THE COMPLETE GUIDE TO INVENTORY MANAGEMENT 2

Chapter 1: What is Inventory Management?

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Inventory management is the process of ordering, handling, storing, and using a

company’s non-capitalized assets - AKA its inventory. For some businesses, this involves
raw materials and components, while others may only deal with finished stock items
ready for sale.

Either way, inventory management all comes down to balance - having the right
amount of stock, in the right place, at the right time. And this guide will help you
achieve just that.

Retail inventory management

Retail is the general term used to describe businesses that sell physical products to
consumers. While not exclusive to retail, inventory management tends to play more of a
role in this industry than any other.

We’ll therefore be focusing mainly on inventory management from a retail perspective

within this guide.

Retail can be split into several areas:

● Offline. Where a company sells via a brick-and-mortar store or physical location.

● Online. Where a company sells over the internet via an ecommerce website
or marketplace.
● Multichannel. Where a company sells in multiple different places,
usually a combination of online websites and marketplaces.
● Omnichannel. Where a company provides a unified, integrated experience
for customers across all the different online and offline channels it sells
on.

Businesses may also choose to trade via wholesale channels. This involves selling
inventory (usually in bulk) directly business-to-business (B2B) or taking part in B2B
ecommerce.

A company’s inventory will therefore need to be managed in accordance with which of

these retail models it operates within.

Inventory management in action

We’ve covered the broad definition of inventory management. But what’s actually
involved when it comes to making good inventory management happen?

Bottom line:

You want to keep inventory levels balanced at all times without ever having too much or
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And there are a few key aspects in achieving this:

● T ypes of inventory. So you know what type of inventory is where and can have
full visibility over it.

● F orecasting. So you know how much stock is needed to satisfy demand over
an upcoming time period.

● P urchasing. So you know when and how to create purchase orders to re-order
new stock.

● S torage. So you know how much of each inventory item can be suitably housed,
and where to send it.

● A nalysis. So you can use metrics to make more informed decisions about
your inventory as time goes on.

● T echniques. So you can quickly and efficiently book-in, put away, pick, pack and
ship inventory as and when needed at your various locations.

● T racking. So you have visibility on where exactly your inventory is as well as

additions (purchases) and subtractions (sales), to give as close to a live stock
figure as possible.

● A ccounting. So you can properly record your inventory on financial documents.

● S ystems & tools. So you know which software is right for your business, and when
the right time is to implement it.

These are the basic ingredients of quality inventory management. And you’ll need to take
a
systematic approach to them in order to best equip your business for long term growth.

The importance of inventory management

A retail business is useless without its inventory. And so while it may not be the most
exciting subject, inventory management is vitally important to your business’s longevity.

Good inventory management helps with:

1. Customer experience. Not having enough stock to fufill orders you’ve already
taken payment for can be a real negative.
2. Improving cash flow. Putting cash into too much inventory at once means it’s
not available for other things - like payroll or marketing.
3. Avoiding shrinkage. Purchasing too much of the wrong inventory and/or not
storing it correctly can lead to it becoming ‘dead’, spoiled, or stolen.
4. Optimizing fufillment. Inventory that’s put away and stored correctly can be
picked, packed and shipped off to customers more quickly and easily.

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 THE COMPLETE GUIDE TO INVENTORY MANAGEMENT 4

Key inventory management terms

Inventory management is a complex subject. And there’s a lot of systems, processes
and general pieces that go into the puzzle.

Here’s a glossary of key terms you’re likely to come across:

● Barcode scanner. A device used to digitally identify items via a unique barcode,
then perform inventory and fufillment tasks like booking-in, picking, counts, etc.
● Bundles. A group of individual products in an inventory that are brought
together to sell as one under a single SKU.
● Cost of goods sold (COGS). Direct costs of purchasing and/or producing any
goods sold, including everything that went into it – materials, labor, tools used,
etc. Does NOT include indirect costs – like distribution, advertising, sales force
costs, etc.
● Beginning Inventory (BI). The value of any unsold, on-hand inventory at the start
of an accounting period.
● Ending Inventory (EI). The value of any unsold, on-hand inventory at the end
of an accounting period.
● Inventory valuation. The process of giving unsold inventory a monetary value in
order to show as a company asset in financial records.
● First-in-first-out (FIFO). An inventory valuation method that assumes stock that
was purchased first, is also the first to be sold.
● Last-in-first-out (LIFO). An inventory valuation method that assumes the most
recent products added to your inventory are the ones to be sold first.
● Average inventory cost. An inventory valuation method that bases its figure on
the average cost of items throughout an accounting period.
● Average inventory. The average inventory on-hand over a given time period,
calculated by adding Ending Inventory (EI) to Beginning Inventory (BI) and dividing
by two.
● Back order (BO). An order for a product that is currently out of stock, and so
cannot yet be fulfilled for the customer.
● Sales order (SO). A document created when a customer makes a purchase,
detailing which products are to be received and how much has been paid or is
owed.
● Purchase order (PO). A commercial document created by a business to its
supplier, detailing quantities, items and agreed prices for new products to add
to on-hand inventory.
● Stock keeping unit (SKU). A unique alphanumeric code applied to each variant
in a company’s inventory, helping to easily identify and organize a product
catalogue.
● Third-party logistics (3PL). Refers to the use of an external third party to
handle warehousing, inventory, fufillment and/or customer service on
behalf of a retail company.
● Order fufillment. The process of getting a customer’s sales order from
your warehouse or distribution center to it being in their possession.

