Careful inventory management (aka stock management) is always important, but it looks different for different retail businesses.
- A supermarket needs careful inventory management to avoid items going out of stock, or too many items going out of date. They need the right amount of products arriving at the right time.
- A small independent retailer also doesn’t want items going out of stock (or hanging around in the stock room for too long). The stakes are lower, but they don't want cash flow tied up (or to miss out on sales).
- And for a brand manufacturing its own products, inventory management extends beyond what happens in their store; it’s the entire process of acquiring and storing the raw materials to manufacture the products, and storing these and products themselves — both finished and unfinished.
When we talk about inventory management methods, we could in reality be talking about one of two things: strategies for approaching inventory management, or how to account for your inventory from a bookkeeping perspective.
We’ll focus on strategies first, and get to accounting considerations in the next section.
Inventory management strategies
So, how do we get to the point of having efficient inventory management? Efficient inventory management looks different to every business, but it can be helpful to understand the distinct strategies larger corporations will adopt for their inventory management so we can assign some ‘method to the madness’. Here are some inventory management strategies to consider:
1. Just-In-Time (JIT)
This method of inventory management focuses on ordering ‘little and often’, so products don’t hang around in your store for long periods of time. This minimises holding costs, and also reduces the chance of products going off, being damaged in storage, or becoming ‘dead’ stock.
It’s a careful balance, though — you need to be working with pretty steady demand, or very accurate forecasting, to carry this out correctly.
2. Economic Order Quantity (EOQ)
Economic Order Quantity is an alternative method of inventory planning and management to the ‘Just in Case’ method we outlined above.
Often, creating or ordering products on a larger scale is cheaper per unit. Rather than assuming that ordering ‘little and often’ is best, the EOQ approach considers all cost factors when planning for stock. For example, it might be more cost effective to order a larger quantity of products (or raw materials) and store them; the money saved might be greater than the holding cost, in which case stocking up in advance might actually make more sense.
3. ABC Inventory Analysis
ABC Inventory analysis is less of a strategy and more an approach to rolling out a strategy. It’s rooted in the Pareto Principle that a large percentage of your business’s success comes from a small percentage of what you’re doing — or in this case, what you’re selling.
Start by dividing all of your inventory into three categories; A being the bestselling and most profitable, C being the least, and B being those that fall in the middle. If you sell through Shopify, you’ll have a version of this analysis in your ecommerce store.
Once you’ve divided your inventory in this way, the idea is that you optimise the supply chain for your ‘A’ products first, and get to the rest later on.
Accounting inventory methods
Your inventory is a current asset — whether it’s in the form of raw materials, goods-in-process (partially finished goods), finished goods (your items, ready for sale) or merchandise (another supplier’s items that you’re reselling).
All must be accounted for — but you can choose one of the following three methods for doing so:
1. First In, First Out (FIFO)
This accounting method works on the basis that you sell your oldest stock first. This is generally considered the simplest and most logical approach as it means your stock isn’t hanging around for too long. It’s the natural choice for most stores, especially those selling perishable items.
2. Last In, First Out (LIFO)
‘Last In, First Out’ assumes you’re selling your most recent stock first. This is slightly more complicated to account for, but can come with some tax benefits. Always check with a qualified accountant if you’re unsure on which approach is right for your business.
3. Weighted average
You might be wondering why, from an accounting perspective, it makes any difference which of two identical items you sell first.
The answer lies in the cost price, which won’t stay flat forever. When it drops or increases, you need a precedent set for how you assign value to what you have in stock at that time.
The weighted average approach is an alternative to FIFO or LIFO, and involves averaging out the differing cost prices across the stock you have left.
FAQs
What does good inventory management look like?
Inventory management is an important process, but when described it can sound kind of nebulous. And maybe that’s because it’s describing something that’s an integral part of running a shop: buying and selling stock.
So when we talk about inventory management, it’s probably more helpful for us to focus on what good or efficient inventory management looks like:
- You don’t often have items go out of stock
- Your stock room is clean and organised, and you can find what you need easily
- Items don’t hang around in storage for long periods of time
- You lose a minimal amount of inventory to ‘retail shrink’ (<1.5%)
- You don’t have to run large end of season sales to get rid of dead stock
- Perishable items move through your shop quickly. You don’t need to mark them down frequently for a quick sale, or write them off because they’ve gone out of date
Do I need inventory management software?
Efficient inventory management doesn’t just ‘happen’; it requires thought, planning, and strategising. Inventory management software is an added expense, but one that’s likely to pay for itself in terms of time saved, and extra inventory efficiency. The right software will help you spot products that are running low or underperforming, among other things.
