What Is Inventory Management?

The ordering, storing, using, and selling of a company’s inventory is referred to as inventory management. This covers the storage and processing of raw materials, components, and final goods. Depending on the demands of a business, there are various inventory management techniques, each with advantages and disadvantages.

The Benefits of Inventory Management

One of a company’s most significant assets is its inventory. A company’s inputs (such as raw materials) and final goods are the foundation of its operations in retail, manufacturing, food services, and other inventory-intensive industries. When and where inventory is needed, a shortfall can be very harmful.

Additionally, inventory might become a burden. The risk of spoiling, theft, damage, or a shift in customer demand increases with the length of time it is left out. Businesses have to keep it, insure it, and mark it down for clearance or even trash it if it doesn’t sell in time.

These factors make inventory management crucial for companies of all sizes. It might be difficult to make decisions about when to refill, how much to buy or manufacture, when to sell, and how much to charge. Small firms frequently use spreadsheet (Excel) formulas to calculate reorder points and amounts while manually monitoring their inventory. Specialized enterprise resource planning (ERP) software may be used by larger companies. Highly tailored software as a service (SaaS) applications are used by the biggest companies. Businesses are also urging artificial intelligence to streamline these procedures.

Depending on the industry, different inventory management techniques are appropriate. If needed, an oil depot can wait for demand to increase by keeping a lot of inventory on hand for long stretches of time. There is no chance that the inventory will rot or become outdated, despite the fact that storing oil is costly and dangerous (a fire in the United Kingdom in 2005 resulted in millions of pounds in damage and fines).

Holding inventory is not an option for companies that deal in perishable goods or products for which demand is time-sensitive, such as 2024 calendars or fast-fashion items, and it can be expensive to misjudge the timing or amounts of orders.

It is particularly challenging to balance the risks of inventory surplus and shortages for businesses with intricate supply chains and manufacturing processes. They may use a variety of inventory management techniques, such as just-in-time (JIT) and materials requirement planning (MRP), to accomplish these balances.

Accounting for Inventory

Since a business normally plans to sell its completed goods within a year or less, inventory is considered a current asset for accounting purposes. Before inventory is recorded on a balance sheet, it must be physically measured or counted. Businesses frequently keep advanced inventory management systems that can monitor stock levels in real time.

First-in-first-out (FIFO), last-in-first-out (LIFO), and weighted-average costing are three methods for accounting for inventory. An inventory account typically consists of four separate categories:

The different resources that a business buys for its manufacturing process are referred to as raw materials. For a business to turn these ingredients into a finished product that is ready for sale, they must go through extensive processing.

The term “work in process” (sometimes called “goods-in-process”) refers to raw materials that are being converted into a final product.

Completed goods are finished products that are easily sold to clients of a business.

Merchandise is the term for completed goods that a business purchases from a supplier in order to resell them later.

Inventory Management Methods

A corporation may employ a variety of inventory management techniques, depending on the nature of the business or the product in question. These consist of days sales of inventory (DSI), economic order quantity (EOQ), materials requirement planning (MRP), and just-in-time (JIT) manufacturing.

These are the four most popular approaches to inventory management; however, there are more. This is how each one functions.

Just-in-Time Management (JIT)

The 1960s and 1970s saw the development of this manufacturing and inventory management paradigm in Japan. The most significant contribution to its development is attributed to Toyota Motor (TM). By buying and holding only the inventory required to manufacture and sell goods within a specific time frame, Just-In-Time (JIT) enables businesses to save substantial sums of money and minimize waste. This strategy lowers the cost of insurance, storage, and liquidation or getting rid of extra goods.

JIT inventory control can be dangerous. In the event of an unforeseen surge in demand, the manufacturer might not be able to find the inventory required to match that demand, harming its image with consumers and driving business to other companies. If a crucial input does not arrive “just in time,” a bottleneck may arise. Even the tiniest delays can cause disruptions.

Materials Requirement Planning (MRP)

Because this inventory management approach is sales-forecast reliant, manufacturers rely on thorough sales data to predict their inventory needs and promptly notify suppliers of those needs.

