Learn more about inventory control: definition, methods, types, and ways to maximize your inventory. Show
Imagine you were going on a round-the-world trip. You could take two large suitcases filled with clothes for every weather condition. You might think you’re smart because you’re prepared for anything, but in reality, it’ll weigh you down and cost more to transport. Contrast this to a single backpack:
Bringing two suitcases seems less risky, but the movement is slower and is less effective overall. The second option is the road to success:
This type of thinking goes for keeping extra raw material inventory lying around. Broadly speaking, as a manufacturer, you handle four different types of inventories:
The average time a business focuses on each type of inventory changes at different stages in the business’s life. During the startup stage, companies tend to focus more on finished products. This makes a lot of sense, as getting products to customers is the top priority. You have to make a name for yourself, and your product is everything. As the business grows, the focus might be on manufacturing and small business inventory management efficiency. What was once barely a concern for the business owner becomes the number one thing on their mind. It seems like inventory management is taking over their life. The business owner might spend more time managing their raw material stock with little to show. More raw materials pile up, seemingly enough to last for unforeseen occurrences. This increases your inventory expenditure on your balance sheet. Not to mention the number of hours lost tracking it all. Before you know it, you are spending more than ever to sell a single unit of product. Your business is bigger. It may even be more profitable. But what are you doing it all for if your overheads are destroying a higher percentage of your income?
An inventory manager must be able to develop an effective inventory control system to manage customer demand. The demand for the product will control inventory costs, carrying costs, ordering costs and storage costs. Inventory control systems are generally categorized as push or pull models. Knowing the definitions, advantages and disadvantages of each system will help a company establish which inventory control method works best for their organization.
The push system of inventory control involves forecasting inventory needs to meet customer demand. Companies must predict which products customers will purchase along with determining what quantity of goods will be purchased. The company will in turn produce enough product to meet the forecast demand and sell, or push, the goods to the consumer.
An example of a push system is Materials Requirements Planning, or MRP. MRP combines the calculations for financial, operations and logistics planning. It is a computer-based information system which controls scheduling and ordering. It's purpose is to make sure raw goods and materials needed for production are available when they are needed.
Disadvantages of the push inventory control system are that forecasts are often inaccurate as sales can be unpredictable and vary from one year to the next. Another problem with push inventory control systems is that if too much product is left in inventory. This increases the company's costs for storing these goods. An advantage to the push system is that the company is fairly assured it will have enough product on hand to complete customer orders, preventing the inability to meet customer demand for the product.
The pull inventory control system begins with a customer's order. With this strategy, companies only make enough product to fulfill customer's orders. One advantage to the system is that there will be no excess of inventory that needs to be stored, thus reducing inventory levels and the cost of carrying and storing goods.
An example of a pull inventory control system is the just-in-time, or JIT system. The goal is to keep inventory levels to a minimum by only having enough inventory, not more or less, to meet customer demand. The JIT system eliminates waste by reducing the amount of storage space needed for inventory and the costs of storing goods.
One major disadvantage to the pull system is that it is likely that a company will run into ordering dilemmas, such as a supplier not being able to get a shipment out on time. This leaves the company unable to fulfill the order and contributes to customer dissatisfaction.
Some companies have come up with a strategy they call the push-pull inventory control system, which combines the best of both the push and pull strategies. Push-pull is also known as lean inventory strategy. It demands a more accurate forecast of sales and adjusts inventory levels based upon actual sale of goods. The goal is stabilization of the supply chain and the reduction of product shortages which can cause customers to go elsewhere to make their purchases. With the push-pull inventory control system, planners use sophisticated systems to develop guidelines for addressing short - and long-term production needs.
It is difficult for inventory managers to always know how much inventory to order and when. The type of inventory control system will depend in large part on what type of product is being produced. Some items, automobiles for instance, may not be able to be produced with the just-in-time or pull inventory control method.
