Inventory management definition

Inventory management is the process businesses use to oversee every stage in the product lifecycle—from raw materials at the factory to finished goods in the warehouse to products bagged at the point of sale. Its objectives are to overcome supply chain variability, meet desired customer service levels at the lowest reasonable cost, and keep just the right amount of inventory on hand.

What is inventory?

The first step to understanding inventory management is to realize what inventory is. Consumers tend to think of inventory as finished goods. But for a business, inventory is anything it must restock. If a company makes soup, its inventory might include anything from tomatoes to packaging cans to the fuel in the delivery trucks that take the soup to the grocery store.

Generally, there are four types of inventory:

1. Raw materials and components: All the items that end up in the finished product. In the soup example, this would be every ingredient for every part of the recipe, including the flour that goes into the noodles and the spices that top off the broth.

2. Work-in-progress (WIP): As the name implies, this is all inventory currently being prepared and packaged. Applying inventory optimization at this stage helps carve out the most cost- and time-effective processes.

3. Finished goods: The end products of the production process that are ready to be distributed to resellers or delivered to customers. These items are fully assembled, packaged, labeled, and checked for quality standards, making them ready for use.

4. Maintenance, repair, and operating supplies (MRO): All the supporting materials that are needed in the production and delivery of items but are not included as part of the final product itself. In a manufacturing plant, this would include things kept on hand such as lubricants, tools, replacement parts, or cleaning supplies used to service machinery.

While these are the most common types of inventory, some companies may have many more sub-categories depending on their specific type of operation.

Why is inventory management important?

In simple terms, the goal of inventory management is to find a balance between a company’s supply of inventory and buyer demand for it. While inventory can be one of a company’s biggest assets, it can also be a major liability. That’s because inventory costs money, and without proper management, it can become unbalanced, tying up a company’s cash resources in overstock or draining revenue through lost sales due to stockouts.

Effective inventory management helps prevent the many expenses and potential perils involved in carrying excess inventory, such as:

• Storage

• Spoilage or theft

• Waste and sustainability issues

• Declining demand/value

• Tax ramifications

Efficient inventory management also helps companies steer clear of the consequences of the opposite problem—not having enough inventory:

• Stalled production lines

• Missed production and delivery windows

• Loss of customer loyalty, reputation, and market share

• Lower profits

But deciding what and when to order is no simple matter, regardless of a company’s size. That’s because inventory management is a complex process—weaving in elements of finance, operations, budgeting and planning, supply chain, and logistics.

Steps in managing inventory

The level of intricacy involved in inventory management varies greatly depending on the size and nature of the business. For example, a small operation that makes just a few products or makes products that don’t require many components or ingredients will have more streamlined processes and a less complicated supply chain to manage. On the other hand, a large corporation that produces many different or highly complex products will have multiple processes that feed into each other, as well as a multi-layered supply chain.

However, all inventory management processes do share some foundational steps:

1. Planning and ordering: Ordering the right products, raw materials, or components at the right time takes a lot of data. It starts with understanding product demand through marketing and sales forecasts, considering seasonal changes, and evaluating economic factors.

2. Delivery: Goods are delivered to the company’s facility. For manufacturers, this means receiving raw materials and subcomponents. For wholesale distributors and retailers, it means receiving finished goods that are ready to sell to customers.

3. Review and storage: Inventory is typically cataloged in a warehouse management system for easy tracking using stock-keeping units (SKUs) and universal product codes (UPCs). Organizing the storage area logically, such as arranging product locations in a pattern and labeling each zone and shelf, makes products easy to sort, locate, and manage. An organized system ensures that older inventory is used first to prevent it from becoming shelf-worn or spoiled. Advanced warehouse management solutions can also identify available space and how to best utilize it.

4. Selling: When a distributor or end customer places an order, the fulfillment process kicks in, verifying stock availability, pulling products using SKUs, and preparing items for delivery. Packing and shipping workflows are essential for timely delivery. Tracking the shipping process enables order status updates that improve customer satisfaction.

5. Reporting and auditing: Accurate recordkeeping tracks inventory at every step, from arrival to storage, handling, and delivery. Regular auditing, whether manually or through automated systems like barcode scanners, ensures that physical counts match records, helping identify discrepancies.

6. Reordering: Businesses can set reorder points to trigger replenishment when inventory hits certain metrics, such as stock levels, turnover rates, or cycle times. Based on demand or item type, they can employ periodic replenishment schedules or top-off replenishment tactics to adjust stock levels based on demand.

Types of inventory management

Different businesses have different product types, demand levels, and supply chain complexities. There’s no single inventory management technique that works best for every company or even every item in a company’s inventory—in fact, there are more than a dozen ways to approach it, and often multiple methods are combined.

However, these are the six most common methods for managing inventory:

• Segmentation: Prioritizes inventory management efforts based on the value and criticality of items.
  
  A frequently used type of segmentation is ABC analysis, where:

  • “A” items typically represent high-value, low-quantity items that contribute the most to revenue but require rigorous control and frequent monitoring.
  • “B” items have moderate value and moderate control needs.
  • “C” items are low-value, high-quantity items that require minimal control.