Using an MRP inventory system, for instance, a ski manufacturer may make sure that supplies like plastic, fiberglass, wood, and aluminum are available depending on anticipated orders. The manufacturer won’t be able to complete orders if it can’t predict sales and plan inventory purchases.

Economic Order Quantity (EOQ)

In order to reduce inventory costs, firms can use the Economic Order Quantity (EOQ) model to estimate the optimal batch size, or the number of units to order or produce at once. This inventory management model is predicated on consistent client demand, and holding and setup expenses are included in the model’s inventory costs.

In order to prevent a company from having to place orders too frequently and from having too much inventory on hand, the EOQ model aims to guarantee that the proper quantity of inventory is ordered per batch. It is predicated on the idea that there is a trade-off between inventory setup and holding costs, and that when both setup and holding costs are minimized, overall inventory costs are minimized.

Days Sales of Inventory (DSI)

This financial ratio shows how many days it typically takes a business to convert its inventory—including work-in-progress items—into sales. There are several methods to interpret DSI, which is sometimes referred to as the average age of inventory, days inventory outstanding (DIO), days in inventory (DII), days sales in inventory, or days inventory.

The number shows how many days a company’s current inventory supply will last, indicating the inventory’s liquidity. Although the average DSI varies by industry, generally speaking, a lower DSI is desired as it signifies a quicker time to clear out the inventory.

Inventory Management Red Flags

A company’s management is probably attempting to provide a more positive image than reality would suggest if it regularly modifies its inventory accounting methodology without good reason.

What Are the 4 Main Types of Inventory Management?

Just-in-time (JIT), materials requirement planning (MRP), economic order quantity (EOQ), and days sales of inventory (DSI) are the four primary forms of inventory management. For some types of firms, each approach might be more effective than others.

How Does Tim Cook Use Inventory Management at Apple?

Tim Cook, the CEO of Apple, is renowned for his emphasis on inventory control. He said, “Inventory is like dairy products,” according to quotes. “No one wants to buy spoiled milk.” Cook introduced just-in-time production techniques to Apple, among other breakthroughs, which are said to have cut the company’s inventory turnover time from months to as short as five days in 2012.

What Is an Example of Inventory Management?

Let’s examine a just-in-time (JIT) inventory system example. By using this approach, a business hopes to get products as close to the actual time of demand as possible. Therefore, rather than keeping an inventory of airbags on hand at all times, a car manufacturer that has to install airbags in its vehicles makes arrangements to obtain those airbags as the vehicles enter the assembly line.

Conclusion

The practice of ensuring that a company has the appropriate goods in the appropriate quantities at the appropriate times is known as inventory management. If you place too few orders, shelves will empty, and sales will be lost. If you place too many orders, the items will languish, costing money, and may need to be discounted or thrown away. There is no one “perfect” technique to manage inventory since every firm is unique—a bakery is not the same as a supplier of car parts. Selecting the strategy that best suits the company and its goods is crucial. Profitability and general success can be greatly impacted by doing this correctly.

FAQ

What happens if a business has too much inventory?

Excess inventory can tie up cash, increase storage costs, and create risks such as damage, theft, spoilage, or products becoming outdated.

What happens when a business has too little inventory?

When stock runs out, businesses may lose sales, disappoint customers, and potentially drive buyers to competitors.

What are the four main types of inventory?

The four main inventory categories are raw materials, work-in-progress items, finished goods, and merchandise purchased for resale.

What is Materials Requirement Planning (MRP)?

MRP is a system that uses sales forecasts to determine what materials and inventory a business will need in the future.

What is Economic Order Quantity (EOQ)?

EOQ is a formula that helps businesses determine the ideal amount of inventory to order at one time while keeping costs as low as possible.

What does Days Sales of Inventory (DSI) mean?

DSI measures how long it takes a company to sell its inventory. A lower DSI generally means products are selling more quickly.

Is inventory management only important for large companies?

No. Businesses of all sizes, from small shops to large manufacturers, benefit from effective inventory management practices.

What industries rely heavily on inventory management?

Retail, manufacturing, food service, e-commerce, healthcare, and logistics are just a few industries where inventory management is critical.

Is there a single best inventory management method?

No. The best method depends on the type of business, the products being sold, customer demand, and supply chain requirements.