The production of large items, such as automobiles, is too complex and takes too long to only produce the amount needed to fulfill specific customer orders. Computer companies, such as Dell, are incorporating the push-pull system, where raw materials and goods are pre-ordered and stored, but the actual computer is not assembled until the customer makes an order.
This guide provides everything you need to get started on inventory control. The easy-to-understand expert advice, guidance, formulas, methodologies, policy development and software guidance will help any business—large or small. Included on this page: What Is Inventory Control?Inventory control, also called stock control, is the process of ensuring the right amount of supply is available in an organisation. With the appropriate internal and production controls, the practice ensures the company can meet customer demand and delivers financial elasticity. Successful inventory control requires data from purchases, reorders, shipping, warehousing, storage, receiving, customer satisfaction, loss prevention and turnover. Inventory control enables the maximum amount of profit from the least amount of investment in inventory without affecting customer satisfaction. Done right, it allows companies to assess their current state concerning assets, account balances and financial reports. Inventory control can help avoid problems, such as out-of-stock (stockout) events. For example, Walmart estimated it missed out on $3 billion worth of sales in 2014 because its inadequate inventory control procedures led to stockouts. An integral part of inventory control is supply chain management (SCM), which manages the flow of raw materials, goods and services to the point where the company or customers consume the goods. Warehouse management also squarely falls into the arena of inventory control. This process includes integrating product coding, reorder points and reports, all product details, inventory lists and counts and methods for selling or storing. Warehouse management then synchronises sales and purchases to the stock on hand. Inventory management is a higher-level term that encompasses the complete process of procuring, storing, and making a profit from your merchandise or services. While inventory control and inventory management may seem interchangeable, they are not. Inventory control regulates what is already in the warehouse. Inventory management is broader and regulates everything from what is in the warehouse to how a business gets the inventory there and the item’s final destination. Inventory control practices and policies should apply to more than just finished and raw goods. The following graphic shows all the things a business might manage using these practices. The Reach of Inventory Control: Beyond Finished and Raw Goods
How Inventory Control Can Improve Your BusinessImplementing proper inventory control procedures can help ensure a business is running at optimal financial levels and that products meet customers’ needs and expectations. According to the 2015 “Global State of Multichannel Customer Service Report”, 62% of customers have stopped doing business with a brand whose customer service was poor. Of those customer service complaints, frustration over out-of-stock or backordered items is high on the list. In fact, research about convenience stores shows that out-of-stocks could cause a store to lose one in every 100 customers completely. Additionally, 55% of shoppers in any store would not purchase an alternate item when their regular product is out-of-stock. Other areas where businesses incur expenses or lose sales that inventory control practices and methods could address include:
According to David Pyke, co-author of Inventory and Production Management in Supply Chains, now out in its fourth edition, and professor of operations and supply chain management at the University of San Diego, “owners of small and emerging businesses would be stunned to see how much help they can get and money they can save by wisely managing their inventory. Many small businesses are not rolling in cash, and much of their funding is tied up in their inventory. Good practices balance customer demand and management of inventory in the smartest possible ways.” Tips and Expert Advice for Getting Started With Inventory ControlFully exploring the intricacies of inventory control procedures and theory may be a lot for some businesses. The tips below can help you identify what you need to do before implementing a new inventory control process:
Actionable Advice From an Inventory Management ExpertInventory control expert Dr. Pyke advises, “It’s been my observation that the business world has a weak understanding of inventory management and control. They are trained shallowly, and sometimes they apply only shallow experience to their practices. Sometimes, that works out great. In my 30 years of experience, however, I have seen that a lot of money can be saved by training and managing inventory control in-depth.” “Like Toyota’s Kanban system for optimising setups, there are obviously areas that we can make flow better. Companies should be proactive in their sequencing system, rather than reactive—all while making that balance. If you look at the underlying mechanisms during planning, you can go from there. The system you choose can vary dramatically depending on the situation and can make all the difference in your actual performance.” How to Control Your InventoryAt its core, taking stock is just the process of determining what you have and where you store it so that you can evaluate it. Not all inventory control procedures are ideal for every business or for the varying stages of an organisation’s growth and development. Some methods are too complicated, especially for smaller companies. You should be able to use your system to track inventory levels, create orders and send out stock. Some basic systems for tracking inventory include:
Some businesses prefer to stick to the simple systems of keeping track of inventory. Other companies plan for growth and scaling. You could also track inventory with:
Types of Inventory Control SystemsInventory control and monitoring systems are accounting approaches to track the number of goods on hand. Big companies often monitor inventory across stores, warehouses and even websites. The two main systems are periodic and perpetual tracking systems.
