Do’s and don’ts of inventory management
If you’re like other entrepreneurs, you may find it challenging to manage your inventory. It’s one of the main headaches in many businesses—having enough inventory on hand for production and customer demand, while not tying up excessive cash in your inventory.
It gets more challenging when you don’t know exactly what you have in stock.
Here are some do’s and don’ts of inventory management.
Do’s
1. Monitor your inventory
Good inventory management starts with tracking what you’ve got. This means having a reliable way of recording how much inventory you have, where each product is located and when you received it. To make sure your system is accurate, you need to regularly count your actual inventory.
Most companies end up using inventory management software to track items through purchasing, receiving, production and sales. Warehouse management systems are a related technology that allow tracking of all inventory transactions, from receiving to shipping, through preparation.
These technologies will let you know what you have in stock, what’s been sold or committed to production, and what’s been ordered. They also integrate with other systems, including accounting and point-of-sale software, to provide real-time visibility to sales, production and finance teams.
2. Measure performance
It’s important to regularly measure the performance of your inventory management. You should choose performance measures that make the most sense for your business.
The most common inventory key performance indicators (KPIs) measure different areas of focus:
- service level
- inventory levels
- inventory accuracy
We generally suggest tracking at least one KPI for each area of focus to ensure an appropriate balance in the efforts made.
Common inventory management KPIs
Service level
Fill rate ratio measures the percentage of customer orders that were filled in a given period with inventory on hand without back orders, stockouts or lost sales.
Fill rate
Orders shipped in full
Customer orders placed
or
Service level ratio measures the percentage at which defined customer service level targets are reached.
Service level
Demand fulfilled on time
Total demand
Inventory levels
Inventory turnover ratio measures the number of times inventory has turned over (been sold and replaced) during a year.
Inventory turnover
Cost of goods sold
Average value of inventory
or
Days of inventory held measures your inventory management efficiency and is helpful in coordinating purchasing, production and sales teams.
Inventory shelf life
Average value of inventory
Cost of goods sold
X 365
Inventory accuracy
Inventory accuracy ratio measures the precision of your inventory data by comparing actual stock on the shelf to what is recorded in your database.
Inventory accuracy
Actual inventory count
Recorded inventory count
or
Warehouse space utilization ratio is another ratio commonly used to measure how efficiently you are using your warehouse capacity as well as the amount of space you have left for storage.
Warehouse space utilization
Amount of space used
Total available space
3. Align inventory management with other processes
Ordering new items should take into account customer demand, sales forecasts, financial considerations, production needs and distribution capabilities.
Companies sometimes buy a truckload of stock on discount, but they don’t look at the costs of holding the stock or the possibility that it may expire before it can be used.
You may want to adopt a process called sales and operations planning (S&OP). It’s a formal method of coordinating activities in a business, including inventory management. You can buy S&OP software to help you organize the process.
Don’ts
1. Use inventory as a Band-Aid
Don’t use inventory as a Band-Aid for operational or supplier problems. Instead, ask yourself why you have so much inventory and work on solutions.
For example, if you find yourself with a lot of buffer stock, look into whether it’s because of excessive lead time or delivery issues. Or is it because you need to compensate for frequent production delays?
Solving these problems will reduce the amount of inventory you need to hold and save you money. An operational efficiency expert can help you improve your processes and eliminate waste.
2. Dump inventory without a plan
If you have a lot of excess or discontinued inventory that’s been gathering dust, you may decide to dump or liquidate it. In order to minimize the financial hit, make a plan.
First, decide what you consider excess inventory and when it’s time to discontinue a product. Next, identify products on which you need to take action.
Finally, create rules for what you will do with aging or excess inventory. Options include:
- asking if you can return the products;
- offering sales reps incentives to sell them;
- liquidation;
- donation;
- destroying items.
Learn how to better manage your inventory
Discover how to set KPIs, ensure that you have the right amount of inventory, and improve your company’s cash flow by downloading our free guide for entrepreneurs: Inventory Management.