Inventory Management Best Practices

Inventory management best practices

You can follow many industry-specific inventory management best practices, but there are also a few general practices that every business owner can benefit from to run and manage an effective business and warehouse year after year.

Conduct Regular Inventory Checks

Having accurate inventory data is crucial to business success as it directly impacts your company’s efficiency and profitability. When inventory counts are wrong, you may over-order inventory or find out you don’t have enough stock to meet your customer’s demand. 

Traditionally, many companies have relied on physical inventory counts, which can disrupt everyday business operations. Nowadays, many are moving to a more flexible approach called cycle counting. Unlike physical inventory counts, where the entire business is closed to calculate all the inventory at once, the inventory cycle count breaks the process down into manageable chunks.

For example, one period will be spent counting one product category in your warehouse while the rest of your warehouse functions as usual. In the next period, another category will be calculated. You will continually cycle through different inventory categories until you get back to the beginning and start over.

Here are some benefits of choosing the inventory cycle counting method over physical inventory counts:

✅ More cost-efficient. Implementing cycle counting as an ongoing practice allows minimal disruption of your daily operations instead of shutting down the entire business to calculate all items at once, which can be pretty expensive to sustain.

✅ More realistic assessment of stock levels. Relying on annual stocktakes can leave a business blind between those key dates. By performing regular cycle counts, you ensure stock levels match digital data and give more accurate information on the actual value of that physical inventory currently in stock.

✅ Saving resources and time. Using the annual inventory count method might be time-consuming and prone to errors. Finding the same mistake in the counting results can be a challenging and monotonous process if there is an error. The cycle counting method helps you avoid waste of time and resources.

✅ Fewer chances to overstock. External influences like new trends or shortages in the market can significantly affect stock levels. Performing inventory cycle counting can reduce the over-ordering of items and increase business knowledge of what is most in demand.

Maintain Safety Stock

Running low on stock is inevitable, but it doesn’t have to disrupt your business – that’s where the safety stock comes in handy. Safety stock acts as an emergency fund – it’s an inventory you “set aside” for use in case of sudden changes in customer demand or unexpected supply problems.
Since you can’t just blindly estimate how much safety stock you need, safety stock formulas can help you determine how many inventory items you will need to purchase to keep customer orders flowing without incurring extra holding costs.
Decide to rewrite this small bit, but we will cover the most commonly used one:

Safety Stock = (Maximum Daily Sales Volume x Maximum Lead Time in Days) – (Average Sales Volume x Average Lead Time in Days)

Let’s say that you run a store that sells clothing. On the best sales day for your most popular t-shirt, you sold 15 pairs (which is your maximum daily sales volume). It would take ten days to receive a t-shirt from your supplier (maximum lead time). The average demand is 5 (average sales volume), while the average lead time is five days. This is what your safety stock equation should look like:
(15×10) – (5×5) = 125
The amount of safety stock you should hold for this item is 125 units.

Know when it’s time to reorder

The reorder point tells you when is the right time to reorder inventory from your supplier, so you don’t encounter shortages or overstock.

Reorder Point = (Average Daily Sales Volume x Lead Time in Days) + Safety Stock Formula

Average Daily Sales Volume is your average sales over time. Let’s continue with a t-shirt example from the previous paragraph. Let’s say that you sell 35 t-shirts over seven days. Your average daily sales figure will be 35 t-shirts divided by seven days, equal to the average sale of 5 t-shirts per day.

Lead time is the period between placing your inventory order with your supplier and receiving it. It takes ten days for the t-shirts to be delivered from the supplier.

We calculated the safety Stock Formula in the paragraph above, so let’s take the value that we received, 125 units. 

Reorder Point = (5×10) + 125 = 175

So it means that the order for the next batch of t-shirts should be placed when 175 t-shirts are left in your inventory.

Keeping track of reorder points or using low stock alerts in your inventory management system allows you to keep ordering and shipping costs down. You’re ordering with enough time to avoid extra expenses for rush deliveries, and you’re meeting your customer’s demand with the inventory you have on hand, meaning your cash flow stays steady.

Understand your inventory turnover rates

To better understand the market demand for your products and the amount of dead stock you may be carrying, you need to know how to calculate your inventory turnover.

It is a ratio showing how many times you have sold and replaced inventory over a given period.

Inventory Turnover = Cost of Goods Sold (COGS) / [ (Beginning Inventory + Ending Inventory) / 2 ]

The formula takes the Cost of Goods Sold (COGS) over a specific period and divides it by the average inventory value over the same period.
The average inventory value is calculated by taking your beginning inventory which is how much you have in stock on the first day of the month, and adding it to your ending inventory, which is how much stock is left on the last day of the month, and dividing the result by 2.

For example, if your COGS was $200,000 in the past 12 months and your average inventory value was $50,000, your inventory turnover ratio would be 4.