The Periodic Inventory SystemMost small businesses still use periodic inventory management because it does not require sophisticated software or inventory scanning. A periodic inventory system relies upon occasional or regular physical counts of the inventory. You decide accounting periods based on the business needs, but you don’t track inventory daily or continuously. Instead, you record all purchases to a purchase account. Once you conduct the physical inventory, you shift the balance in the purchase account into the inventory account. Finally, you adjust the inventory account to match the cost of the ending stock. You can calculate the cost of ending inventory using either FIFO (first in, first out) or LIFO (last in, first out). The challenges of the periodic system are especially apparent when performing a physical inventory count. Most normal business activities must be suspended during this time because it requires significant manual labour. Many companies hire additional staff and try to perform this outside of regular business hours, such as during a night shift. This type of system incurs more fraud because there is nothing tracking inventory between physical counts, reducing accountability between inventories, and because it is more challenging to determine where any inventory discrepancies occurred. The Perpetual Inventory SystemThe perpetual system may be more expensive to implement than the periodic system due to equipment and software needs. However, the system continuously and immediately updates inventory numbers. This system calculates inventory based on sales and purchases via the point of sale and asset management software. This way, you have accurate stock on-hand accounting at all times. Perpetual tracking is the best way to avoid stockouts when your customers deplete inventory on a particular product. With a perpetual system, you can achieve minimal employee contact with the goods. The challenges of this type of system occur when you use it without also performing physical inventories. In other words, the recorded inventory may not accurately reflect what is physically in-stock as time goes by, never mind accounting for drop shipments or inventory on order. You must account for breakage, stolen goods and loss to ensure the system is accurate. Further, errors and improperly scanned items affect the inventory records. You can handle this mathematically by applying corrections that mostly account for these things. Experts agree, though, that even though physical inventories are not common, you should implement some manual stock taking process to complement a perpetual system. You can integrate these types of systems with supply-chain automation to make quicker decisions informed by data. BarcodesBarcodes can be part of either a perpetual or periodic inventory system. Some may consider the barcodes part of an inventory management system, but in truth, this is equipment that falls under your existing inventory management system. A barcode is essentially a little picture with text or numbers that gets put on each stock item. The text or numbers store a large amount of information. A scanner reads that information and transfers it to a database, which tracks the parts and their locations. The system performs scans when the new inventory arrives and when it is issued out. Barcodes have a rapid return on investment (ROI) by lowering operating expenses once implemented, even for small businesses. Other benefits of barcoding include:
Implementing barcodes on inventory is a smart idea because they offer scalability and accuracy, even to small and growing businesses. Radio Frequency Identification (RFID)RFID tags are also a type of equipment that falls under an existing inventory management system. RFID tags are a type of smart tracking. RFID tags contain electronically stored information, more information than is possible with conventional barcodes. Tags can be passive or active: Active RFID tags include batteries, whereas passive tags do not have batteries. The RFID reader supplies the power for passive tags through radio waves, whereas active tags send out their radio waves. Both types of tags automatically update to identify the stock and capture any associated data. RFID tags are an effective way to protect high-value items and products that require additional security compliance, such as pharmaceuticals. Active tags are the best course in businesses where inventory security has been an issue. Although security is the primary benefit of RFID, other features include:
