What is Inventory Management?

Inventory management is the process or system of handling all the goods that an organization owns. In simpler terms, inventory management deals with how a company orders, stores, and uses its goods.

Inventory management is an integral aspect of supply chain management. Supply chain refers to all processes and resources involved in producing and delivering products. In this respect, inventory management involves the management of raw materials and finished goods. Organizations of all sizes make use of an inventory management system to manage their inventory levels.

Objectives of Inventory Management

The following are the objectives of managing inventory in a business:

  • To reduce the cost of managing and storing inventory
  • To ensure that a business maintains sufficient stocks of goods
  • To prevent dead stock and ensure point-of-sale availability of goods
  • To make sure that no stock perishes and all goods are used either on a last-in-first-out or first-in-first-out basis

What is Inventory?

Inventory is all the goods that any business deals in to sell in the market. For example, a company that manufactures clothes to be sold in the market would require different types of goods like thread, fabric, and dyes, and all these would form inventory for the company.

The main aim of a business in holding and selling these goods is to earn profit. For any business to do so, it is necessary to ensure the optimal flow of the right goods at the right time. This is possible only if a business manages its inventory in an efficient manner.

For any business, the types of inventory that are considered important include:

  • Finished Goods: These are the products or goods that are maintained by a business for the purpose of selling to its customers.
  • Raw Materials: Every business that manufactures goods requires raw materials. These are the goods that are used to produce the finished goods.
  • Work-in-Progress: This refers to inventory that is part-way through the manufacturing process. In other words, goods that are currently being manufactured but are not completely finished are considered to be work-in-process inventory.
  • Maintenance, Repair and Operating Goods: These are the goods needed by any business to support and enhance the manufacturing process. These are also called MRO goods.
  • Safety Stock: Safety stock is the goods that are maintained by a company so that it can meet uncertain demand and supply. In other words, there may be times when a company experiences high demand, and it is this safety stock that helps to meet this increased demand. Also, there can come times when a company is not getting enough supply of goods from suppliers. This is another case where the company can use safety stock to meet the shortage of goods.

Every company must maintain optimal inventory levels of all these types of goods or inventory so that its supply chain is not affected in any manner.

Businesses make use of inventory valuation methods to find the value of products in inventory using different valuation methods. 

Inventory Valuation Methods

  • First-In-First-Out (FIFO): In the FIFO method, it is assumed that the goods are sold in the order in which they are manufactured or purchased.
  • Last-In-First-Out (LIFO): In the LIFO method, it is assumed that the latest goods manufactured are sold first.
  • Weighted Average Cost: The inventory cost is based on the average cost of all items purchased.

Using these methods, we can find the economic order quantity. EOQ, or economic order quantity, is the ideal quantity of goods that a business must maintain so that its other costs associated with the inventory are minimized. The formula for EOQ is as follows:


Where Q= EOQ

D= Demand

S= Order Cost

H= Holding Cost

Process of Inventory Management

As a process, inventory management entails tracking stock and managing it as it moves through the supply chain or from suppliers to multi-warehouse. 

The steps of the inventory management process are:

  1. Purchase: This stage is the one where raw materials or goods are purchased. Some materials are purchased to be used for manufacturing goods. Other goods may be purchased to be sold to the customers without requiring assembly.
  2. Produce: The production stage is an integral part of inventory management for manufacturing organizations. In this stage, the raw materials are converted to finished goods. 
  3. Hold Stock: This stage basically involves the storage of goods. A company can hold stock of materials before they are used for producing goods and/or maintain adequate stock levels of finished goods before they are sold in the market.
  4. Sell: This is the stage where the goods are sold to customers. The main aim of selling the goods is to earn profits.
  5. Report: This is the stage where the inventory management system is evaluated. In this stage, a business gets to know how much of the goods are being sold and the profits that are being generated from the sales.

An integral part of managing inventory is inventory control. A business needs to know its stocks inside out. This includes the goods it has in the brick-and-mortar store and whether the goods are being managed and stored efficiently. Inventory control aims to keep the costs of managing and using inventory low.

Inventory Management System

To effectively manage and control inventory, every business needs to implement an inventory management system. An inventory management system includes all the processes and technologies used to control the inventory, such as tools to identify every item of inventory. This system is important to ensure goods flow through the organization in the right manner. If an inventory system is not in place, the flow of goods cannot be managed and controlled.

Benefits of an Inventory Management System

  • Enhanced cash flow for the business
  • Improved reporting of inventory
  • Reduction in labor costs and storage costs
  • Effective organization of inventory
  • Better relationships with suppliers and vendors

Because businesses need to manage and control different types of inventory, a manual system of managing inventory may not suffice. This is where inventory management software comes into play.

Inventory management software is a program that businesses use to track, order, sell, and maintain purchase orders in real-time. Inventory management software offers several advantages for a business. These include:

  • Allowing for automatic ordering and re-ordering of stocks. With an automated system, the business is informed what goods are needed and in what quantity. This means that a lot of time is saved in counting and managing stock.
  • Planning and forecasting the demand and supply of goods. When stock is at a very low level, the software notifies the business, and the business can make the necessary arrangements to handle the shortage of goods.
  • Allowing the business to manage its goods and the flow of these goods in the most optimal manner. This helps to lower the cost of maintaining inventory because goods are managed in real-time.

Inventory management software also comes with its drawbacks. These are mainly associated with crashes of the automated system or software. A technical failure in the software could mean that a business loses all data related to its inventory, and this can lead to huge losses. 

Techniques to Manage Inventory

Some of the best techniques that can be used for managing inventory include:

  • Just-in-time: This is a technique wherein a business holds as little stock as possible. With this technique, a business does not need to incur huge costs in managing inventory. This technique works well for small business owners, as they can order goods only when needed. This helps small businesses to save a lot of inventory-related costs.
  • ABC analysis: This is a technique in which inventory is divided into different tiers. With the help of this technique, a business can identify and focus on only those goods that help it to earn high profits.
  • Dropshipping: With this technique, a business does not maintain stock of any goods. The business outsources all its inventory needs. This means that the business incurs minimum costs, but the risks associated with this technique are very high. 
  • Backorder: This is a technique in which a business takes orders for those goods that are not available. In other words, a business arranges for the goods after receiving the order. This means that a business does not have to maintain stocks of all types of goods. However, if the goods cannot be arranged for the order, the business suffers losses.
  • Cross-docking: In this technique, a business does not need to hold stock of any goods. The business orders goods and these are packed immediately for delivery in the warehouse. This helps to prevent the business from maintaining dead stock.

Context and Applications

Inventory management is applicable in all businesses, whether manufacturing or retail. This concept can be applied to manage the stock and goods a business possesses. Manual and automatic inventory management systems are practically applied and seen in all businesses.

This topic is significant in professional exams for both undergraduate and graduate courses, especially for business management and operations management courses.

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