Table Of Contents
- Firstly, What Is Inventory?
- Methods That Are Used For Inventory Management
- Top 8 Inventory Management Techniques
- FIFO Stands for First In, First Out
- LIFO (Last In, First Out)
- JIT (Just In Time)
- Average Costing
- Economic Order Quantity (EOQ)
- Cycle Counting
- Continuous Inventory System
- ABC Analysis
- Typical Inventory Mistakes That You Must Avoid!
- Wrapping It Up!
Inventory Management Techniques of Tomorrow: Trends Shaping the Future
Inventory management may initially sound boring, but it’s vital to operating a successful and efficient business. Whether you have a small shop or a big warehouse, knowing what you have, where you have it, and how much it costs is the key to avoiding chaos.
That’s where inventory management techniques come to the rescue! These techniques tell you the best way to handle your products — from when to order them to how much to stock.
There are numerous techniques like FIFO, LIFO, JIT, and many more, each with its pros and cons depending on your business type.
The aim? Make sure you have the right products at the right time without wasting space, money, and time. Let’s dissect these techniques simply so you can choose the best one for your business.
Firstly, What Is Inventory?
Inventory mainly refers to all the materials and products that a company owns and further intends to sell as a part of its business operations.
Thus, to manage all the inventories, you must incorporate accurate tracking for better effectiveness and efficiency. This is where the inventory management comes into play!
Inventory management mainly involves both recording and tracking information, which includes:
- Quantity
- Stock location
- Value
These pieces of information can help your business make further decisions about operations, purchasing, and sales.
Inventory management techniques are a little different from the way you control and oversee your inventory levels.
Your inventory management process would include activities such as:
- Order planning
- Warehousing
- Transportation
Effective inventory management can help you ensure that your business has the right stock for products according to customer demand. This can also provide minimum waste and a well-optimized workflow.
So, yes! Inventory is more like a key asset for your business. Moreover, it can make a significant impact on all of your financial statements. This is why it is necessary to have accurate and up-to-date records of your inventory levels.
Methods That Are Used For Inventory Management
Modern inventory management includes two major things: tracking and managing the inventory. This can further help you meet customer demand. Here are the various methods that your business can use to manage its inventory:
- FIFO — first in, first out
- LIFO — last-in, first-out
- JIT — just-in-time
- Average costing
- Economic order quantity
- Cycle counting
- Perpetual inventory system
- ABC analysis
Each method has advantages and disadvantages. Thus, it is really necessary to choose the right inventory management method based on your specific business needs.
Always remember, whenever you are choosing the right method, there are certain factors that you must consider:
- Types of products that you sell
- Overall customer demand
- And lastly, your budget.
Top 8 Inventory Management Techniques
I hope you understand inventory management and how to manage all of your inventory stock easily! Now, check out these eight inventory methods to help you get started.
FIFO Stands for First In, First Out
Summary:
FIFO is a method of inventory management. It treats the first bought or made things as the first to be consumed or sold. It resembles a line where the oldest will always be the first to exit the warehouse.
Advantages:
- Accurate cost tracking: It equates the cost of older inventory with current revenue, which is helpful for financial reporting.
- Prevents spoilage: FIFO is excellent for perishables since it ensures that older stock is consumed before newer stock.
- Easy to use: It is simple to understand and use, especially in businesses with straightforward inventory systems.
Disadvantages:
- Can cause increased cost in inflation: In inflation, FIFO can increase taxable income since the low-cost, older items are sold first, and thus, the high-cost items remain in stock.
- Doesn’t represent recent market prices: During price fluctuations, FIFO may provide a misleading estimate of profit margins.
LIFO (Last In, First Out)
Summary:
LIFO is just the opposite of FIFO. In LIFO, the latest acquired or produced goods are the first to be sold or consumed. It’s the same as taking the last that you grabbed off of a shelf.
Advantages:
- Inflation tax advantage: As prices go up, LIFO sells the newer (more expensive) items first. This can decrease profits and the tax paid.
- Matches costs with money earned: It helps match the cost of goods sold with the money earned, especially when prices are rising.
Disadvantages:
- Forbidden everywhere: Some countries and accounting systems (such as IFRS) prohibit LIFO, which may be an issue if you are international.
- Old stock can remain unsold: Applying LIFO can hold older stock in inventory, which is undesirable if products have expiration dates or go out of style.
JIT (Just In Time)
Summary:
JIT is a technique wherein inventory is purchased and shipped only when required. It keeps the quantity of stock in hand to a bare minimum.
It is like a restaurant that purchases ingredients only when it wants to prepare a meal, and nothing has to be wasted.
Advantages:
- Reduced inventory costs: With less inventory, you spend less on storage and handling.
- Effective production: Assists in reducing waste since you only produce what is required at the moment.
- Improved cash flow: Since you’re not carrying idle inventory, your cash flow is probably going to be improved.
Disadvantages:
- Inventory risk of shortage: If a supply chain fault occurs, then you may encounter a shortage in stock, ultimately leading to loss of sales or production delays.