• Just-in-time (JIT) inventory management: Orders goods only when they’re needed. This method requires precise demand forecasting and reliable supplier relationships to safeguard timely delivery.

• Safety stock: Keeps backup quantities of items on hand for emergencies, supply chain disruptions, or unexpected surges in demand. If JIT is the just-in-time approach, then safety stock is the just-in-case approach, although it does increase carrying costs.

• Economic order quantity (EOQ): Calculates the most efficient order quantity using factors like demand variability, order lead time, and carrying costs.

• First-in, first-out (FIFO): Sells older inventory first because the cost of goods sold (CoGS) accurately reflects the current market prices.

• Last-in, first-out (LIFO): Sells the items most recently produced first, assuming that during times of rising prices, they’ll have higher production costs/CoGS and help reduce taxable income.

8 business benefits of inventory management

To keep up with rapidly changing customer demands, businesses must have an accurate picture of their inventory. Even though implementing inventory management takes time, effort, and financial investment in processes and infrastructure, it’s essential to business success.

Here are eight business benefits of prioritizing inventory management:

1. Increased revenue: Making sure the right products are available at the right time and place to meet customer demand quickly can increase sales and revenue.

2. Reduced costs: Minimizing excess inventory through accurate tracking and demand forecasting lowers the carrying costs associated with storage, handling, and obsolescence.

3. Improved customer service: Having the right products available when customers need them bolsters satisfaction, loyalty, and brand reputation.

4. Heightened efficiency and productivity: Leveraging automated tools for tracking and management significantly improves efficiency, reduces manual errors, and boosts overall productivity within the organization.

5. Freer cash flow: Analyzing inventory levels improves cash flow management by making sure operating capital isn’t tied up in stagnant inventory.

6. Forecast accuracy: Adhering to effective inventory management techniques hones demand forecasting accuracy so businesses can anticipate market trends and plan inventory levels more effectively.

7. Risk mitigation: Staying ahead of challenges like seasonal variations, supply chain disruptions, and market fluctuations mitigates risks and maintains operational stability.

8. Reduced waste: Reducing the number of products that become outdated, expired, or damaged reduces waste, improves sustainability efforts, and increases overall profitability. Deploying strategies like FIFO helps optimize inventory rotation.

What is an inventory management system?

With so many factors involved, managing inventory can be an overwhelming undertaking without the help of technology. Fortunately, inventory management systems have come a long way from their humble beginnings as spreadsheets manually tracking goods in warehouses.

Today’s inventory management solutions can range from freestanding point products for small and mid-size organizations to complex enterprise software-as-a-service (SaaS) platforms that integrate with systems from all over the business:

• Accounting

• Sales

• Shipping

• Enterprise resource planning (ERP)

• Digital supply chain (DSC) tools

Most inventory management technologies can monitor supply and stock levels, locations, and movement within warehouses, as well as track product receipt, picking, packing, and shipping. Premium inventory management systems can provide automation, cost calculations, and real-time scenario planning.

Some vendors even offer customization to suit specific business requirements. For example, a food service business could incorporate expiration-date tracking and alerts to ensure the rotation of perishable items and minimize food waste. A retailer could integrate real-time demand forecasting and automated reorder points to manage seasonal products during peak and off-peak seasons.

Inventory management examples in different industries

Inventory management isn’t a one-size-fits-all exercise. Depending on the nuances of their particular industry and operations, companies will have their own pain points and best practices to address them.

Here’s a look at some use cases for managing inventory across industries:

• Retail: Both online retailers and brick-and-mortar stores must manage a wide range of products and deal with seasonal demand fluctuations. Many large retailers have implemented sophisticated e-commerce inventory management that utilizes real-time data analytics to forecast demand accurately. Technologies like RFID tagging and automated replenishment systems help manage inventory levels, reduce stockouts, and improve customer satisfaction.

• Manufacturing: Factories must balance having enough raw materials to meet production demands and avoid excess inventory that ties up working capital. This is why many manufacturers employ JIT inventory management.

• Food and beverage: Restaurants, cafes, and food retailers face unique inventory management challenges due to the perishable nature of their products. Many establishments use inventory management software that tracks ingredient levels, expiration dates, and recipe costing in real time to optimize inventory levels and reduce food spoilage.

• Healthcare: Hospitals, clinics, and pharmacies rely on inventory management to ensure the availability of critical medications and medical supplies. Automated inventory systems help healthcare facilities track usage rates, monitor expiration dates, and streamline ordering to prevent shortages.

How to choose an inventory management system

Not all inventory management systems have the same capabilities, nor do all businesses struggle with the same inventory challenges. That’s why it’s important for businesses to identify their key inventory pain points before shopping for a solution.

Here are some things companies should ask vendors when considering candidates for their inventory management system:

• Integration: Does the solution integrate seamlessly with existing infrastructure such as POS systems, e-commerce platforms, ERP software, and other relevant applications? Or are expensive custom interfaces required?