An ideal inventory turnover ratio may vary between industries, but for most retailers, the 4-6 ratio means they have a well-balanced inventory – they receive new stock before they need it and can move it relatively quickly.

A rate of 3 or less means you have excess inventory. For example, if you sell ten units over a year and always have ten units on-hand (a rate of 1), you invested too much in inventory since it is way more than needed to meet demand.

Aim for lower DIO

Days inventory outstanding is the average number of days you hold inventory before selling it. This formula shows how quickly you can turn inventory into cash. 

DIO = (Average Inventory / Cost of Goods Sold (COGS)) x number of days in period

Here:

  • Average Inventory = (Beginning inventory + Ending inventory) / 2
  • Number of days in the period – the period may be any time frame, i.e., 365 days for a year or 90 days for a quarter

The average days of inventory outstanding depend on the industry and the nature of the product. However, you should be aiming for a lower number than your industry standard. Low DIO means your inventory is being sold out more frequently, leading to a higher profit. Cutting down your DIO also helps free up cash that can be invested in other business areas.

If your DIO is higher than preferred, you might decide to introduce discounts, product bundles, or other incentives to encourage customers to purchase more frequently.

Keep your pipeline flowing

Pipeline inventory refers to paid stock that has not reached the warehouse from your supplier. To stay on top of your pipeline inventory, you need to know how to calculate it first.

Pipeline Inventory = Lead Time x Demand Rate

To get pipeline inventory, you have to take the lead time, which is the time frame between payment and the receiving of the products, and multiply it by the demand rate, which is how many units are sold per week, per month, or quarter.

Let’s say we sell pet toys. Getting them from a manufacturer takes two weeks, and we sell 100 toys per week. When calculating the pipeline inventory, we get the following:

2 weeks x 100 units per week = 200 units

We would need to order 200 pet toys per order to maintain consistent inventory levels.

An alternative to calculating the pipeline inventory would be calculating the Economic Order Quantity (EOQ). EOQ helps calculate how much stock to order to minimize inventory holding costs and meet customer demand.

EOQ = √ [ 2DS/H]

D – Yearly demand in units.

S – Order costs. These are the expenses incurred to create and process an order to your supplier.

H – Holding cost is the amount you lose yearly for holding inventory.

For example, you sell 1000 bottles of shampoo each year. It costs you $5 per year to hold a single bottle in inventory, and the cost to place an order is $2.

The EOQ formula is the square root of (2 x 1,000 bottles x $2 order cost) / ($5 holding cost), which equals 28.3. The ideal order size to minimize costs and meet customer demand is slightly more than 28 shampoo bottles.

Improve your sell-through rate

The Sell-through rate is an essential retail sales metric that allows you to monitor the efficiency of your supply chain. It is a percentage that shows how well your finished goods inventory translates into sales for your business.

Sell-through rate (%) = (Number of units sold / Number of units received) x 100

The formula takes the number of goods sold over the given period, divides it by the number of units received within the same period, and the result must be multiplied by 100.

The Sell-through rate varies depending on the industry. However, the general rule is that anything above 80% is excellent, while below 40% is concerning.

Any product you store in your warehouse costs you money, which can be used to purchase more popular products. If your sell-through rate is low, you will have to dig deeper to find the problem – calculate the sell-through rate for each product to see which ones are selling well and which ones are selling poorly.

One of the ways to recover a low sell-through rate is to combine low-selling products with high-selling ones into bundles and apply a discount. Selling a package deal will help you move stagnant inventory and generate more sales.

Sell bundled products

Product bundling, or in other words, inventory kitting, is a technique in which several products are grouped and sold as a single unit, usually for a lower price than if they were sold individually.

Bundling can benefit businesses by:

  • Increasing average order values 
  • Preventing deadstock by selling old or unwanted products
  • Simplifying customer experience

When considering which products to bundle, the best approach is to add items that complement one another and can be used together. For example, if you’re selling a mobile phone, it would be wise to include a case and screen protector.

You can also create bundles by a particular theme. For example, if you sell products for pets, you could have a “New dog bundle” with food bowls, toys, a collar, and a leash.

Inventory management systems like Multiorders help you to manage bundled items’ inventory and avoid overselling easily. Whenever a bundled item is sold, inventory levels for each product in the bundle adjust automatically. 

Also, as soon as a bundle component becomes out of stock, the whole bundle goes out of stock. 

Invest in inventory management software

Inventory is the backbone of any eCommerce retail business. Therefore, properly managing it becomes crucial.

Using Excel sheets for inventory management may work for small businesses with limited products. However, to obtain an accurate inventory count, being able to track inventory in real-time, ship, and receive orders makes it crucial to use inventory management software.

Inventory management software’s purpose is not just efficient inventory handling but also automation of the entire eCommerce operations process. 

You can easily manage the back-end operations of selling your products across multiple channels by using one single platform.

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