Every retailer has been kept up most nights by inventory woes. Have too much of stock and it eats into your margins. Have too little and your customers will go looking for the same product elsewhere. Then there are price fluctuations that eat into your margins, sale seasons when it is hard to predict how much you can sell, and returns from customers who wanted something even more.
With so many variables in the mix, is it even possible to manage your inventory effectively? Is it possible to not let the dead stock eat into your revenues? Indeed, is it even possible not to have dead stock at all?
Moreover, with many retailers choosing to sell online as well as in physical stores, keeping track of stock movement across channels is that much harder.
A good inventory management software can save you the pain of having to keep track at all times, wondering when to reorder and addressing the general chaos that is a warehouse.
Primaseller can help you synchronize your inventory across not just your physical stores but even in online stores across multiple channels too. So if you’re looking to scale up and take your business online, or even if you’ve already done that and faced inventory issues, the solution is at hand.
A vast majority of the confusion regarding inventory management stems from the idea that it is split into two facets- on the one hand, it is part of casual conversation and everyday woes and on the other, it seems like a subject for the academic experts.
This is why we have curated an article for you on what is inventory management. Give this one a read before you delve into the calculations covered in this guide.
With this comprehensive guide to inventory management, we hope you’ll be able to understand your inventory better and gain insights on how you can manage it even better
Why Should I Hold Any Inventory At All?
You may have often wondered why you even have any inventory at all. Is it not just simpler to ask a supplier to send you products as and when you have some demand for them? The issue, however, lies in the fact that we never know for sure what a customer’s spending pattern is.
For example, it is possible that your manufacturer cannot keep up when your demand peaks. Or your vendor may increase the price of a product you agreed to sell for way lesser.
Having your own inventory helps hedge against the great uncertainty that is consumer behavior. When you buy in bulk, you also have an advantage when it comes to price negotiations. Moreover, you can significantly reduce the time between order and delivery by having your own stock.
The fundamental principle of inventory management revolves around placing an order for goods at the right time, with the right source that can provide you with the right quantity at the right price and the right quality.
Chapter 1: Gathering Your Information
The basis of any good inventory management system, be it manual or automated, is knowledge. Knowledge of every single one of your products and knowledge of the vendors that supply it to you are at the very core. Here are a few things you can list down about your products:
- The product name and description
- The product prices- cost price, selling price, wholesale price, etc.
- Every product’s unique code, or SKU
- The product picture, shipping instructions, etc.
- The exact location of the product in the warehouse- this is very important for shipping
And here are a few things you need to know about your vendors:
- Name and contact person details
- All contact information such as email address, phone numbers and mailing address
- Billing details and your payment policy with the vendor
While all of this information can be maintained in physical logs as it was traditionally done, most retailers have moved on to digitizing this information a long time ago.
What’s more, a cloud-based inventory management software offers more benefits such as access from absolutely any place in the world that has an internet connection. Information stored in the cloud is much safer than in the written form or even on a system, as both these avenues are prone to accidents and data loss.
Once you have this information in a format that is not cumbersome, you have the advantage of not just having the information ‘somewhere’ but actually having it at your beck-and-call all the time.
Then comes the issue of locations. Warehouses are huge spaces, and you as a large retailer may be stocking up several items in an inventory. This is where the significance of naming each aisle, each rack and every storage nook comes into play. You have a product, you have all the product information, but if you don’t know where it is physically present, you’ll never find it.
Usually, small and medium retailers face this problem to a far lesser degree, owing simply to the fact that they stock lesser inventory. If you’re a small retailer, the process of naming each location in the warehouse may actually be more of a waste of time than beneficial, so judge your individual requirements before you start labeling locations.
Chapter 2: Taking Stock
Once you have the product and location information sorted, take some time out to count everything in your inventory. Sure, it is a cumbersome process, but it is a good starting point for you to know what you have in stock.
There could be many reasons for counting your stock from scratch- perhaps you are a new business just starting out, and you want to have everything in order before you begin operations. Or maybe you don’t recall the last time you did an accurate inventory check and would much rather do it now. Here are a few instances when you absolutely must count your stock:
- When you want to know the value of your inventory as an asset
- When you want to manage your stock levels better
- When you want to know if you have enough stock for the upcoming sale season
So what exactly should you be counting from your inventory?
