The science of inventory management & 8 essential techniques you should master for big savings

The science of inventory management & 8 essential techniques you should master for big savings

An introduction to inventory management

I don’t know how many of you believe in this, but inventory management is an invaluable exercise in cost cutting and if you haven’t realized that yet, it’s time you started now. Not only can you save a tidy sum by avoiding purchase of extra goods that would just sit in the warehouse unsold, it will also save you warehouse storage costs on these unnecessary goods. Even when the situation reverses, it could still save you money by preventing loss of sales when it turns out that you don’t have adequate stocks to fulfill them.

So, what is inventory management really and why should it be an important part of how you handle your business? Quite simply put, inventory management is both the art & science of optimizing or rightsizing your stock of goods for sale to match the expected sales. This way you neither pay for extra goods and storage nor lose sales when there is insufficient stock.

This, of course, will sound much easier said than done. For starters, whoever knew accurately what expected sales are going to be like. That is why we use the word optimizing, which means rightsizing, to the best of our ability. It’s better to have some scientific planning going into this than none.

The same concept applies to raw materials inventory too, through a system known as materials requirements planning or MRP. Stock quantity of raw materials and components that go into manufacturing your finished goods must be optimized to fit into the planned production runs. Excess stock will block your cash and require extra storage space as well. On the flipside, dry stock will delay your production output.

Various stages of inventory management for a typical business unitImage Source: medium.com

Breaking down the system that is inventory management

Let us look at a product-oriented business scenario here to deconstruct the inventory of finished goods, whether manufactured or purchased from a manufacturer. Of course, the same concept would apply to the management of raw material stocks too.

The purpose of holding inventory stock of finished goods is to meet expected sales. Obviously, when sales are lower than your stocks you will have inadvertently blocked investment and used up extra storage space that could be taken up by future stock. On the other hand, when sales exceed the stock, it could mean both an opportunity as well as loss of revenue on missed sales.

Effective inventory management is knowing how much inventory to stock for sales
Image Source: medium.com

Expected demand or demand forecast

In order to forecast demand the following factors need to be taken into account:

Past sales trends

If you have been in business for some years, then you’d probably possess a certain amount of sales data that shows basic sales figures plus yearly growth, along with monthly trends. Using this data you can assume a certain growth for the current year and forecast sales for the year. Growth rate expected will depend on macroeconomic factors like the country’s economic growth, the outlook in the industry you are operating in, company and product factors and the competitive scenario.

Seasonal factors

There is a seasonal factor that plays a prominent role in forecasting demand for many products. Demand will fluctuate due to factors such as winter vs summer seasons for appropriate clothes, back-to-school season, weekdays vs weekends, holiday season and even time-of-the-day for certain products.

Promotional factors

An effective promotion run by you can certainly impact demand favorably in the short term, and interestingly, vice versa. 

Macroeconomic factors

As mentioned above, economic factors at large such as overall growth-rate of the economy, performance of various industries, unemployment rate, cash or purchasing power in the system, new technology and disruptive technology trends, and innovations have a domino effect on all businesses.

You could use a combination of the above approaches in addition to expert opinions, published forecasts, government outlook reports, salesforce estimates and market research to forecast demand for your product with reasonable accuracy. Click here to know more on the art of demand forecasting, its objectives and methodology.

Demand forecasting is an extensive area of study to correctly estimate consumer demand for different products
Image Source: medium.com

Minimum stock level (Reorder level) or safety stock

Consider a typical sales scenario where your sales in April previous year was 100 units. Considering a growth estimate of 5% you may be expecting to sell 105 units in April this year. However, you are also planning a strong promotional campaign in March end, which may give you an additional sales of 20 units.

At the same time, however, the competition has brought out a new variant in your product category that might take away 10 units from you. So, your net forecast would now be around 115 units. But, these are all projected figures and there is a certain probability for each of them.

To plan the inventory, your safe level may be of 115 units average over the month. But as sales will be spread out over the month, your minimum stock level may be, say, 30, and this also becomes your reorder level. So, as soon as your stock hits 30, you may proceed to order a certain quantity to replenish your stocks. Here’s a brief on how to calculate your reorder point through something called reorder point formula.


