance Sheet.

The three most widely used inventory valuation methods are:

  1. First-In, First-Out (FIFO)
  2. Last-In, First-Out (LIFO)
  3. Weighted Average Cost

First-In, First-Out (FIFO)

With the First-in-first-out (FIFO) valuation method, the inventory items purchased first are also sold first, and inventory items that are purchased last are sold last in the market. FIFO (first-in-first-out) valuation method states that inventory items are sold in the same order in which they are purchased or manufactured.

FIFO (first-in-first-out)valuation method is the most commonly used inventory valuation method across the industries. Most of the businesses prefer FIFO (first-in-first-out) valuation method as most of the companies sell their products in the same sequence in which they purchase it from their supplier. Read more about FIFO(first-in-first-out) valuation method here.


Last-In, First-Out (LIFO)

The last-in-first-out (LIFO) inventory valuation method is exactly the opposite of the FIFO valuation method. LIFO method assumes that the most recently purchased or manufactured items are sold first. Read more about LIFO(last-in-first-out) valuation method here.


Weighted Average Cost (or Avg Cost)

According to the Weighted Average Cost inventory valuation method, Cost of Goods Sold (COGS) and inventory are calculated based on the average cost of all items purchased during an accounting period. This method is mainly used by businesses that don’t have much variation in their inventory. Read more about the weighted average cost valuation method here.

What Are the Different Types of Inventory Systems?

Two commonly used inventory systems are:

  1. Periodic Inventory System
  2. Perpetual Inventory System

Periodic Inventory

According to the periodic inventory system, the physical count is done occasionally to measure inventory levels. The periodic inventory system takes inventory balance at the beginning of a period and adds all newly purchased inventory during the period, and deducts ending inventory to derive the cost of goods sold (COGS). Small businesses mainly use periodic inventory accounting systems. Read more about the periodic inventory system here.

Perpetual Inventory

According to the perpetual inventory system, all your product’s stock levels are updated automatically whenever a stock is received or fulfilled. Most retailers prefer using the perpetual inventory system to view real-time inventory. With the perpetual inventory system, your product stock levels are updated in real-time whenever a product is received or fulfilled to the customer. Read more about the perpetual inventory system here.


Inventory Management Process

Inventory Management Process
Inventory Management Process

Inventory Management process starts from placing a purchase order and continues until a sales order is fulfilled. The inventory process also includes sales and purchase return process. Here we have listed and explained the main steps in inventory management process.

  1. Purchase Order
  2. Receiving Goods in the Warehouse/Store
  3. Stocking Products in a Warehouse/Store
  4. Accepting an Order from a Customer
  5. The Sales Order Fulfillment Process
  6. Shipping Online Orders
  7. Returns and Replacements

Purchase Order

The inventory management process starts with placing a purchase order to your vendor. Purchase orders (POs) are purchase request documents sent by a buyer to a seller with a request for products or services as an order. Each purchase order will include product details such as product name, type of item, quantity, price, etc.

Receiving Goods in the Warehouse/Store

Once your supplier has accepted the purchase order, the vendor will ship the products to your warehouse. While receiving the purchase order, a quality check is done to ensure the quality and also to reduce returns and replacements.

Stocking Products in a Warehouse/Store

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All goods received from suppliers are stored in the store or warehouse maintained by the business. The storage of goods depends on different factors, such as if the goods can be stored in the boxes or need to be exposed to light/humidity. It also depends on whether the products are perishable or non-perishable.

All shelves and aisles should be labeled correctly in the warehouse so that you can easily find the inventory items. When a sales order comes in, you can check the shelf and aisle numbers assigned to the inventory items in the system and collect your order.

Accepting an Order from a Customer

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There are multiple ways of receiving orders from your customers. Customers can place the sales order online in your online store, or they can purchase goods from your retail outlet.

If you have an online shop, the customer can view and add products to the shopping cart. Once the customer has placed the order, you can view a list of orders which are pending fulfillment.

If you have a retail outlet, then you can use a Point of Sale (POS) system to record sales. In the Point of Sale (POS) system, you can keep updating the stock count for all the inventory products available in your store. Once sales are recorded, the system will automatically reduce inventory count based on the number of items sold.

The Sales Order Fulfillment Process

If you have an online store, then you need to pick and pack the order inventory items for shipping to your customers. You can generate a picklist to pick products from your warehouse. Once you have added all items in an order in one place, you can start packing it.