Some challenges with using RFIDs include:
If you are considering using RFID tags, they have become cheaper in recent years. Experts say the best use of RFID tags is to place them at high-risk points close to your stock, such as at exits. Finally, for products with a limited shelf life, an RFID system can provide information to ensure quality control, such as when they were brought in and their expiration dates(if relevant). A recent trend among small businesses is the use of QR codes, which are like barcodes, but you don’t need to buy expensive equipment to read them. You can install an app on a smartphone that reads QR codes. They also carry more information than a barcode because of their matrix-like patterns. QR codes are not active systems like active RFID tags and not nearly as expensive. Methods of Inventory ControlInventory control methods are the ways you use your business’s strengths and relationships, your expertise, formulas and forecasts to determine how much supply you keep, sell, store and order. Effective inventory control balances controlling costs and meeting customer demands. A company’s days of inventory outstanding (DIO) measures how many days a company holds stock before selling it. The DIO is an efficiency measure because inventory ties up funds. The lower the DIO the better, especially for a small business. DIO scores have increased in the past five years by 8.3%, meaning that companies have poorer inventory control practices. Additionally, there is a need to increase warehouse space, which means… The Correlation Between DIO and Warehouse Space
The most effective inventory control methodology can vary between companies. Whichever methodology you choose, it should be clear to employees and have well-defined policies and procedures. If you use software with your methodology, look at systems that boast the key features your company needs, not just a one-size-fits-all package. Organisational control starts with labelling items, whether via SKUs or a more complex system. Quality control requires having quality standards and policy for staff to follow. Inventory control best practices include:
Management Methodologies Used in Inventory ControlMany inventory control and management methodologies are relevant to all industries, whether you are a shoe retailer or a big oil company. The different management methodologies:
Methods to Replenish StockThere are many ways to control stock, whether you use techniques that specify when to order, forecasting formulas or selling and storing techniques. Ways to control stock by when or how you order goods or materials include:
Control Stock With How You Sell ItYou can also control stock with how you sell it. In some cases, the stock is not even a part of your onsite inventory, but you can still control it. Here’s how based on when or how you sell your products:
Forecasting for Inventory ControlInstead of using a manual method to reorder, look at ways to mathematically forecast what is in stock or when to order. These methods can include categorising your stock, such as in the ABC method, but mainly show what you currently have in store:
Let’s say that Ava has to calculate the ROP for the liquid bandages her company manufactures in its facility. She calculates the safety stock (SS) for this product at 50 units. She then calculates the Lead Time Demand (LTD) for that product. Her manufacturing department uses 20 units of raw materials per day, and it takes about five days for a reorder of those materials to arrive. Using this information, she can calculate the ROP: If stock for liquid bandages falls below 150 units, then Ava must place a reorder. Follow this handy chart to calculate your ROP: “Inventory management gets complicated very quickly, explains Dr. Pyke. “For example, a reorder point model has a trigger. So, the order fixed quantity is hopefully set up in a way that optimises the trade-offs involved (i.e. too much versus not enough). When I am helping a business, this is where I usually start their training. Moreover, problems often come in manufacturing when there are lags between the startups and process changeovers—for instance, an ice cream manufacturer changing over from chocolate to vanilla versus vanilla to chocolate. In the latter example, going from vanilla to chocolate, there are fewer complications and problems. Also, chocolate covers over a multitude of sins! However, when you go from the more complex (chocolate in this scenario) to the less complex (vanilla) process, it can take longer and add unnecessary layers of complexity.”
