The What and How To Efficient Inventory Management

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Running a business is never an easy feat and businesses are on a constant search of finding the leading key to grow bigger and better. Especially in the retail industry, key factor such as inventory management is of great importance. In fact, enough to make or break your business. The sooner you start vamping up your inventory management, the stronger your cash flow will get. Don’t be surprised on how a well managed inventory can easily translates into better cost saving, more product control, higher efficiency and ultimately, profit boost. Now that is only the tip of the iceberg, but before we go further on how to efficiently manage your inventory, let’s find out what does inventory management actually means.  

What Is Inventory Management?

To put simply, inventory management can be defined as a collection of all the tools, techniques, strategies used to store, track, deliver, and order inventory. It is common for businesses to invest a large amount of capital in order to acquire inventory. Hence, making perfect sense how managing or mismanaging your inventory can maximize or minimize losses and profits. Generally, inventory (although dependent on the nature of business) are divided into these 3 main types which are;

  • Raw materials inventory -  Raw materials that your business will convert into goods or services.
  • Work-in-process inventory - Inventory made out of unfinished goods that your business will complete before they are ready for sale.
  • Finished goods inventory -  Finished goods inventory that is ready for sale.

Regardless of the type of inventory that is relevant to your business, we have listed out some of the most common techniques of inventory management practiced in the supply chain industry. 

Standard Inventory Management Techniques

1. Set Par Level

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Start of by setting the “par level” for each of your products. Basically, par level refers to the minimum amount of products required to be in store at all times. If the stock dips below the minimum, it acts as a reminder that it’s time for you to restock.But how to know what is the ideal par level for every product? To answer this, practically, there is no easy way other than conducting research and going through your sales report. The dynamic of ordering inventory, essentially, is dependent on how fast a product sells and how long does it takes to get back in stock. This will help to systemize the ordering process and allows you to adjust your par level accordingly if the existing minimum no longer validates. 

2. First-in, First-out (FIFO) and Last-in, First-out (LIFO)

Both FIFO and LIFO are inventory accounting methods to value your inventory and answering the question of using either the former or the latter, is actually according to your inventory type. Fist-in, first-out (FIFO) refers to the method of arranging your inventory where your oldest stock (first-in) gets sold first (first-out). This applies especially for perishable products in order to avoid loss due to spoilage.On the other hand, last-in, first-out (LIFO) points out the method of arranging your inventory where your newer stock (last-in) gets sold first (last-out). This method suits non-perishable products such as bricks or concrete mixes where every time you received a new batch, you won’t need to rearrange your stock or rotate batches as they’ll be the first ones out anyway. 

3. ABC Analysis

ABC analysis is another popular technique where you basically divide up your inventory into 3 different categories which are A,B and C, based on annual consumption unit, inventory value, and cost significance.

  • A - High value products with low frequency of sales (10% of overall inventory)
  • B - Medium value products with moderate frequency of sales (20% of overall inventory)
  • C - Low value products with high frequency of sales (70% of overall inventory)

The percentage of product amount from overall inventory is derived based on the Pareto Principle.*The reason behind ABC analysis is no rocket science, basically, products in category A are kept low in quantity as their financial impact is largely significant but with unpredictable sales. Meanwhile, products in Category C are the ones that drive the number of sales, therefore making up the bigger part of your inventory. Category B products are kept slightly more than those of category A in this case. 

4. Just In Time Inventory Management

If you are a bit of a risk taker, then this method might catch your attention. The Just In Time (JIT) method refers to the process of ordering and purchasing inventory a few days before you need it for distribution or sale by utilizing the lead time to process order. Provided that delivery is always on time along with the confidence for a smooth logistic operation, you are able to cut warehouse holding cost and avoiding slow moving stocks from piling up. 

5. Economic Order Quantity

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Economic order quantity (EOQ)  literally trains you to be economic. The purpose of EOQ is to reduce inventory as much as possible in order to keep your cost as low as possible. You need to order the lowest amount of inventory but still meeting peak customer demand. At the same time, you need to maintain from going out of stock but without producing obsolete inventory all together. Not to fret, this formula from Kenneth Boyd, author of Cost Accounting for Dummies will help you calculate EOQ.There are three variables: demand, relevant ordering cost, and relevant carrying cost used to set up an EOQ formula:

  • Demand: The demand, in units, for the product for a specific time period.
  • Relevant ordering cost: Ordering cost per purchase order.
  • Relevant carrying cost: Carrying costs for one unit. Assume the unit is in stock for the time period used for demand.

Note that you need to calculate the ordering cost per order. Then, calculate the carrying costs per unit. Here’s the formula for economic order quantity:  Economic order quantity (Q) = square root of [(2 x demand (D) x ordering costs (S)) ÷ carrying costs  per unit (H)] 

6. Dropshipping

Many are familiar with dropshipping even if they are not direct players in the retail industry - with us seeing more and more regular public becoming dropship agents supporting local businesses in Malaysia. Essentially, dropshipping is more to a business model than it is a pure inventory management method. Dropshipping business model allows you to to sell and deliver products without even owning or keeping them as stocks.In dropshipping, assuming you are a retailer - your supplier produce the goods, warehouse them, and deliver them to your customer for you instead. Hence, benefiting you in the sense of;

  • Low startup costs
  • Cut-down cost of inventory
  • Reduced order fulfillment costs
  • Ability to sell and test more products with less risk

Additionally, the whole process of dropshipping is quite simple. The rule of thumb is whenever you received an order, you simply need to forward the order to your supplier and they will take care of the rest.  

So, How To Decide The Best One That Works For You?

Unfortunately, there is no shortcut answer to which method that will work best to manage your inventory. Experimenting with the classic trial and error through research effort is still the best way to go. Before this article comes to an end, do note there are also other methods of inventory management out there which we will cover soon. So, stay tune! Meanwhile, check out our other informative business articles here or drop by our official site by clicking the button below.