If you are using a manual inventory system, stock levels for these items picked are manually adjusted. If you are using an integrated inventory management software, inventory count will be automatically adjusted when the order is picked.

Shipping Online Orders

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Every business can have multiple shipping partners for goods delivery. All orders must be packed according to the shipping partner guidelines. The shipping order delivery details, such as customer address with shipping labels, are attached outside the package. Once you have shipped the package, you can track them using the tracking number provided by your shipping partner.

You can share the package tracking number with your customers so that they can track the order. Once an order is delivered to your customer, your shipping partner will update you on the delivery status. Once the customer has received the package, the order is considered as fulfilled.

Returns and Replacements

If your customers are not satisfied with the purchase or the product is faulty or damaged, they can choose to return a product or request a replacement. The customer will send the package to your store/warehouse. Once you have received the package, you need to check the faults or damages in the product. If the product has no fault or damage, you can add it back to your inventory and update the stock count. Else, you need to discard the product and write it off by doing a stock adjustment entry.

Most of the online retailers negotiate the return terms with their shipping partners. Either the customer or seller pays for the shipping of the returned product, or your shipping partner can pay for one return for free.

For customers who are purchasing goods from the retail store, they will bring back the product to your store with the bill. You can either offer a refund or replacement for the returned products. Whenever a customer makes a sales return request, you need to update the inventory levels with the returned product and reduce the inventory count for the shipped product.

Key Inventory Management Terms & Techniques You Need To Know

Here we have listed some commonly used inventory management terms and techniques:

Reorder Level

The reorder level is the stock level at which you must raise a purchase order request to your supplier to stay above the minimum stock level.

Reorder Level Formulae-

Reorder level = Daily Consumption x Lead Time

Example of Reorder Level Calculation-

If you have a furniture store and you sell 50 chairs every day, and your supplier takes one week to deliver goods to your warehouse. Here to avoid stockout, you need at least 50 X 7, which is 350 chairs available in your inventory at all times. Whenever the stock level for chairs in the warehouse falls to 350 chairs, you need to reorder by sending a purchase order to your vendor. If you follow this, you will never run out of stock.

Reorder Point

The reorder point is that point when you need to reorder stock for a product, to avoid the risk of stock shortage. To find out the reorder point, you need to keep an eye on your inventory levels and order whenever a product is close to stock-out.

Reorder Point Formulae-

Reorder Point = (Average Daily Sales x Lead Time)+Safety Stock

Example of Reorder Point Calculation-

Suppose you sell five chairs a day, and you have only ten units in your safety stock. If your supplier takes five days to deliver chairs to your warehouse, your reorder point is (5 x 5)+10, which is 35 units.

Maximum Stock Level

The maximum stock level is the level of stock beyond which businesses should not stock up on any particular inventory item. The maximum stock level calculation is affected by several factors, such as if the goods are perishable, warehouse/store capacity and consumer preferences, etc.

Formulae for Maximum Stock Level-

Maximum Stock Level = Reorder level + Reorder quantity — (Minimum Consumption x Minimum Reorder Period)

Example of Maximum Stock Level Calculation-

If your inventory reorder level is 1000 units, and your reorder quantity is 500 units, and you sell a minimum of 100 units every day in your store. If your supplier takes five days (minimum reorder period) to deliver goods to your warehouse, the maximum Stock Level is 1000+ 500 — (100 x 5), which is 1000 units. Here the maximum amount of stock (maximum stock level) that you need to keep in the inventory is 1000 units.

Minimum Stock Level/Safety Stock

The minimum stock level or safety stock is the minimum amount of stock you need to maintain to fulfill your customer’s demand. The calculation for safety stock depends on the lead time. Lead time is the amount of time your vendor takes to supply products after receiving the purchase order. Minimum Stock Level also depends on the rate at which your product is being sold during the lead time.

Minimum Stock Level/Safety Stock Formulae-

Minimum Stock Level = Reorder Level — (Normal Consumption x Reorder Period)

Example of Minimum Stock Level/Safety Stock Calculation-

If your inventory reorder level is 1000 units, and you sell 100 chairs every day, and the reorder period is five days. Here the minimum stock level or safety stock is 1000 — (100X5), which is 500 units. Here the minimum amount of stock (minimum stock level or safety stock) that you need to keep in the inventory is 500 units.