- Sellable goods in the warehouse – this is obviously the focus of the exercise
- If you also manufacture the product, you need to count the items that classify as raw material, work in progress and finished goods
- Items that are in transit to your warehouse from a vendor
- Items that are held in a third party facility, such as when you have your goods in Amazon’s warehouse
Chapter 3: The Costs Of Keeping An Inventory
The costs of procuring and maintaining inventory levels can broadly be split into three categories:
- Ordering Costs: This is the cost of the products themselves, plus the resources you need to bring them to your facility. Depending on what sort of agreement you have with your vendors, this may include everything from shipping and paying for the goods to quality control and the salaries of staff who man the facility.
- Carrying Costs: Carrying cost is, quite literally, the cost of ‘carrying’ this stock on your shoulders. This includes the lease you pay on the warehouse, the product handling expense until the time it is shipped, insurance, losses of stock due to the elements, taxes, etc.
- Stock-Out Costs: The whole point of effective inventory management is for you to avoid this cost. Stock-out cost, as the name implies, refers to the cost of losing a sale because you didn’t have enough inventory, or because you failed to meet the delivery commitment you promised.
Chapter 4: Inventory Jargon
Well, at least it may seem like jargon, but these terms that are casually thrown around in inventory management can help you understand better.
Maximum Stock Level
As the name implies, this is the level of stock indicated by a number beyond which you simply shouldn’t stock up on a particular product. This number is influenced by several factors- the perishability of goods, the amount of warehouse space you have, changes in consumer preferences, etc.
Maximum Stock Level = Reorder Level + Reorder Quantity – (Minimum Consumption x Minimum Reordering Period)
For example, if you know that when inventory touches 1000 units (reorder level), you must order 500 units (reorder quantity), and that your goods take at least 5 days to reach you from a vendor (minimum reordering period), and also that you sell a minimum of hundred units every day (minimum consumption), the maximum amount of stock that you need to keep in the inventory is a 1000 units.
Minimum Stock Level
This is the absolute minimum number of products you need to have in order to fulfill market demand. The calculation for this number depends on the lead time. Lead time is the amount of time it takes for you to receive a product from the vendor, from the time that you’ve placed an order for it. Another factor that influences Minimum Stock Level is the rate at which your product is being sold during the lead time.
Minimum Stock Level = Reorder Level – (Normal Consumption x Reordering Period)
Before we get into an example, let’s also talk about the reorder level, which is always higher than the minimum stock level.
This number represents the point at which you must raise a reorder request from your vendor so as to ensure that you stay above the minimum stock level.
Reorder Level = Daily Consumption x Lead Time
For example, let’s consider that there’s a seller of wall clocks of a certain model. He is able to sell 500 clocks every day, and the lead time is a week, which means it takes a week for him to restock.
In order to avoid running out, he needs at least 500 X 7 which is 3500 clocks ready in his inventory at all times. Whenever the level of clocks in his warehouse falls to 3500, he needs to reorder immediately so he has new stock ready once the seven day period lapses and he runs out of whatever he already has.
In the simplest of terms, the reorder point is that point in time when you need to reorder stock for a product, to avoid the risk of running out of stock. The crude way to do this would be to keep an eye on your stock and order whenever it is coming close to being over. But how soon before it is over do you need to order? That is the question.
Reorder Point=(Average Daily Sales x Lead Time) + Safety Stock
If you have 10 units in your safety stock, and you know that you sell 5 units a day and that your vendor takes 5 days to deliver your products to you, your reorder point is reached at (5 x 5)+10 or 35 units. In other words, you reorder a product with these attributes when your stock level for them reaches 35 units.
Chapter 5: Controlling Supply And Demand
Is it even possible to control supply and demand, at least within the limited means and resources you may have?
Using inventory forecasting, it is possible to predict to a fairly accurate number the number of sales you would be making in a certain point of time in the future. While uncertainties do crop up, by monitoring your inventory levels, using the reorder point to decide when to order for new stock and deciding what is the optimal stock level you need to maintain, you can cut inventory costs significantly, while catering to the existing demand.
There are a few other things retailers do to minimize the risk of too much or too little inventory as much as possible.
- Have an agreement with your salesperson to split costs if a product suddenly stops selling.
- Talk to your vendor about accepting returns should a product not do as well as expected.
- If you’re selling bulk orders, also keep a list of other potential customers handy, should the initial customer cancel.
- When sale season approaches and you’ve decided to jump on the bandwagon if a product doesn’t sell well, be prepared to offer heavy discounts in order to empty the inventory.
Chapter 6: Recording Stock Movement
When you have items arriving at your warehouse, do these things without fail:
- Sort goods into two piles- the accepted pile and the rejected pile. Those in the rejected pile go back to the vendor due to quality issues. Add the number of goods in the accepted pile to the existing inventory.
- If too many products have been rejected, you’ll have issues with keeping the inventory levels at an optimum level. Raise a reorder request immediately.