Video Source: inflowinventory.com

Reorder Quantity

The quantity of goods that you order to replenish stock when you reach reorder level is called the reorder quantity. Following up with the example on minimum stock level cited above, the reorder quantity may be set at 20 units or whatever works out for you.

The calculation of reorder quantity takes into account the time it would take for goods to reach your site plus the rate of sales. A good way to plan your reorder quantity could be to categorize the period into weekly or biweekly schedules based on weekly or biweekly sales and weekly or biweekly flow of goods, depending on replenishment time.

Read here for more details on how to calculate reorder quantity in three simple steps.

Inventory management best practices & techniques to hold on to

Now that we have taken care of the nitty-gritty of inventory management, let’s get down to these industry proven techniques that will have you master the system in no time.

1. ABC Analysis

This approach in inventory management follows the 80/20 rule or the Pareto Principle, which states that 80% of your profits are likely to be contributed by 20% of your inventory or SKU (stock keeping unit). This will help you analyze which 20% of your goods contribute to the 80% profits in a categorized manner.

  • Category A products will be the ones that contribute to the highest annual sales with high consumption rate and most likely will take up a small percentage of the items in the stock, probably 20%. It would therefore, be advisable to prioritize them in terms of stocking to avoid missed sales in case of unavailability of goods in the future.
  • Category B will comprise products of mid value and will therefore occupy a large chunk of your inventory with slightly lower consumption rate. About 30% of the items in your inventory will belong to category B.
  • Category C will comprise items with the lowest sales because of low consumption rate, but will incidentally occupy a large portion of the set items. Yielding as low as 10% of the annual sales, category C items will take up 50% of the inventory, although it would be smarter to keep the the stock of C items as low as possible after some sales runs.

2. SKU rationalization

Having too many variants or SKUs leads to unmanageability at every level. You can sort this by planning for production runs of all those SKUs, ordering raw material and storing a wide variety, listing those products on your eCommerce store and manage & forecasting their sales.

An analysis of the number of SKUs versus their sales contribution also needs to be done and a call taken to drop units whose sales contribution is lower than the manageability issues they generate. Learn more on SKU rationalization and its benefits here.

SKU rationalization is a process of inventory optimization using analytical tools
Image Source: tradegecko.com

3. Year-end Inventory reconciliation

Most businesses have traditionally been conducting a physical reconciliation of stock or inventory count, as is commonly known, at the end of each year. This is the practice of putting all traffic on hold to take a full physical count of the goods and match it with the figures on your records.

The practice generally started to tally the accounts for for annual tax filings and its inherently being a simple, easily understood concept. Of late, however, some companies have found this practice rather disruptive to their business and have been turning to alternate options that we’ll discuss below. Here’s a quick read on inventory reconciliation through five simple steps in case you’re interested.

4. Random checking

In this approach, businesses periodically take up products at random, make a count of its inventory and compare it to what the accurate stock should be. This generally means disrupting just a small part of your warehouse and staff and therefore, more preferred in recent times.

When done consistently, and as a sampling exercise, it can give you a very good idea on the overall situation, provided the products chosen over time are representative of the total. In other words, it implies that you not only focus on Group A products through this approach, but a few products from Groups B and C as well.

5. Cycle counting

The cycle count procedure in inventory management is perhaps the most preferred method that is favored by most businesses. This procedure of inventory auditing offers less disruption with its location-wise concentration on subcategories in your inventory on an agreed day. Cycle count makes sure that you carry out inventory audit of all or nearly all products, one by one, in a cycle throughout the year.

This enables you to spread out the effort over time, while at the same time you will be able to address problems periodically instead of in one go at the end of the year. Of course, the order of the cycle covering different products needs to be judiciously worked out, mixing Group A, B and C products in the right proportions. Here’s a look at some of the many benefits of cycle counting.

6. Improved supplier collaboration

One of the keys to running a successful business is working closely with your suppliers, which has benefits going far beyond just inventory control. Every business is dependent on regular, uninterrupted supplies of raw materials and finished goods.