- Supplier dependence: You rely primarily on suppliers to deliver goods in a timely manner and in the proper quantities.
- Difficult to control: JIT requires good planning and ongoing coordination, which is not simple without proper systems.
Average Costing
Summary:
This approach calculates the average cost of all the products being sold and then applies it to charge the cost of goods sold.
It is similar to collecting all your buys, averaging them, and assuming that each item costs the same.
Average cost formula = Total cost of purchases / Number of units purchased
Advantages:
- Simplicity: It’s straightforward to calculate and doesn’t necessitate following single items.
- Suitable for changing prices: It minimizes the impact of the price variations over time, therefore suitable when the costs are not fixed.
- Even profit margins: Since the cost is evenly spread, it is easier to estimate profit margins over time.
Disadvantages:
- Not always accurate: If the cost between various batches of inventory varies significantly, the cost averaging can fail to provide the true cost of goods sold.
- Less useful for tax planning: It lacks the same tax benefits when costs rise or fall substantially as compared to LIFO or FIFO.
Economic Order Quantity (EOQ)
Summary:
EOQ is a formula for determining the best order quantity at which ordering and holding costs will be in balance.
You’re trying to find a balance between ordering just the right amount to meet demand and not overstocking.
This formula is: Q = √[2(DK/H)]
Where
Q = The optimal order quantity
D = Annual demand
K = Ordering costs
H = Carrying costs
Advantages:
- Cost-effectiveness: EOQ balances the ordering cost with the inventory holding cost and can be cost-effective.
- Improved inventory management: By determining the optimum order quantity, companies can avoid stockouts or overstocking.
- Scalability: It is scalable for any business size, whether you are purchasing a few or numerous.
Disadvantages:
- Needs reliable data: EOQ is good if you have reliable data for costs and demand. If your estimates are wrong, the formula won’t work correctly.
- Not appropriate to modify fluctuating demand: If your demand fluctuates randomly, then EOQ won’t be a good method because it assumes constant demand as a condition.
Cycle Counting
Summary:
Cycle counting is a procedure whereby a company counts part of its inventory on a rotating basis, rather than counting all of it at once during a physical inventory. It is similar to taking mini check-ups on your inventory throughout the year.
Advantages:
- Less disruption: Because you count small quantities of inventory at a time, the company can continue operating without enormous disruptions.
- Improved inventory records: Ongoing checks enable one to spot discrepancies and avoid larger problems in the future.
- Cost-effective: It is cheaper than undertaking a complete inventory count because it segments the work into pieces.
Disadvantages:
- Consumes time: Regular counting can still consume a lot of time and effort.
- Risk of errors: Performed incorrectly, cycle counting may miss fluctuations or generate incorrect records.
Continuous Inventory System
Summary:
A perpetual inventory system keeps up-to-date accounts of your inventory. When you use or sell something, the system adjusts in real time. It’s a type of virtual count of what you have on your shelves at any given time.
Advantages:
- Real-time updates: It shows the current inventory levels, which helps to make it easier to track and handle stock.
- Better accuracy: Because inventory is tracked continuously, you’re less likely to have discrepancies or stockouts.
- Improved decision-making: With reliable, real-time information, companies can make smart buying and inventory decisions.
Disadvantages:
- Costly to install: The system is expensive to install and maintain, particularly for small enterprises.
- Hard to manage: Advanced technology and sound systems are needed, which are hard to manage without proper expertise.
ABC Analysis
Summary:
ABC analysis is one way of categorizing inventory based on its value. Products are classified into three groups: A (most valuable), B (less useful, and C (least useful). This helps prioritize the most beneficial products.
Advantages:
- Focus on the key things: It enables companies to apply their resources to the key things.
- Better control over inventory: By knowing what is most essential, you can ensure it is always there and reduce waste on less helpful things.
- Cost-saving: Resources are utilized where they will be most useful.
Disadvantages:
- May take a long time: It may take a long time to stock inventory under A, B, and C, particularly when handling massive stockpiles.
- It doesn’t look at everything. It mainly looks at value, so other factors like demand or how quickly things spoil might be ignored.
Typical Inventory Mistakes That You Must Avoid!
Even with good inventory management skills, things can go awry if you’re not being careful. One giant mistake is overstocking — having too much of something just hanging around, taking up space and holding your cash hostage.
Conversely, understocking can be just as bad. Running out of products when customers want them can lead to lost sales and dissatisfied customers.
Another common issue is poor forecasting — not planning and assuming you know what you’ll need. This typically translates to ordering too much or too little. And don’t miss out on ignoring regular inventory checks.
If you don’t check your stock regularly, little errors can become enormous headaches. These mistakes might seem small at first, but they can affect your cash flow and customer satisfaction.
Keep an eye on your stock, check it regularly, and plan wisely — it’ll save you headaches and dollars!
Wrapping It Up!
Inventory control is simple. With the right techniques, you can save money, reduce waste, and make your customers happy.
Just select the technique that works best for your business, drill down on it, and manage your inventory. That’s it!
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