Managing hundreds and thousands of inventory without an organised system in place or methodical analysis tools, especially in e-commerce businesses, can turn out to be a time-consuming process. Moreover, it leads to increase in inventory levels with a shortage of fast-selling, profitable items. Without optimizing inventory, organizations run the risk of overpaying but underperforming.
Inventory occupies space, gets damaged, and sometimes even becomes obsolete. That is why carrying a surplus or deficit of inventory can cost the organization. In fact, when obsolete inventory accumulates over a period of time, it translates to losses.
In order to prevent the aforementioned business misapprehensions, it is imperative for organizations to find the perfect balance between demand and supply. This balance is known as Inventory Optimization. The process maintains a level of inventory that eliminates out-of-stock and overstock situations, by having the right products, at the right place, at the right time, thereby reducing costs and improving efficiency.
The best way to optimize inventory is by following these 3 processes – Manage, Control, and Forecast:
Inventory Management: What is it, importance, methods
Inventory management is to track and manage inventory as it is procured, stored, and distributed through various channels. Efficiently managing inventory is the key to any successful e-commerce business. It makes sure that you have the right amount of inventory available at the right time and at the right costs.
To get started, it is important to set up a process for inventory management. Following are the steps that are generally involved in it:
- Delivery of Goods: These could include raw material or finished goods.
- Reviewing, Segregating, and Storing: After reviewing, the goods are stored in bins. For easier tracking, they are assigned SKUs or barcodes.
- Monitoring Inventory Levels: Performing regular cycle counts to avoid overstocking, understocking, overselling, etc.
- Placing Stock Orders: These orders can either be placed by customers or the company employees.
- Order Approval: Verifying the actual orders against the purchase orders.
- Moving Goods: Transfering the goods production area to the customers.
- Updating Inventory Level: Updating records after the goods are transferred.
- Purchasing New Inventory: Buying inventory that has crossed the threshold limit. This stage is easy to identify if the inventory is regularly updated.
Importance of Inventory Management
Big, small, or medium sized, inventory management is crucial business practice for all. The primary goal of inventory management is inventory tracking in a way that it is neither overtocked nor understocked. On a broader scale, proper inventory management is how you ensure consistent customer satisfaction and minimize any losses.
All in all, here are the key reasons that sum up the importance of inventory management:
- Tracking your inventory gives a centralized view of the stock
- Control costs and empower sales teams by analyzing performance. These analytics could be sales reports, margins reports, inventory forecasting, etc.
- Improve order fulfilment as per customer expectations
- Diffuse the situations that lead to lost stock, overstocking, and stockouts
- Cut down on time and manpower for day to day operations.
Methods of Inventory Management
Moving on, one of the best ways to effectively manage inventory is by Categorizing it. By breaking down inventory into categories, organizations can handle warehousing and shipping more effectively. The most practical way to do this is by using the ABC analysis method. In this method, you categorize your inventory into 3 categories:
- (A) High-value products, with a low frequency of sale (Slowest Moving Products)
- (B) Moderate value of products, with a moderate frequency of sale (Slow Moving Products)
- (C) Low-value products, with a high frequency of sale (Fast Moving Products)
The ABC Analysis relies on the Pareto Principle which implies that 80% of an organization’s revenue comes from 20% of its customers. These customers usually purchase category A products and account for the majority of revenue. Therefore, it is more costly for the organization to lose these customers than it is to lose customers who buy category B and C products.
Source: Latest Quality
The goal of categorising inventory is to help the Inventory Manager divide their attention appropriately. For example, products that fall under category A may need to be ordered more often than products that fall under category C because their amount kept on hand is much smaller.
Once all the inventory is fit into the ABC framework, it can be organized in the warehouse in such a way that the operations can be optimally fulfilled. The most popular way is to keep the fast-moving products in the staging area.
