Do’s and don’ts of inventory management

Having the right products, at the right time, in the right location and quantity is essential for business success, yet many companies have no idea where they stand

3 minutes read

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.