There are several manufacturing companies engaged in producing these goods for you. These companies are slaves to their own business factors, many beyond their control. Often this may result in temporary variations in supplies. To avoid your business from being impacted by such factors it is vital to have a close relationship with your suppliers.

This will help you stay forewarned of any likely variations and at times you may even prevent them by working out solutions jointly with the suppliers. Alternatively, you may even look for other suppliers to fill up the gaps well before the disruptions arrive.

A benefit that goes beyond inventory supplies is that you can have an influence on the design and quality of the goods or parts you are seeking, by being an insider in the suppliers' business. Read more on improved supplier collaboration and how it can lead you to success.

7. Out of stock alert system

Most inventory management software today have alerts at various levels built into them. Be more responsive to these alerts when stocks reach targeted levels and take appropriate, predetermined steps. Check out how you can use Zoho Books, one of the many inventory management software, to set an out of stock warning.

8. Centralized Inventory System

If you are selling your goods across multiple channels and storing them in several warehouses, it would make sense to use a centralized inventory management software. This pools in information from various stocking points and sales channels, and gives you a realistic picture of your inventory. Here’s a list of the top performing inventory management software for all business categories that you can benefit from.

Ordoro is an inventory management software designed for eCommerce companies
Image Source: ordoro.com

Some helpful tips in inventory management

Spoilage: This goes for food items which go bad due to shelf-life expiry and are not fresh or edible any longer. A continuous watch over such goods is required and quick action in terms of pushing out stocks directly or through a discounted offer, much before the expiry date, is the best way to avoid spoilage. Of course, there’s always that basic technique of ordering low shelf-life food items in limited or the right quantity.

Dead stock: In the world of commerce, dead stock is usually represented by goods that doesn’t get picked up by the market either because it has gone out of style, out of season or become unappealing in some way. If you’re someone that doesn’t use inventory management software, that dead stock could be wasting around in your warehouse forever without you knowing it.
The answer again lies in continuous watch over the stocks and weeding out dead stuff in time so that the damage is limited. Here are some practical tips to avoid dead stock and losing your money.

First In, First Out (FIFO): The concept of FIFO refers to the movement of goods into the warehouse, meaning goods that arrive to the warehouse first and are sold out first. In other words, the units that are sold out or disposed off follow the same order as that of their acquirement or production.
The apparent advantage of this method is that overall average freshness of the stock is maintained, lest some of the stock keeps sitting on the shelves at the back and may become dead stock. Worse still, they may become outdated or obsolete due to a change in the packaging, pricing, version or technology in the market.
So, it’s better to have open aisles storage (as opposed to against-the wall shelvings) so that new arrivals can be loaded from the open back side of the shelves. And goods for sales usually are taken from the front side of the shelves. Do make sure that slow moving products do not take up a lot of storage space and fast moving products are stored nearer the packaging bay to reduce aggregate movement time.

Unforeseen problems:  Several problems may crop up (in fact they usually do) in the practical scheme of things. For some reason, you may experience a sudden spike in sales and you find that you simply don't have sufficient stock to meet the demand.
Under the circumstances, you may resort to a quick reorder, but the supplier may have certain constraints and the delivery might be longer than expected. Or you may encounter issues at the supplier’s end, the manufacturer may change priorities or models or they may even discontinue your product.
At other times, there may be a miscalculation and you may simply end up with the wrong inventory level. If not that, then you may face a temporary cash shortfall, which would impact your ability to replenish stocks. These unforeseen problems surely impact your business, but the damage caused by them can be minimized by sound inventory management techniques.

Conclusion

Inventory management is not an art that is easy to take control of if you don’t go about it in the proper way. Whether you own an eCommerce store, a restaurant, a clothing line or just about any business that requires you to stock on goods, the fundamental principles of inventory management is the same - analyze, audit and control the stock.

Embrace sound inventory management as a core component of your business and you will watch your business on a sound footing with minimal cash problems at all times. At 0707, we have the business acumen and market experts that can & are willing to show you the ropes of inventory management whenever you are ready to discuss with us.

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