The first rule of thumb that every Inventory Manager must implement is the FIFO system. It is absolutely essential for inventory to be arranged in such a way that the oldest stock is shipped out first and not the newest, regardless of whether the goods are perishable or not. This is because, over time, unsold items go through a certain amount of wear and tear, and if unsold, older stock could turn into damaged goods, eventually leading to deadstock.
In today’s technologically driven e-commerce business, the most productive way to manage inventory is by investing in an Inventory Management Software. Such software not only helps build but also scale an e-commerce business. It helps the Inventory Manager to ensure that there is never an overstock or understock. It also helps synchronize inventory across all the sales channels, track shipments, and consolidate all the inventory-related activities into one convenient system that can be leveraged to boost sales and find opportunities for the business.
Inventory Control: What is it, importance, methods
Inventory control is different from inventory management, and it is important to know the difference between the two. Inventory control basically regulates the inventory that is already in the warehouse. It involves knowing what items are being stored and the availability of the amount of that product with the distributor. Additionally, it also involves knowing the whereabouts of the products in the warehouse ensuring that all inventory remains in a good condition, and laying out the warehouse in a way that minimizes the cost of order fulfillment.
Inventory management, on the other hand, dictates when to order products, and in what quantity along with the most effective supply source for every item warehouse. This ensures that the right quantity of the right product is available at the right location at the right time.
In order to achieve better inventory management, it is important to improve inventory control.
The first step to controlling inventory is to set minimum viable inventory levels. The goal is to have just enough stock to meet demand and avoid delays. To establish the number of minimum viable stocks, a thorough understanding of the demand and the amount of time it takes to replenish the stock with the wholesaler or manufacturer, is needed. This number is bound to change over time as the company grows and orders increase.
Importance of Inventory Control
Efficient Inventory control reduces the inventory investment costs and handling cost while keeping the customer satisfaction levels unharmed. To be more specific, here’s why inventory control is important and should be taken care of by the businesses.
- Ensures the smooth flow of raw material and assists in continuing production operations.
- Minimize administrative workload, human resource requirements, and labor cost.
- Prevents output fluctuations:
- Helps in making effective use of working capital by avoiding overstocking.
- Facilitates cost accounting activities
- Avoids duplication in the ordering of stock.
- Prevents a company from fluctuations in the demands of its products.
Technology may be progressing, but it always has the scope to result in errors. Auditing inventory, as old school as it sounds, is the key to controlling inventory and ensuring that your data is accurate and reliable. There are 3 ways to do this:
- Physical Inventory Audit: As the name suggests, this is the practice of physically checking all your inventory in the warehouse. It may sound tedious, but doing this once a year helps organizations to ascertain their inventory data, detect errors in the system, and rectify them. It is a great practice that helps build confidence in the inventory management system and the team.
- Spot Checks: While Physical Inventory Audit is time-consuming and tedious, the process can be broken down by using the Spot Check Method. It means to take a particular product and count the stock and cross-verify it with the numbers on the file. This way, the accuracy of the system can be kept in check throughout the year without disrupting business.
- Cycle Counting: Another efficient alternative to Physical Inventory Audit is Cycle Counting where the process of inventory audit is spread out throughout the year and is performed on a daily, monthly, or weekly basis. A different product is checked on a rotating schedule to ensure that the management system’s data is accurate. Higher value products need to be checked more often than others as their loss can pose a larger risk to the business.
Source: Bastain Solutions
It is very common for organizations to have their own high and low seasons for business but it is important to put in the effort to make the most of the high season by being prepared for it. Leverage past sales data to identify the high season and brace for it.
It is advisable to keep inventory low during the low season but not wait too long to ramp up supplies before high season. If the organization has the potential to make a lot of sales during the holidays, or summer, it could be effective to promote the products and try to sell as much of it as possible so that there is not much deadstock.
Keeping operation costs as low as possible during the year is the goal and that is why organizations must use the low seasons to get the resources like partners, warehouses, tools, etc. that they need, in order.