Let’s say that Ava wants to know the optimal number of size 12 glass bottles she wants to have in-stock for production. They are quite costly to purchase and store, so she must calculate the EOQ. Ava’s production team uses 1,000 size 12 glass bottles annually. It costs her firm about $3 per year to hold that bottle in inventory, and the fixed cost to place an order is $5. Therefore, What EOQ Means
The ideal order size to minimise costs and meet customer demand is a little more than 33 size 12 glass bottles. Now that you have the ideal quantity, you can also use the ROP formula to determine the perfect timing to order these size 12 glass bottles. Follow this handy chart to calculate your EOQ: Supply Chain Inventory ControlThere are some options for controlling your inventory along the supply chain. Whether you are on the production side or within the warehouse, these techniques can help. Supply Chain Inventory Control Techniques
Stock Quantities: How Much to KeepThe type of stock (raw, unfinished, finished or consumable) you have can also determine how much you should keep on hand. For raw stock, look at the following factors:
Unfinished stock, also called work-in-progress (WIP), costs you in storage space but is often beneficial. You can add an extra level of protection to your production with unfinished stock. For example, if you have a machine in the middle of a process that is at risk of breaking down, you can pull the unfinished stock to bypass that part of the process. Keep extra finished stock around when you identify a product’s demand or when you are confident that your batch productions are adequate. You would also naturally have extra finished stock around when you are completing a large order. How much consumable product stock you should keep around also depends on the reliability of your suppliers. If the demand for those products is well-known and steady, you may want to keep extra. Further, if you expect price rises or get a significant discount for bulk buying, having additional consumable stock is acceptable. Inventory Control Policies and ProcessesInventory control starts the moment goods enter your organisation, whether through the front door or via a receiving dock. Developing standard operating procedures (SOPs) can help everyone understand their responsibilities related to stock. SOPs are step-by-step instructions that define routine activities. What to Include in an SOPIn the case of inventory control, the SOP should, at a minimum, address:
If you are developing new SOPs, clearly define policies and processes, and ask staff members (especially new ones) to review them for understandability. Additional tips for inventory control policies include:
Basic Invoice Control PoliciesEffective invoice control policies should inform staff about how your business invoices customers, including the schedule, forms and procedures. Developing reliable basic invoice control policies and procedures ensures you collect the hard-earned income from your products or services. Invoices are typically sent after order fulfilment. Your invoice policies can be templates and should be clear and simple so that staff can follow them without many issues. The invoice types you need to control are:
Inventory Control ProcessesInventory control processes are the actions and techniques you use to organise inventory and measure the gaps, opportunities and relative success of ordering and production. Many companies use KPIs to measure the success of their processes and procedures. Some companies are so worried about not having enough inventory, they overstock, which costs them more than just the price of goods. Since they tie up their capital, they must store their products at a cost, and they can become damaged or depreciated. Break down your inventory into three basic categories:
When developing inventory control processes, determine if you should also simultaneously perform a business assessment. You should assess business functions and processes, particularly in the order-to-delivery (OTD) process, in the as-is state to identify the gaps and opportunities for change. Change management principles should take you from the as-is state through the implementation of your to-be changes. If you want to serve customers better, determine how your inventory control policies and processes affect them. Key Performance Indicators in Inventory ControlKey performance indicators (KPIs) are metrics that demonstrate how well portions of your company are functioning and how well you are achieving your key business objectives. KPIs are also useful for comparing your business to others in your industry. In inventory control, KPIs can help identify pain points and why you are losing money. If you are having stockouts, you will want to fix them so you can keep customers. You will want to look at your long-term and short-term goals using KPIs. Therefore, certain KPIs make sense to run regularly. For example, a stock-to-sales ratio is one KPI that can track forecasting: Another KPI is sell-through-rate (STR), which helps retain customers. Use the STR as a metric to identify how long a product is in stock, if you need to reprice it and when to reorder. This metric is often compared to the inventory turnover rate, which has a longer period to calculate (often a full year). The sell-through-rate KPI compares stock received through a supplier to determine how much you sell monthly: Average inventory is a KPI that helps you understand how many products you are storing over specified periods: Finally, the fill rate is a KPI that tells you how well you fulfilled your orders for single deliveries or for deliveries over a given time. This KPI is also called line item fill rate (LIFR), with the term “line” referring to the line on an order or manifest. The formula