Inventory management explained

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 realise what inventory is. Consumers tend to think of inventory as finished goods. But for a business, inventory is anything it must replenish. If a company makes soup, its stock might include anything from tomatoes to packaging tins to the fuel in the delivery lorries that take the soup to the supermarket.

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 stock.

2. Work-in-progress (WIP): As the name implies, this is all stock currently being prepared and packaged. Applying inventory optimisation 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, labelled, 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 items kept on hand such as lubricants, tools, replacement parts, or cleaning supplies used to service machinery.

While these are the most common types of stock, 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 implications

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

• Production lines at a standstill

• Missed production and delivery slots

• 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.

6 Steps in managing inventory process

The level of complexity 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 requires 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 premises. For manufacturers, this means receiving raw materials and sub-components. For wholesale distributors and retailers, it means receiving finished goods that are ready to sell to customers.

3. Review and storage: Inventory is typically catalogued in a warehouse management system for easy tracking using stock-keeping units (SKUs) and universal product codes (UPCs). Organising the storage area logically, such as arranging product locations in a pattern and labelling each zone and shelf, makes products easy to sort, locate, and manage. An organised 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 utilise it.

4. Selling: When a distributor or end customer places an order, the fulfilment 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-up replenishment tactics to adjust stock levels based on demand.

Key Performance Indicators (KPIs) for inventory management are vital for assessing and improving inventory processes. Consider the following important KPIs:

• Inventory Turnover: This indicator shows how frequently inventory is sold and replenished within a certain period, reflecting the effectiveness of inventory management. A high turnover rate suggests efficient practices and reduced holding expenses.
• Days in Inventory: This metric indicates the average time inventory remains in stock before being sold. Fewer days point to a more efficient inventory turnover.
• Stock-Out Rate: This KPI monitors the frequency of stock shortages. It is essential for ensuring customer satisfaction and maximizing sales by identifying where restocking is most needed.
• Inventory Accuracy: This measures how closely inventory records match the actual physical stock, helping to identify and resolve discrepancies to maintain correct inventory levels.
• Carrying Cost of Inventory: This calculates the total expenses associated with holding inventory, such as storage, insurance, and capital costs. Managing this KPI is crucial for maintaining healthy financial performance.
• Fill Rate: This represents the proportion of customer orders that are fulfilled in full and on time from existing stock, directly influencing customer satisfaction and loyalty.

Inventory management types and techniques

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: Prioritises 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 requirements.
  • “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 ensure 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 such as 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.

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 prioritising inventory management:

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

2. Reduced costs: Minimising 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. Increased efficiency and productivity: Utilising automated tools for tracking and management significantly improves efficiency, reduces manual errors, and boosts overall productivity within the organisation.

5. Freer cash flow: Analysing 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 optimise 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 organisations 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 despatch. Premium inventory management systems can provide automation, cost calculations, and real-time scenario planning.

Some suppliers even offer customisation to suit specific business requirements. For example, a food service business could incorporate expiry-date tracking and alerts to ensure the rotation of perishable items and minimise 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 systems features and technologies

Modern inventory management systems combine automation, advanced analytics, and integration capabilities to streamline operations and enhance decision-making across the supply chain. Several core features and technologies stand out:

• Automation: Automation lies at the heart of inventory management. Systems employ barcodes, RFID tags, and even IoT sensors for automated data collection and real-time tracking of goods. Automated order processing, replenishment, and shipping confirmations reduce manual errors and accelerate fulfillment. In more advanced settings, Automated Guided Vehicles (AGVs) and mobile robots are deployed in warehouses to transport goods and increase efficiency.
• Real-Time Visibility: One of the most critical capabilities is real-time visibility into stock levels across locations. Cloud-based platforms make this data accessible from anywhere, while smart track-and-trace systems ensure accuracy throughout the supply chain. Features such as cycle counting further maintain reliable inventory records without disrupting daily operations.
• System Integration: Inventory systems rarely operate in isolation. They integrate closely with Warehouse Management Systems (WMS), Transportation Management Systems (TMS), and broader Enterprise Resource Planning (ERP) platforms. This integration unifies data across accounting, sales, and procurement, enabling a single view of operations and smoother coordination between logistics and financial functions.
• Advanced Picking and Storage Strategies: To reduce travel time and improve order fulfillment, systems support batch-picking and cluster-picking methods. Technological innovations such as pick-to-light systems, vertical storage solutions, and robotic picking tools further boost productivity and accuracy in high-volume environments.
• Predictive and Analytical Capabilities: Beyond operational efficiency, modern inventory systems leverage predictive analytics and demand forecasting to anticipate market shifts and optimise stock levels. By analysing historical data and identifying patterns, businesses can make more informed purchasing decisions and reduce the risk of stockouts or overstocking. Lot and serial number tracking add another layer of traceability, supporting compliance and quality assurance.

Examples of inventory management 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 shops must manage a wide range of products and deal with seasonal demand fluctuations. Many large retailers have implemented sophisticated e-commerce inventory management that utilises real-time data analytics to forecast demand accurately. Technologies such as 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 drink: 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, expiry dates, and recipe costing in real time to optimise inventory levels and reduce food spoilage.

• Healthcare: Hospitals, clinics, and chemists rely on inventory management to ensure the availability of critical medications and medical supplies. Automated inventory systems help healthcare facilities track usage rates, monitor expiry 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 bespoke 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 customisation?

• 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 pencilled 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 input. Warehouses are embracing robotics to streamline inventory management and order fulfilment 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 analysing 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 organisation 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 shops to create convenient customer experiences. Customers can even buy online and collect in-store (BOPIS) or receive faster deliveries from local warehouses.

• 3D printing on demand: Utilising 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 personalisation.

• 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 optimising the returns process is significantly impacting inventory management by reducing costs, improving customer satisfaction, and minimising environmental impact with fewer product returns.

• Integration of sustainability: 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 replenish.

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 a 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 optimisation?

Inventory management is about setting high productivity and efficiency targets for all inventory operations. Inventory optimisation is a subset of inventory management that refers more specifically to profit margins and minimising loss. It involves strategically managing and controlling inventory levels to maximise 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 optimisation of inventory to meet customer demand, minimise 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, colour, and other product variations.

A universal product code (UPC) is a standardised, 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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