A lot of small businesses struggle with inventory management. Ineffective inventory management techniques result in higher costs and negatively impact the liquidity of your business.
It’s also easy to get confused by the number of different inventory management techniques that are out there. It’s important that you understand how these techniques work so you can decide which is most suitable for your business.
Following, we’ll be discussing some of the most popular inventory management techniques and how they contribute to effective inventory planning.
What Is Inventory Management?
Inventory management is a process that helps you manage your stock levels. This includes both finished goods and raw materials. In short, inventory management involves the ordering, storing, and selling of stock. In addition, you need to accurately keep track of stock levels and product demand. Being able to manage your inventory can also lead to reduced storage costs, handling expenses and less waste.
Effective inventory management involves having the right product, at the right time, in the most cost-effective manner.
Getting this right can also help you win over your customers.
Inventory Management Techniques
Depending on the requirements of your business, you can choose between one of the following inventory management techniques:
1. Always Better Control Analysis (ABC)
The Always Better Control Analysis (ABC analysis) is an inventory management method that classifies inventory items according to their monetary value.
This type of inventory management is suitable for small businesses offering multiple products. To use this method, sort your inventory into three categories. You can then invest your resources into items that generate the most amount of money.
Category A Items:
This consists of your high-priced items. Typically, such items generate the largest amount of revenue for your business. However, they are also costly (production costs, security costs, etc.). As a result, you are likely to have a limited number of these in inventory. You will manage items from this category as follows:
Value – High
Volume of Stock – Low
Review of Stock – Regular re-ordering
Category B Items:
This category includes items that are moderately priced. The revenues and costs associated with such items are also moderate in nature, and they are subjected to less stringent controls. You will manage items from this category as follows:
Value – Moderate
Volume of Stock – Medium
Review of Stock – Re-ordering on a monthly or quarterly basis
Category C Items:
Category C consists of items that are low in value but are stocked in large amounts. They may not generate a large amount of revenue but are sold frequently.
Due to their low cost, they don’t have a high maintenance cost. As such, you can purchase them in bulk without having a significant impact on your inventory investment. You will manage items from this category as follows:
Value – Low
Volume of Stock – High
Review of Stock – Re-ordering on an annual or semi-annual basis
The Just-In-Time inventory control method is based on ordering inventory only when it is needed. This type of inventory management lets you cut storage costs, reduce waste, and increase efficiency. In JIT, you only purchase goods from a vendor when you receive an order from a customer. As ideal as it may sound, implementation can be very difficult, and you will need to consider the following factors:
- Can your products be supplied or manufactured on short notice?
- Are your suppliers reliable? If so, can they deliver the raw materials/finished goods to you on a timely basis?
- Do you understand the buying patterns of your customers, seasonal variations in sales, and product demand?
- Are your operations streamlined to ensure each order is processed and delivered on time?
Ideally, a JIT inventory management system is suitable for businesses that produce customized products, or offer services such as auto-repair, event planning, and food. It can also be adopted by e-commerce businesses.
3. First-In-First-Out (FIFO) and Last-In-First-Out (LIFO)
These inventory management methods sort inventory according to their date of production. FIFO is most suitable for businesses that deal with perishable items. With this method, you sell your oldest stock first, which prevents the accumulation of old inventory.
In order to enforce a FIFO system, you must take a close look at how your inventory is placed on shelves. Make sure that your latest inventory is stored at the back. Rotating old inventory to the front of the shelf is critical to making sure that FIFO works effectively.
Using FIFO can reduce the chances of your inventory becoming obsolete with time. As a result, this helps you reduce waste.
LIFO is the opposite of FIFO. With LIFO inventory management, the newest stock is sold first. For this reason, this inventory management technique is most suitable for businesses offering non-perishable items.
The use of LIFO has several tax advantages. It shows a lower profit on your income statement (new inventory tends to be more expensive than old inventory). Lower profits mean lower taxes.
It is also easier to manage inventory using LIFO. Since these are non-perishable items, you do not have to worry about sorting products according to their expiry.
4. VED Analysis
VED analysis is used to manage an inventory based on spare parts required for production. It splits these items into three categories according to their importance. These categories are:
V – Vital
The first category consists of spare parts that are vital for production. If you were to run out of these items, production would be disrupted. As a result, keeping these items in stock is “vital” to your production efficiency. These items may also present safety issues if they are not available.
E – Essential
The second category consists of spare parts that are essential for production. The unavailability of these parts may not disrupt production completely. However, there may be a temporary delay. Unlike the first category, these spare parts do not impact the safety of a production process.
D – Desirable
These are items that are non-functional in nature. Their absence does not have an impact on the production process or upon the performance of the final product.
It should also be noted that if you’re adopting this inventory management technique, you may need to combine it with the ABC analysis technique. This is because you need to consider the functional importance of these spare parts while also considering the annual consumption cost of these items.
5. Minimum Stock Levels and Safety Stock
Maintaining a minimum stock level is among the most basic forms of inventory management. It involves the identification of a minimum stock level. Once your existing inventory reaches this level, you can order new stock. This method is particularly suitable for small businesses.
In order to use this inventory management technique, you need to gather data. This data includes your sales cycles, customer buying patterns, and seasonal sales fluctuations. This will help you determine the amount of inventory you need to order for a given period.
Also, be sure to include your lead times. Calculate the average number of days it takes for the ordered items to get delivered in order to factor it into your ordering cycle.
Safety stock involves ordering additional stock, above and beyond the normal levels. This inventory is used when you are uncertain about your supplier delivering on time or during a period of unpredictable consumer demand.
However, storing this excess inventory can be costly. There is also the risk of the inventory become obsolete and not getting sold.
6. Economic Order Quantity (EOQ)
This inventory management technique helps you determine how much inventory you need to order. It does so by taking into account the demand of the product and its cost. You will need to gather data regarding:
- The number of units sold over a particular period
- The cost of ordering. This includes transportation costs, labor costs, etc.
- The cost of storage
Your goal when using this technique is to identify the optimal stock levels that need to be maintained. This can help reduce costs related to purchases, delivery, and storage of the inventory. You can also use this type of technique in tandem with techniques for minimum stock level management and ordering safety stock.
When managing your inventory investment, there are several inventory management techniques that you can use.
The inventory management technique that you choose will depend on the nature of your business, the scale of production, and your product portfolio.
It will also depend upon your relationship with your suppliers, your cost-cutting objectives, and the logistics required to manage the flow of product. As always, identifying the best technique to suit your needs during your inventory planning process will pay dividends over the long term.