Cost of Goods Sold (COGS)

The cost of goods sold (COGS) refers to the direct costs of manufacturing, storing the goods sold by a company for an accounting period. The cost of goods sold (COGS) includes the cost of the raw materials and labour cost incurred during the production of goods. The cost of goods sold (COGS) does not include indirect expenses, such as distribution costs and sales force costs.

Cost of Goods Sold(COGS)Formulae-

Cost of Goods Sold(COGS) = Beginning Inventory + Purchases during the Period — Ending Inventory.

Note: Above formula is used in periodic inventory method. In perpetual inventory method, the cost of goods sold is calculated in real time based on actual cost of the stock sold.

Cycle Count

Cycle count refers to counting a small amount of inventory without doing the entire manual stocktake. The inventory cycle count allows you to find out if your inventory records match up with your actual stock.

Bill of Materials (BOM)

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A bill of materials (BOM) is a product manufactured by processing different raw materials, assembling different components. A bill of materials is usually the finished product made by assembling different individual components, materials, and services.

Goods Fulfillment

Goods fulfillment refers to delivering goods to your customers. There are different fulfillment methods, such as pick pack ship, dropship, direct fulfillment, etc. Your inventory is updated once you have fulfilled the sales order.

Goods Receipt

Goods Receipt refers to receiving goods from your suppliers. Your inventory is updated when you receive the goods from your vendors. You can create a goods receipt linked to your purchase orders or bills.

Warehouse Management

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Warehouse management allows you to manage multiple warehouses where your goods are stored. This is a must-have feature for the growing businesses as they need to maintain stocks in multiple locations to manage inventory efficiently. Here we have explained different storage places in the warehouse:

Racks

Racks are the large sections of shelving units where your product is stored.

Locations

A location is a designated area in a warehouse where products are stored. Pickers collect all the products from the different locations in the warehouse.

Aisle

Aisle is the walking space between your racks.

Shelf

The shelf is the horizontal space spanning across a rack.

Bin

A bin is any storage place within a location that contains one or more spaces or slots for products, for example- a bin of pins, a bin of paper, etc.

Serial Number

A serial number is a unique number used for identification of inventory items. A serial number allows you to identify different products available in your inventory.

Batch Tracking

Batch Tracking is a system that allows you to group a set of products that share similar properties such as expiry date. Batch tracking is mainly used to track the expiration of items.

Stocktaking

Stocktaking is the physical verification of the stock on hand and goods condition stored in your store or warehouse. Stocktaking is manually checking and recording all your stock on hand. Stocktaking is a vital part of your inventory control as it affects your purchasing, production, and sales.

Stock Adjustment

Stock Adjustment is manually adjusting product stock without creating purchase or sale transactions. Stock Adjustment is mainly made to update the stock in hand to handle damaged goods, data entry errors, etc. When you create a stock adjustment entry, your inventory levels are automatically updated.

Stock Transfer

The stock transfer feature enables you to transfer stock between multiple stores or warehouses. You can create a stock transfer entry to move goods from one warehouse to another.

Inventory Forecasting

Inventory forecasting refers to studying past trends to find out the stock amount or level required in an upcoming period. Inventory forecasting helps you to avoid situations such as stockouts and minimize your stock holdings.

Dropshipping

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Dropshipping is a fulfillment method. In dropship, businesses do not hold any inventory, and your supplier ships your orders with your name and label directly to your customers. Dropship is a very common fulfillment method used these days as the seller doesn’t need to maintain the product inventory. With the dropship fulfillment method, users can directly ask their suppliers to ship the products directly to their customers. Read more about dropship here.

Consignment Inventory

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In the consignment inventory method, you can make an agreement with your suppliers that you will only pay the supplier when their product sells in your store. According to consignment inventory, the producer of the stock holds ownership of the stock until the product is sold. Retailers and supermarkets mainly use this method. Here the retailer doesn’t pay for the product until it is sold in the store.

Backorder

The backorder feature allows you to place a purchase order to your supplier to fulfill customer sales orders that you can’t fulfill due to insufficient stock levels. In the backorder, you can send a purchase order to your supplier when you receive a sales order request from your customer. Backordering inventory products allow you to eliminate the need for inventory holding and save cost in storing inventory.

Pick Pack Ship

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There are multiple ways of fulfilling or sending goods to your customers. The most common method used by online stores is to pick, pack, and ship. Pick, pack, and ship is the process of picking products from your warehouse, packaging it, and then shipping it to your customer.

Picking

Picking feature allows you to generate a picklist for your warehouse team to pick the products by scanning the barcode. Your warehouse staff can view the list of all existing picking orders and pick products from your warehouse.