When items leave your facility, look into these things:
- Remove the number of goods from your inventory and reset the value to the current level.
- Monitor the reorder level and place an order with the vendor if necessary.
For a very long time, people have done this either manually or through an Excel sheet. However, if you’re a growing business, it makes sense to invest in a good inventory management system.
Here’s how you would raise a request for stock and receive it in Primaseller.
Once you login to your Primaseller account, click on the Purchase Orders Tab on the bottom left corner. You’ll see the screen shown above. On the top right corner, click on the ‘Create Purchase Order’ button
You’ll see a screen to create a new purchase order. Here, you can select details like the vendor you’re ordering from, the warehouse that will receive this stock and the estimated date by which stock will reach the warehouse.
In the same screen, at the bottom, you can select the products you’ll be ordering from this vendor. You can search for the products by their name or the SKU code, or even scan them.
Once you’ve selected the products you want to reorder, look for the ‘Save & Send’ button at bottom of the same screen. Once you click on this, your vendor will receive a written request for the goods you need, along with information on when you need them.
This way, you always have a written record of all the purchase orders you have raised. Just look for details of sent receipts, those in progress and those that have been fulfilled in the main Purchase Orders tab on your left-hand dashboard.
Several retailers, out of fear of running out, keep what is known as ‘safety stock’, almost like the reserve petrol in a vehicle. When unexpected levels of sales occur and they’re unable to fulfill a requirement, they move goods from the safety stock.
However, most inventory management experts agree that this is a bad idea, as it takes up unnecessary space and financial resources. If you keep an eye trained on the reorder level and adjust it based on your sales, you would ideally not need a safety stock.
Chapter 7: Process To Control Inventory
Depending on the kind of products you sell and variations such as seasons, spending patterns and how quickly you can restock, your choice of inventory control systems would vary.
In the continuous system, your order quantity is fixed. You set a level for when you should order in more products (reorder level) and you order a fixed number of items when the existing inventory touches that number. This system is most suitable for products that have very little variance in sales over the year.
In the periodic system, the number of products you order is never the same but depends instead on the fixed time period within which it is being ordered. For example, if one of the products you sell are fairy lights, they would do well in the October-December time period, so you order more of the fairy lights just before that time period begins. Likewise, you order less of the fairy lights in the February-April time period, when their requirement may be significantly lesser.
One system that is gaining popularity now is the perpetual inventory system. The advent of digital inventory management systems allows you as a retailer to use every sales receipt as a measure of your inventory levels. Using this system, you can completely eliminate the need to count stock periodically, as each sales receipt is recorded as ‘one less.’
What’s more, some systems also allow you to accept returns and count it back in your inventory if it is an acceptable product, or until the time that your vendor agrees to take it back for defects.
Chapter 8: A Few Formulas To Help You Along
In order to estimate how much inventory you have on hand in a month, quarter or year, you use the average monthly inventory.
Average Monthly Inventory= (Inventory at month beginning + Inventory at month ending) /2
Inventory Turnover or stock turn is a measure of how many times you have entirely replaced your existing stock with new ones.
Inventory Turnover = Net Sales/ Average Stock
where net sales are the revenue you have after accounting for returns, and average stock is calculated as above for any period of time you need.
There are several ways to calculate safety stock levels, and the easiest to use estimate is to take the two months in the year when the highest and lowest number of products were sold, and subtract one from the other.
Safety Stock= Highest number of products sold in a month- Lowest number of products sold in a month
Do note that this is a very simple formula that is good for giving you an estimate.
If your product sales remain fairly stable across all months in a year, the formula to calculate critical stock is fairly simple. But first, we need to know the average monthly sales, which is the average number of products you sell in a month.
Average Monthly Sales = Total number of products sold in a year/ 12
Do remember that if your product has seasonal surges, this formula is practically useless and you’d need a much more sophisticated system to make this calculation.
The critical level is basically like finding the middle ground between too much safety stock and too little inventory on hand. This number helps you figure out how much stock you need to keep on hand without accumulating too much.
Critical Level = (Monthly Order Quantity + Safety Stock)/ 2
While these easy to use formulae will hold you in good stead when you need a quick check, if you sell multiple products or products that have sales variations, they may end up giving you results that aren’t very dependable. If that is the case, it is always better to depend on a sophisticated system than on manual calculations.
If you’ve successfully gotten to the end of this guide, congratulations! You now understand what happens in your warehouse!
What’s more, you’ll now be able to have all the information you need at your fingertips. We hope this guide has demystified inventory management for you to a good extent. Let us know in the comments!