Cost Accounting

Inventory Management: Techniques And Types Explained

Last updated Tuesday, January 24, 2023

Inventory management sounds like a straightforward subject, yet it is one of the most complex tasks a business can face. In this article, we summarized everything to know about the matter, including all inventory management techniques, examples, and simple explanations to all—read on to find out everything.

What Is Inventory Management?

Inventory management aids businesses in determining which merchandise to order, when, and in what quantities.

Inventory is tracked from product acquisition to sale, so there are many points during its life where handling it appropriately is essential for success.

A proper inventory management technique guarantees the inventory needed to fulfill client requests by recognizing and reacting to patterns.

Key Basics About Inventory

  • Inventory turns into revenue only after it is sold
  • Inventory ties up cash before it is sold while being shown as an asset on the balance sheet
  • As a result, having too much inventory is expensive and lowers cash flow
  • Inventory turnover is one metric for effective inventory management. It is used in accounting to determine how frequently stock is sold over time
  • A company doesn't want to have more inventory than sales
  • Deadstock, or unsold stock, can result from a lack of inventory turnover

Read more about Inventory Valuation.

The Importance Of Inventory Management

Because it helps to ensure that there is rarely too much or too little product on hand, inventory management is essential to a company's health because it lowers the danger of stock outs and erroneous records.

Public corporations must keep track of their inventory. To demonstrate compliance, businesses must document their management procedures, too.

Inventory Management's Advantages

The ability to fulfill incoming or open orders and increased earnings are the two key advantages of inventory management. Additionally, inventory management saves money.

Understanding inventory trends can help you better utilize the stock you already have by allowing you to know how much and where you have it in stock.

This lowers expenses associated with inventory and reduces the quantity of unsold stock before it becomes obsolete. It also enables you to retain less stock at each location (store, warehouse) since you may pull from anywhere to fulfill requests.

  • Enhances Cash Flow: With effective inventory management, money is always flowing through the company since it is spent on inventory that customers buy.
  • Ups Customer Satisfaction: Ensuring clients receive the products they desire promptly is one way to earn loyal customers.

Challenges In Inventory Management

Having too much inventory, not having enough inventory, and not knowing what things you have in inventory and where they are placed are the main issues of inventory management. Other challenges include:

  • Obtaining accurate stock information: Without accurate goods information, you can't determine when to restock or which stock sells well.
  • Spotting processes that are inefficient: Outdated or manual procedures can slow down operations and make work more prone to mistake.
  • Customer demand is continuously changing, as are their preferences and requirements. How will you be able to determine when and why their preferences change if your system is unable to observe trends?
  • Utilizing warehouse area well, if similar items are difficult to get, staff will squander time. Getting inventory management right can help solve this problem.

Inventory, Simply Explained

A company's inventory comprises the components, completed commodities, and raw materials it sells or utilizes in manufacturing.

Note: Inventory is viewed as an asset in accounting.

Accounting professionals utilize stock-level information to accurately report values on the balance sheet.

Stock vs. Inventory

Stock is another name for inventory in retail businesses: The phrase "stock on hand" is widely used by managers to describe goods like clothing and housewares.

Across industries, "inventory" more broadly refers to items that are kept for sale, as well as raw materials and production-related parts.

Some claim that the term "stock" is more frequently used to describe inventory in the U.K. The phrases inventory and stock are sometimes used interchangeably, even though there is a distinction between the two.

What Kinds Of Inventory Are There?

The following 12 categories of inventory are available: raw materials, work-in-progress (WIP), completed items, decoupling inventory, safety stock, packaging materials, cycle inventory, service inventory, transit, theoretical, excess and maintenance, repair, and operations (MRO).

MRO is sometimes not thought of as an inventory type.

Processes For Inventory Management

When you manufacture on demand, the inventory management procedure begins as soon as a business gets a client order and lasts until the order is sent.

If not, the process starts when you predict your demand and then make orders for the necessary components or raw materials.

Analyzing sales patterns and planning the organization of product storage in warehouses are other steps in the process.

The Operation Of Inventory Management

Inventory management aims to comprehend stock levels and goods placement in warehouses. The movement of goods from the supplier through the manufacturing process and to the consumer is tracked by inventory management software.

Stock receiving, picking, packaging, and shipment are all tracked by inventory management at the warehouse.

Terminologies And Techniques For Inventory Management

Formulas and analysis are used in several inventory management strategies to plan stock. Others depend on protocols.

Every technique aims to increase precision. A company's methods are determined by its requirements and inventory, so there is no one-fits-all solution.

By reading the guide on inventory management strategies, you may choose which method is most effective for your company.

Here is a list of them:

  • ABC Analysis: Finding the most and least popular stock kinds is the essence of this technique.
  • Dropshipping: With this method, the consumer receives their order straight from the supplier's warehouse.
  • Batch tracking: This technique collects comparable goods to keep track of expiration dates and locate faulty products.
  • Bulk Shipments: This approach considers items that suppliers load straight onto trucks or ships, unpackaged. Inventory is purchased, stored, and shipped in great quantities to save resources.
  • Cross-Docking: This technique involves unloading goods from a supply vehicle onto the delivery truck directly, hence there is little to no storage involved.
  • FIFO and LIFO: FIFO (first in, first out) refers to moving the oldest stock first. According to the last in, first out (LIFO) method, since prices are continually rising, the inventory that was most recently acquired is the most costly and thus must sell first. Most businesses opt for FIFO as it is the more generally compliant method.
  • Economic Order Quantity (EOQ): This formula outlines the precise quantity of inventory a business should order to save on storage and other expenditures.
  • Just-In-Time Inventory (JIT): Companies use this technique to keep stock levels as low as possible before a refill.
  • Lean Manufacturing: This approach focuses on getting rid of waste or anything else in the production process that doesn't provide value for the consumer.
  • Reorder Point Method: Businesses use this formula to determine the minimum stock level they should have on hand before placing another order.
  • Materials Requirements Planning (MRP): This system manages manufacturing planning, scheduling, and inventory management all in one to enhance overall efficiency.
  • Consignment: If your company uses consignment inventory management, you won't pay a supplier until a product has been sold. Keep in mind, though, that up until your business sells the inventory, that supplier still owns it.
  • Minimum Order Quantity (MOQ): To keep prices down, a business that relies on minimum order quantity will only purchase the bare minimum of inventory from wholesalers with each order.
  • Perpetual Inventory Management: This technique involves continuously tracking stock sales and consumption.
  • Safety Stock: This is an inventory management method that will prevent excess stock on hand even if the business is unable to refill its storage.
  • Six Sigma: This method is a data-driven technique for reducing inventory-related waste in enterprises.
  • Lean Six Sigma: This approach, which aims to cut waste and boost efficiency, blends lean management with Six Sigma techniques.

Learn the The Essential Accounting Terms Everyone Should Know.

The Conclusion

Inventory management has the potential to make or break a business. Therefore, choosing the method that best fits your organization is critical.

Also, you need to constantly reevaluate your options, as a changing environment can often demand another inventory management technique.

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