Inventory Control Methods
Economic Order Quantity (EOQ)
The EOQ model is set on the foundation that the finished products are sold at a consistent rate over a period of time. One of the most crucial steps in inventory control is to maintain a balance between the cost of holding the inventories with the cost of placing inventory replenishment orders. When ordering and the holding costs are balanced, the overall inventory costs are minimized and the resulting order quantity is what we call the economic order quantity.
Total inventory cost = Ordering cost + Carrying cost
Total ordering cost = Number of orders x Cost per order
= U/Q x F
u = Annual usage
Q = Quantity ordered
f = fixed cost per order
Total carrying cost = (Average level of inventory) x (carrying cost) x (price per unit)
Total carrying cost = Q/2 x C x P
Q = Quantity ordered
C = Carrying cost
P = Purchasing Price per unit
Having your stock meticulously organized can make a lot of difference. It seems like a simple concept but it does require a lot of strategic planning. The organizational process includes labeling your stock with SKUs that are easy to read and comprehend. For starters, keep track of the initial stocktake and then use the right inventory management techniques to keep track of movements and levels.
Quality control is yet another essential part of inventory control that remains perpetual. Select the suppliers whose quality standards match that of yours and order a lot of samples before developing a long term relationship. Once you fix your suppliers, you can implement batch tracking to ensure that the stock consistently meets your highest quality standards.
Inventory Forecasting: What is it, importance, methods
Inventory Management is fully reliant on-demand predictions. The organization cannot know how much inventory to have in place until it knows how much sales to expect in the future. It is nearly impossible to make a 100% accurate forecast but it is necessary to have a close figure and this is where it can get complicated.
A good place to start the forecasting process is by looking at past sales, identifying where sales were high, and preparing inventory for the same. It is as important to look into the future as it is to look at the past. Keeping an eye out for opportunities and converting them into sales is imperative.
Inventory forecasting in general involves the following practices:
Source: Oracle Netsuite
Importance of Inventory Forecasting
- Cut down on inventory holding costs: One of the major benefits of inventory forecasting is that it helps with inventory storage management. With inventory forecasting, you buy what you need and stock the required amount instead of getting stuck with too much of that product. It reduces the unwanted storage space and cuts the cost associated with it.
- Minimize Stockouts: Stockouts imply a loss in sales revenues. Inventory forecasting helps avoid these situations by predicting the upcoming demand. Now, this prediction may not be entirely accurate but the information gives you an understanding of how many units to order and when to restock.
- Minimize product waste: Inventory forecasting helps in identifying the products that are not selling and those selling slower. Based on this information, you can repurpose your distribution strategy. You can choose to bundle these items with the fast-selling products and prevent them from getting wasted. This makes more room in the warehouse and in turn, increases revenue.
Inventory Forecasting formula:
Inventory forecasting depends on the factors like sales history, trends, demand, reorder point, average lead time, and safety stock in order to make a calculative guess on the inventory levels.
Here’s a step by step process for using the inventory forecasting formula:
Measuring lead time demand
Lead time is the number of days it takes for your vendor to fulfill your order. In order to avoid a stockout situation, you need to predict the product demand during that time. This is called lead time demand.
Source: Corporate Finance Institute
Calculating these metrics prevents the risk of going out of stock on products while waiting for the new ones.
(Lead time demand = average lead time in days x average daily sales)
Lead time demand is the product of the average lead time in days and average daily sales. The average lead time can be calculated from the amount of time the vendor takes to deliver the products in general. To calculate the average daily units sold, you can look at the previous sales data and calculate the average amount of products that are sold on a daily basis.
Analyzing sales trends
Sales trends inform you about market conditions and your customers’ buying patterns so that you never encounter stock outs with popular or fast-selling products. Companies can fix which products to analyze over a particular period of time. Sales trends can be classified into two main categories- macro and micro. A macro trend focuses on a range of products over a larger time frame, while micro trends analyze specific products over a short period of time.
Fixing the reorder point
A reorder point (ROP) defines the specific level at which you need to replenish your stock. Simply put, it determines when to place an order before you run out of a product. During forecasting, a static ROP will be of no help. The value of ROP should be variable based on forecasted sales trends and it should be constantly adjusted during every sale season.
