The basics of Inventory Management

Inventory management is a key component of supply chain management(SRM) and necessary for any business involved in buying or selling products. It supervises the flow of goods for manufacturers to warehouses to the point of sale. Keeping a detailed record of each new or returned product is important. However, it can be an extremely complex process especially for large organizations but the basics are the same regardless of the business size or type.

First, goods are ordered through the purchasing department then they are delivered to a warehouse usually in raw materials and placed in the stock areas. Afterwards, the goods are pulled from stock and move to the production facilities to be made into finished products. Those finished goods are returned to the stock areas and finally, products are shipped out to the customer through the sales department.

Inventory management uses a variety of data to keep track of the goods as they move throughout the process including lot numbers, serial numbers, cost of goods, the number of goods and the dates when they reach each step of the process. Inventory management software systems began as simple spreadsheets that tracked the quantities of goods in a warehouse but have recently become more complex. The software can now go several layers deep and integrate with the accounting and ERP systems. It can be highly customized for large organizations to keep the right amount of goods in hand to fulfil customer demand and stay profitable. Several methodologies are used such as stock review just-in-time methodology and ABC analysis methodology for inventory management.


How much inventory should you hold?

One of the principles of supply of goods to a market is that companies hold enough stock to satisfy customer demand without holding too much. Holding the right quantities of stock to satisfy demand will minimize cost. However, when dealing with thousands of stock-keeping units, the art of balancing demand with supply is intricate.

It becomes even more complex when multiple storage facilities are used and customer service times are short or vary according to the critical nature of products. The best way to understand how much stock you should have is to determine how much it costs you. The costs vary from 2.4% to 16% of sales revenue. You might want to check costs before embarking on a cost reduction exercise in your endeavour to reduce costs. It’s important to understand what are the typical costs involved.


Inventory Cost Drivers


Facility costs – these are holding costs which include rental mobile and static equipment utilities

Compliance costs – wherever expenses are necessary to bear. For example, the expense to be incurred for dangerous goods or pharmaceutical products.

Human capital – this is the cost of labour to manage stock. For example, moving it, handling it and counting it.

Finance costs – when capital is invested in inventory the cost of Finance is interest or opportunity cost for investing capital elsewhere.

Management costs – these are white-collar personnel and information technology charges

Procurement costs – these relate to the cost of purchasing, including inbound transport inventory turnover.

Inventory turnover – As a rule of thumb, the faster the stock turns the less it will cost you to hold. However, stock turns in some businesses such as spare parts will be very low, say one to three times per annum. Whereas stock turns in fast-moving consumer goods (FMCG or CPG) business can be as high as 20 to 30 times per annum. Regardless, the increasing stock turns for any business to an optimal level is beneficial.

Stock accuracy – If stock records are wrong vast amounts of time and expense can be wasted sorting them out. Ideally, the stock accuracy should be 98% or better. This means that 98 times out of 100 the stock on the system matches the stock in the storage bin. The lower percentages are always linked to higher operating costs.

Pillage and knowledge –  the cost of theft, stock losses and damage to products must be factored into your analysis

Service levels – Too rigid or a single service level approach can cost dearly. Companies that will offer goods supplied anywhere anytime in any quantity at the fastest delivery time possible will have higher levels of stock than those who offer a service level specifically tailored to customer needs.

So in all of this what is the solution? Identify your customer service level. Smart companies segment their supply to three service classes.

Critical goods – These are products that are needed quickly such as for medical or emergency purposes.

Non-critical – Goods/Products that are needed within a reasonable time frame but are not necessarily urgent such as computers household white goods and building materials

Scheduled delivery  – Goods which can be built or customized for particular customers and delivered according to agreed delivery times. This applies to some technology products and also furniture.

A further delineation may be made between retail, wholesale or end-user customers. In any case, it pays to start with a good understanding of customer needs before advancing to the next stage.


Strategies to better manage inventory


Vendor managed inventory

Some companies involved in manufacturing integration or assembly rely on their vendors to manage their stock until the goods are used on the production line. Under this arrangement, the manufacturer doesn’t have to carry any stock and only pays for the stock when used. This strategy can save the manufacturer money but can consequently load certain costs upon vendors. This apparent misalignment of cost between the manufacturer and the supplier is beneficial to end customers as the total cost to supply becomes lower.

Postponement logistics

This is common to many international manufacturers and it’s the process of postponing final assembly of goods until demanded in the offshore market where they will be sold. This enables the efficient storage of a smaller range of goods while offering a fast response time to the designated market. It has been used in the fashion industry to good effect and also in industries such as appliances, computers and gaming. With a large number of companies moving to manufacture offshore to South and North-East Asia postponement is becoming more common and feasible for smaller markets such as Australia.



Inventory management is a challenging and inexact science. It should be approached carefully to ensure full understanding and application of the most appropriate supply chain strategy.

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