Packing

The packing process refers to packing the picklist items by selecting packaging material such as cartons, envelopes, bags, etc. The packaging material and process depends on the products sold by your business.

Shipping

Once you have packed all the orders as per your shipping partner guidelines, you can create a shipping entry by printing and adding a shipping label on your package. The shipping labels have customer address, tracking number, carrier details, etc. Once you have added the shipping label on the package, you are ready to ship the package to your customer.

What Does an Inventory Manager Do?

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The inventory manager is responsible for managing the store or warehouse where all the company’s inventory is stored.

The inventory manager is responsible for:

  • Keep an eye on stock levels to avoid stockout or stock shortage
  • Track and report the inventory levels
  • Conduct regular stock audits
  • Supervise and manage other warehouse staff
  • Calculate the reorder level, reorder point, minimum and maximum stock levels
  • Use inventory management techniques to optimize the inventory
  • Inventory forecasting by studying past trends

Why Do You Need Inventory Management Software?

Benefits of Inventory Management Software
Benefits of Inventory Management Software

An inventory management software helps you to automate the entire inventory management process for your business. Choosing and implementing the right inventory management software is very crucial for any business. There are so many inventory management tools available in the market. Here we have listed the benefits of inventory management software:

Tracking Inventory

Inventory management software can help you to keep track of your inventory items and maintain a centralized database to view and manage the inventory stock across all the stores or warehouses. With a single click, you can view reports with total stock for each product and its location.

Control Your Costs

A good inventory management software helps you to generate reports with your stock performance. In these reports, you can view inventory items that are selling fast and which are just taking the shelf space in the warehouse. These stock performance reports help you to add the right inventory at the right time and right place to avoid stockouts, excess inventory, etc.

Improve Your Fulfillment Process

Inventory management software helps you to streamline your fulfillment process and avoid late deliveries caused due to stockouts or stock shortage. With an inventory management software, you can generate automated reports with products that have reached the minimum reorder level, and you can create a purchase order to restock the product. Also, you can view and analyze the past data trends to set the reorder level to avoid late deliveries caused due to stockouts or stock shortages. These reports also help you to set realistic expectations for your customers.

Manage Planning and Forecasting

Inventory management software helps you to improve the demand forecasting by analyzing data trends from historical transactions. You can generate automated reports and alerts to minimize your stock holding, which will enhance your revenues and cash flow. Also, inventory forecasting helps you to meet your customer expectations better.

Reduce the Time Spent on Managing Inventory

Inventory management software helps you to reduce the time spent in managing and tracking inventory items. Also, you can save the time spent in recounting the inventory.

Benefits of Inventory Management Software

Here we have listed the benefits of inventory management software:

  1. Track and manage your inventory in a centralized database
  2. Improve your fulfillment process by avoiding stockouts and stock shortages
  3. Inventory planning and forecasting by analyzing data trends
  4. Manage stock across multiple stores and warehouses
  5. Automated bookkeeping with goods receipt and fulfillment

Summary

Inventory management has a significant impact on your business’s bottom line. All companies must understand the importance of inventory management to achieve fast and efficient operations at an affordable cost. Effective inventory management helps enterprises to reduce operations costs. All businesses should implement inventory management software to reduces errors caused by human intervention. This will help them to achieve a more efficient, more profitable, and better fulfillment process to serve their customers.

Automate Your Inventory Management Process with Deskera Books

Automating inventory management is essential for all small businesses as it helps you to manage and track your inventory, prevent stock shortage, manage multiple stores/warehouses, and ensure accurate record keeping. Automating your inventory management process with inventory management software will save time and money spent on managing inventory manually.

Did you know that only 43% of businesses automate their inventory?

Automating inventory management is not just good practice or a buzz word. It is a strategic advantage for your business!

Deskera Books allows you to automate your entire inventory management process. You can easily track and manage your inventory at one place using an online accounting and inventory software. You can give Deskera Books a try for free.

Different fulfillments Methods Available in Deskera Books
Different Fulfillment Methods Available in Deskera Books

Learn More about Deskera Books Features:

  1. Inventory with Deskera Books
  2. Back Orders with Deskera Books
  3. Dropship with Deskera Books
  4. Pick Pack Ship with Deskera
  5. Warehouse Management with Deskera
  6. Invoicing with Deskera Books

Sign up for a 30-day free trial of Deskera Books now!

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Nidhi S

Product Manager at Deskera

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