The formula for calculating the ROP is:
ROP = (average daily sales x lead time) + safety stock
Calculating safety stock
Safety stock is the extra quantity of a product to be kept in storage to prevent a stockout situation. However, safety stock in excess can lead to higher holding costs while an insufficient safety stock amount can result in lost sales. Having said that, safety stock serves as insurance against demand fluctuations and it has its own benefits.
- It helps in saving on the shipping costs because it eliminates the need of expediting delivery by vendors.
- Additionally, you can increase sales revenue by always having stock on hand for customers. Plus the safety stock covers you until the next batch of ordered stock arrives in the storage.
You can calculate the optimal amount of safety stock for your business using the following formula:
Safety stock = (maximum daily sales x maximum lead time in days) – (average daily sales x average lead time in days)
Maximum daily sales = Maximum number of units sold in a single day
Maximum lead time = The longest time taken by the vendor to deliver the stock
Average daily sales = Average number of units sold in a day
Average lead time = Average time taken by the vendor to deliver the stock
Inventory forecasting methods
All forecasting models draw information from the wavering trends in consumer demands. The more accurate your model is, the more profit margins you will be able to push. Let’s take a look at some of the most common inventory forecasting methods for purchasing and planning:
In the trend forecasting method, we analyze past sales or market growth data to determine the upcoming possible sales trends. The trend going upward or downward is analyzed for the particular item and the result obtained help in forecasting the demand. The trend data helps in making a calculative guess for future sales and based on this data, you can modify the inventory management strategy accordingly.
This method is adopted when historical data is not available or relevant. Qualitative forecasting involves predicting demand on the basis of current and potential economic demand in the market. Inventory planners run qualitative forecasting models frequently over a certain period of time using market research, sales feedback, panel consensus, and personal instinct. This method works well for newly established businesses that are looking to introduce a completely new product from their lineup.
This model uses past sales data to predict the demand in the future and hence, is more accurate. However, it works best for well-established businesses as it relies on previous sales information. The quantitative forecast model can be created using the data available from the previous quarter or year. The accuracy of the forecast depends on the amount of data that exists.
This method involves converting the previous sales data into a graphical form to help you analyze sales trends visually, and hence, more effectively. The troughs and crests on the graph help identify inventory exploration, patterns, and trends in the past that help in east forecasting.
Forecasting inventory plays a major role in dictating the future of your business, especially around the peak sale seasons. Hence, it is advised to use a proper system for getting up to speed with the process. With EasyEcom, you can overcome the roadblocks involved with calculating the sales and planning inventory with ease. For accurate forecasting, the system can be configured to calculate the previous month or season’s sale and based on the data retrieved, the next batch of inventory can be estimated.
In order to plan the inventory for the upcoming month based on the last month’s sale, you need to provide the number of days you want to plan the inventory for along with the range of days you want the inventory planning to be done based on.
To be specific with a particular product or vendor, you can further apply a filter based on the brand name, SKU, or vendor name. The system will then provide you with the recommended quantities for the inventory, based on the previous month’s average daily sale. The suggested quantity also calculates the time taken by the vendor to deliver the products. Similarly, the system also provides you with the recommended quantities to plan on the upcoming festive season , based on the sales made during the same time last year.
For any organization, business is affected by multiple factors, both external and internal. Market trends play just as much of a role in predicting the sales of a given product as much as the marketing efforts of the organization do. In fact, even day-to-day activities fluctuate the sales of an e-commerce business. Product advertising, promotions, and discounts or even listing a product on the homepage can boost sales.
In all of this, the most important thing is coordination between the inventory management team and the marketing/advertising team. It’s logical, advertising products push their sales but they also have to bear in mind the stock levels and turnover ratio. This is where inventory can be truly optimized.
There are several tools available in the market to help companies forecast their demand to generate a near-accurate result. Yet, most companies prefer to use a mix of automated tools, instincts, and traditional techniques to forecast demand.