Inventory management – terms, formulas, and more



What is Inventory Management?

Inventory management is basically the process of ordering, handling, storing, and using a company’s non-capitalized assets – its inventory. Some businesses deal with raw materials and components, while others may only deal with finished products that are ready for sale.

The key takeaways are that inventory management comes down to the right balance – having the right quantity of stock, in the right place, at the right time.

In this blog post, we will be mostly speaking about retail inventory management. Retail is a term used to describe businesses that sell physical products to consumers. While not exclusive to retail, inventory management tends to play a more important role in this industry than any other.

There are multiple types of retail:

Offline retail – where a company sells products using a brick and mortar store or a physical location

Online retail – where a company sells products over the internet using an eCommerce website or a marketplace

Multichannel retail – a company sells products in different places, it’s usually a combination of eCommerce websites and marketplaces.

Omnichannel retail – a company that sells products using both offline and online channels.

Some businesses might even choose to trade via wholesale channels – this means that they sell their inventory, usually in bulk, to other businesses.

Why is inventory management important?

Inventory management is vitally important to a business’s longevity and customer satisfaction – without it the business would be put into a chaotic situation and lose customers.

Having good inventory management can help with:

Improving cash flow – If you put cash into too much inventory at once, it means that it won’t be available for other things – such as payroll and marketing.

Customer experience – Your customers will be disappointed and angry if you don’t have enough stock to fulfill orders you’ve already taken payment for.

Avoiding shrinkage – purchasing too much of the wrong inventory and not storing it correctly can lead to it becoming slow-moving or dead inventory – that can end up being spoiled or stolen.

Optimising fulfillment – inventory that is put away and stored correctly can be picked, packed, and shipped off to customers more quickly and easily.

Key terms when it comes to inventory management

Inventory management can be a very complex and complicated subject. There are a lot of systems, processes that you need to use to get the desired results. When searching for the best inventory management solution online, you might come across some unfamiliar terms. Here’s a glossary of key terms you’re likely to come across:

Average inventory – the average inventory that you have over a given time period. This can be calculated by adding the Ending inventory to the Beginning Inventory and dividing it by two.

Average inventory cost – it’s an inventory valuation method that is based on the average cost of items throughout an accounting period.

Back Order – an order for a product that is currently out of stock and cannot be fulfilled for the customer

Beginning inventory – The value of any unsold, on-hand inventory at the beginning of the accounting period.

Carrying Costs – The total costs associated with holding and storing inventory for a period of time – usually until it is sold for a customer.

Cost of goods sold – it is the total cost of purchasing or producing any goods sold, including everything that went into it – materials, labour, tools used, etc. This does not include direct costs such as distribution, advertising sales force costs, etc.

Dead stock – inventory that remains unsold for a very long period of time, until it becomes outdated and virtually unsellable.

Ending Inventory – the value of unsold, on-hand inventory at the end of an accounting period.

Inventory count – this is also known as stock take, this is the systematic process of counting all of the items you have in your warehouse in order to verify accuracy.

Inventory shrinkage– this is a term that is used in accounting, that is used to indicate inventory items that have been stolen, damaged beyond sealable repair or otherwise lost between the point of purchase and point of sale.

Last-in-first-out – an inventory valuation method that it assumes the most recent products added to your inventory are the ones sold first.

Lead time – the time it takes for a supplier to deliver new stock to the desired location once a purchase order has been issued.

Stock Keeping Unit (SKU) – is an alphanumeric code applied to each variant in a company’s inventory, helping to easily identify and organize a product catalogue.

Formulas you need for proper inventory management

When it comes to inventory management, it’s not enough to know the common terminology, there are some specific formulas that you need to know as well. Here are a couple of formulas that you should know when it comes to Inventory Management

Inventory turnover

Inventory turnover measures the number of times you have sold and replaced inventory over a given period:

Inventory turnover = Cost of goods sold/Average inventory

This basically gives you a rough idea about how efficiently you manage your inventory, the higher the inventory turnover rate, the more efficient a business is at getting through its inventory.

Sell through rate

Sell through rate takes the amount of inventory a retailer receives and compares it against what is actually sold over a given period. It is usually expressed as a percentage:

Sell through rate = (Number of sales/ Stock on hand)x100

This helps analyse if your investment in a particular product is working out well. A low sell-through rate indicates that you either overbought or priced too high, while high sell-through rates indicate you may have under-bought or priced too low.

Safety stock

This is basically a backup stock that is needed to meet unexpected supply problems or sudden changes in demand.

Safety stock = (Max daily sales volume x Max lead time) – (Average daily sales volume x Average lead time)

It’s essential for you to find balance when it comes to safety stock – you want to have enough to meet demand but you don’t want to have too much stock to put a strain on cash-flow.

Reorder Point

The reorder point helps you determine when to order new inventory. It is a specific point in time that acts as a trigger to re-order as soon as stock has diminished to that certain level.

Reorder point = (Lead time in days x Average daily sales volume) + Safety stock

It’s essential to consider the lead time for new stock to be delivered when setting reorder points. Enough stock should be leftover to keep up with demand before the newly purchased inventory becomes available for sale.

Why is it important to have inventory management software

Inventory management software can help you by doing all the heavy lifting – it tracks inventory additions and subtractions automatically, without relying on manual, paper or spreadsheet processes. An inventory management system can track inventory across all of your selling platforms, whether you’re selling on marketplaces such as eBay or Amazon, or if you sell on your own Shopify or Magento websites.

Nventree is a cloud-based inventory management system that can help you avoid overselling products on various platforms, improving cash-flow and maximizing profits. It can even help with processing your orders from various websites. To find out more, click here.