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 THE COMPLETE GUIDE TO INVENTORY MANAGEMENT 5

● Order management. The systematic process behind organizing, managing and

fulfilling all the sales orders coming into a business. From receiving orders and
processing payment, right through to picking, packing, shipping, handling returns
and communicating with customers.
● Inventory variant. The variations of a single product that a company may hold
in its inventory. For example, stocking a t-shirt in various colors and sizes.
● Inventory visibility. The ability of a person or business to see exactly
where its inventory is and how it is being used.
● Pipeline inventory. Any inventory that has not yet reached its final destination
of a company’s warehouse shelves, but is currently ‘en route’ somewhere
within their supply chain - e.g. currently being manufactured, or being shipped
by the supplier.
● Lead time. The time it takes for a supplier to deliver new stock to the desired
location once a purchase order has been issued.
● Carrying costs. The total costs associated with holding and storing inventory
in a warehouse or facility until it is sold on to the customer.
● Inventory count. Also known as a stock take, this is the systematic process of
taking a p hysical count of inventory in order to verify accuracy.
● Dead stock. Inventory that remains unsold for a long enough period of time for it
to be deemed outdated and virtually unsellable.
● Inventory shrinkage. An accounting term to indicate inventory items that have
been stolen, damaged beyond saleable repair or otherwise lost between the
point of purchase and point of sale.
● Supply chain. The complete flow a product or commodity takes from origin to
consumer - including raw materials, to finished goods, wholesalers, warehouses
and final destination. A retailer might only be directly responsible for certain
chunks of this supply chain, but should still be aware of it in its entirety for the
products they sell.
● Multichannel. A retail model that sells in multiple different places, usually online
via a combination of websites and marketplaces.
● Omnichannel. A retail model that goes beyond multichannel to integrate all of
a company’s online and offline sales channels into one, unified customer
experience.
● Overselling. Taking online orders for a product that turns out to be out of
stock (usually through poor inventory management). Preventing overselling
is key to providing a high-quality experience for online customers.

Key inventory management formulas

It’s not just common terminology you need to know when it comes to inventory
management. There are some specific formulas to take note of too.

We’ll be going into greater depth with how and when to use these formulas later on in
this guide. But here’s a quick run through to use as a reference point:

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1) Inventory turnover
Inventory turnover measures the number of times a company has sold and replaced
inventory over a given time period:

This gives an insight into the overall efficiency of a company and its inventory
management processes. The higher the inventory turnover rate, the more efficient a
business is at getting through its inventory.

2) Sell through rate

Sell through rate takes the amount of inventory a retailer receives, and compares it
against what is actually sold over a given period. It’s usually expressed as a
percentage:

This helps analyze if your investment in a particular product is working out well. Low sell
through rates indicate you either overbought or priced too high, while high sell through
rates indicate you may have under bought or priced too low.

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 THE COMPLETE GUIDE TO INVENTORY MANAGEMENT 7

It’s a great way to make decisions on future purchase quantities for a product or
from a particular supplier.

3) Days of inventory outstanding (DIO)

Days of inventory outstanding (DIO) measures the typical number of days it takes for
inventory to turn into sales.

It’s hard to draw insights from just one calculation. But you should look into typical
industry standards, and also keep track of whether you are trending up or down as
time goes on.

4) Safety stock
Safety stock is the backup stock needed to meet unexpected supply problems and/or
sudden changes in demand.

Bear in mind that you want to have enough safety stock to meet demand. But not so
much that increased carrying costs puts a strain on cash flow.

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 THE COMPLETE GUIDE TO INVENTORY MANAGEMENT 8

5) Reorder point
The reorder point helps determine when to order new inventory. It is a specific point in
time that acts as a trigger to re-order as soon as stock has diminished to that certain
level.

It’s important to consider the lead time for new stock to be delivered when setting
reorder points. Enough stock should be leftover to keep up with demand before the
newly purchased inventory becomes available for sale.

6) Economic order quantity (EOQ)

EOQ is a formula that helps calculate exactly how much inventory to order. It takes into
account a company’s typical demand, ordering costs and carrying costs to provide the
most economical figure possible:

This is obviously quite a complicated formula to use. But we cover this in greater
depth in C hapter 4: Purchasing Inventory.

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 THE COMPLETE GUIDE TO INVENTORY MANAGEMENT 9

Inventory management software

An inventory management software or system does all the heavy lifting for a retail
business when it comes to its inventory. It tracks inventory additions and subtractions
automatically, without relying on manual, paper or spreadsheet processes.

Systems like this are becoming more and more popular among growing businesses as
they tackle the challenges of modern multichannel and omnichannel retail.

Choosing an inventory management system that’s right for your business can be a
tricky process. But here are a few pillar features of good software:

● Real-time tracking. Syncs a live inventory figure across all sales channels
and warehouses.
● Forecasting. Uses past sales data to project estimated inventory requirements into
the future.
● Purchasing. Helps manage all suppliers and purchase orders for quick and easy
stock replenishment.
● Rules & automations. Allows creation of inventory rules, e.g. to dictate how
much stock shows on each sales channel.
● Cloud-based. Accessed from anywhere with data never being overwritten by
team members making changes.

Many systems (like Veeqo) will also help manage and automate a plethora of other
operational tasks - like sales & wholesale orders, picking & packing, shipping, and
returns.

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 THE COMPLETE GUIDE TO INVENTORY MANAGEMENT 10

This initial guide covers all the basics of inventory management you need to know. But
there’s much more that goes into it that we’ll explore in the coming additional chapters,
starting next with the different types of inventory you need to be aware of.

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