• Features and functionality: Does the solution offer key capabilities such as stock tracking, barcode scanning, automated reorder points, demand forecasting, lot and serial number tracking, and reporting?

• Scalability: Can the solution handle current inventory size and complexity, as well as scale for future growth?

• Cost: Are there additional costs beyond the sticker price, such as subscriptions or fees for implementation, integration, or customization?

• Reviews and reputation: Does the solution have reviews and testimonials from existing customers to prove a track record of successful implementations and reliable customer support?

• Support and training: Is the solution backed by a responsive support team and training/support documentation to help deployment and user adoption go smoothly?

Trends in inventory management

Inventory management has evolved far from the days when shopkeepers penciled hand-counted stock totals into dusty countertop ledgers. Not only are today’s businesses managing inventory digitally—often across multiple, geo-distributed sites—but inventory management is expected to lean even more heavily into transformative technology in the future.

Here are some ongoing trends in inventory management:

• Warehouse automation and robotics: Adoption of Industry 4.0 technologies, including artificial intelligence (AI), machine learning algorithms, and IoT has become widespread. These technologies enable advanced inventory software with increased automation, reducing reliance on error-prone manual data entry. Warehouses are embracing robotics to streamline inventory management and order fulfillment processes with automated sorters, drones, and robotic process automation.

• Advanced AI capabilities: As competition continues to intensify in the retail and manufacturing sectors, AI-driven capabilities such as demand sensing are becoming more common. AI-powered inventory management platforms are analyzing historical purchase data and economic indicators to proactively identify demand trends and fine-tune inventory strategies.

• IoT and cloud connectivity: The integration of IoT and cloud-connected devices, along with the transition to cloud-based inventory systems, is amplifying efficiency in manufacturing, production, warehouse, and logistics processes. These technologies provide live updates and seamless access to inventory data from any wireless device so that everyone in the organization has the most current information at their fingertips.

• Predictive analytics and blockchain: The power of predictive analytics is reshaping inventory management, predicting potential supply chain interruptions and forecasting future demand. Additionally, the adoption of blockchain technology is enhancing supply chain transparency by creating an unalterable record of all transactions, fostering trust and reducing risk.

• Omni-channel inventory management: The rise of multi-channel inventory management enables businesses to manage inventory efficiently across multiple channels, combining remote warehouses with local brick-and-mortar stores to create convenient customer experiences. Customers can even buy online and pick up in-store (BOPIS) or receive faster deliveries from local warehouses.

• 3D printing on demand: Utilizing 3D printing technology for as-needed, in-house production of parts and products within the warehouse has become a viable option, reducing shipping costs and turnaround times while enabling product personalization.

• Vendor-managed inventory (VMI)/supplier-managed inventory (SMI): Taking a collaborative approach to inventory management, VMI/SMI involves vendors/suppliers actively engaging in monitoring and replenishing products, reducing the burden on companies and enhancing inventory management efficiency through shared data and insights.

• Reverse logistics: Proactively optimizing the returns process is significantly impacting inventory management by reducing costs, improving customer satisfaction, and minimizing environmental impact with fewer product returns.

• Sustainability integration: Modern inventory management platforms are bolstering sustainability efforts, bringing operational improvements that promote recycling and reduce waste.

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FAQs

What is inventory?

Consumers tend to think of inventory as finished goods. But for a business, inventory is anything it must restock.

What’s the difference between inventory and stock?

Although the terms inventory and stock are often used interchangeably, the two words have subtly different meanings in inventory management. While stocks are only finished goods ready for sale, inventory refers to a business’s entire range of items, including raw materials, works-in-progress, and finished goods. A stock is an inventory, but vice-versa isn’t necessarily true.

What are vendor-managed inventory (VMI) and supplier-managed inventory (SMI)?

They’re the same thing. Instead of the customer placing orders, the vendor (supplier) monitors inventory levels and makes restocking decisions at the customer’s location based on agreed-upon criteria. This collaborative approach helps improve inventory accuracy, reduce stockouts, and upgrade supply chain efficiency.

What’s the difference between inventory management and inventory optimization?

Inventory management is about setting high productivity and efficiency targets for all inventory operations. Inventory optimization is a subset of inventory management that refers more specifically to profit margins and minimizing loss. It involves strategically managing and controlling item levels to maximize efficiency, reduce costs, and meet customer demand.

What’s the difference between inventory management and inventory control?

Inventory management is the broader strategic oversight and optimization of inventory to meet customer demand, minimize costs, and avoid overstocking or stockouts. Inventory control deals with the precise tracking and accuracy of inventory levels to prevent discrepancies, loss, and theft.

What’s the difference between an SKU and a UPC?

A stock-keeping unit (SKU) is an alphanumeric code used internally by businesses to track inventory. They’re exclusive to each company and help manage and identify specific products within their inventory system. SKUs can include information such as size, color, and other product variations.

A universal product code (UPC) is a standardized, 12-digit barcode used globally to track sales and inventory and identify products at the point of sale. They’re created by the manufacturer to ensure that a product can be identified anywhere in the world by its unique barcode.

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