As your business grows, you’ll need to start deciding how much capital to invest in your inventory — especially since inventory makes up the largest percentage of costs for many retail and wholesale businesses.
Although it sounds like a straightforward question of demand and supply, poor inventory management can ruin a business. These range from fearing worst-case scenarios and carrying excessive inventory that is subjected to obsolescence or spoilage, to carrying an insufficient amount that results in dissatisfied customers.
Everything boils down to satisfying customer demand and optimizing inventory turnover… but how?
The core concept behind inventory management is to ensure you have the right amount of inventory, in the right place at the right time, at the right cost.
Deciding how much stock to order appears to be a gamble, but asking a few questions can simplify the whole process and help you get started.
- How much are your ordering and holding costs?
The Economic Order Quantity (EOQ) equation helps in deciding the ideal order quantity that would offer the lowest overall cost to the company.
- What items need to be ordered?
Obviously, inventory with the potential to generate profits should be ordered. Remember — sometimes companies stock items that do not generate profit by themselves, yet generate profits through the sales of related items and/or services. Think printers and ink, or coffee machines and capsules.
- Which items are selling well? What’s not doing well?
Identifying your bestsellers and prioritizing importance based on high impact and value will help prevent the waste of precious resources (especially time). The easiest way to do so is to use the ABC classification.
• Items in group A are the top sellers you want to keep the closest eye on.
• Group B’s items are of relative importance.
• Group C is of the least importance.
Assessing which items belong in which group depends on their ranking in:
• Annual sales
• Percentage of sales for each item
- When should we order more of an item?
Deciding the Reorder Point (ROP) depends on the timing and quantity of orders placed, along with the knowledge of lead time. This is often determined in relation to the inventory management system you choose to suit your business model.
The Fixed-Order Quantity System ensures that an order is placed once the inventory level drops to a predetermined level that marks the reorder point in order to maintain the inventory level.
However, the Fixed-Time Period System sets a target inventory level to be maintained and inventory is checked in preset intervals (eg. every week), placing orders to restore the target quantity as required.
Now that everything’s set up, all that’s left is to measure the health of your inventory management system!
Two standard metrics to measure the efficiency of your inventory management and the financial health of your organization are the inventory to sales ratio (which should be kept low) and the inventory turnover rate (high rates = success, but be careful if it’s too high).
Inventory management success starts with understanding the fundamentals, but the key lies in using your creativity in tailoring these to develop custom solutions for your business.
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