for LIFR is: Another formula that determines LIFR is: A fulfilled order is complete when it is at 100%. For example, Jack Heinz orders four products: This company shipped lines one through three (the seamless carbon steel pipes, copper pipes and plastic trench drain with grates) on May 20, 2019. When the company ran the LIFR, it was noted as 75%, because there were four line items, of which only three were filled: The company shipped out the 90-degree threaded fitting on line four on May 24, 2019, bringing the LIFR to 100%. However, if your metric focuses on customer satisfaction based on fulfilling orders immediately, keep the metric for only the initial rate. The initial LIFR is 75% and undoubtedly provides more information than the final LIFR. You can also calculate fill rates by case and value. When you expedite items outside the total shipment, you cannot count those non-expedited items as having been misses, and you should factor out the expedited items. In other words, your primary concern should be how your business fills orders regularly, not during exceptions. For more KPIs to track, see “3 Critical Inventory Accounting Metrics You Should Be Tracking.” Inventory Control SoftwareManually controlling inventory has its challenges: It can be labour-intensive, difficult to share, prone to human errors, create excess paperwork you do not need and require continuous monitoring and fact-checking. According to Dr. Pyke, one software solution doesn’t fit all organisations. He says, “there are systems that integrate with existing ERP (enterprise resource planning) systems. Some organisations have developed their own systems, taking their best thinking, and developing what they need exactly in-house. When I consult, I often help small businesses develop their own spreadsheets to start. One of the companies I advise is a large software company, and their software is excellent and can do major things for their company. These systems do exist for smaller companies, but there are also inexpensive options that can do just as good a job.” 4 Questions to Ask Before Buying Advanced Inventory Tracking SoftwareIf you are starting to look at advanced software to track inventory, you will need to approach it carefully and thoughtfully. Choose inventory control software by answering four main questions:
Getting Started With Inventory Control SoftwareTo effectively control your inventory, you need item-level visibility—something software can provide if you use it consistently. In this case, consistent use means that every staff member uses it the same way every time they produce, sell or receive goods. Software can provide many things at your fingertips. For example, you always know what’s been sold and how fast, any unique offers and discontinued products. You have an electronic version of each transaction, which can include the part number, quantity and when and where you sold it. For more information on why to buy inventory control software, see “Lower Your Costs by Using Inventory Tracking Software”. Other advantages of having dedicated inventory control software include:
To get started, look for the software with features that support your business’s needs and future. When looking for new inventory control software, consider these features:
When looking at any system, it’s important to keep in mind future needs and how technology can help. Dr. Pyke shares, “There is a big animal called forecasting coming. Everyone wants to predict everything underlying every purchasing decision that consumers make. Machine learning and the vast data amounts will only make the ability to forecast better. Taking advantage of that ability in a way that does not cost too much is the future of this industry. “Blockchain in the supply chain is also up-and-coming. You do not need blockchain to be valuable, but the visibility to what is out there will improve. Over time, it will be interesting to see what is real and what is hype, but it all will have an impact, regardless. My advice is for businesses to sit on the sidelines for a bit and see what happens. Eventually, companies will be able to use it for improvements in inventory management.” For more information on features you should look for to support your business, see “3 Key Features to Look for When Selecting Inventory Management Software.” The Best Practices of Using Inventory Control SoftwareWhether you use a dedicated software system or spreadsheets, you still need to follow some best practices. Use whatever tools are on hand to optimise inventory levels. Once you have inventory control software set up, follow these tips:
You should also ensure that you do not purchase something too complicated for what your company needs and that the software is worth the cost. If you don’t, it’s not just a waste of money, but you could end up needlessly frustrated. If your software comes with analytics capacity, though, make sure you perform the measurement. If you bought or are looking to purchase inventory control software, use it to perform the following calculations:
For more information on choosing the right inventory management system, see “Choosing the Right Inventory Management System.” How to Keep Your Stock SecureEnsuring your stock is secure should also be top of mind when thinking about inventory control. Whether your concern is thieves and shoplifters or your employees, stock security affects the bottom line. To protect your goods from people who would steal them out your front door, identify which inventory is the costliest or the most desirable. For example, laundry detergent and razor blades are high-target commodities. Everyone needs them; they are sure to resell and are amongst the most stolen items in any grocery store. These products should be accessible to customers but placed in a high-visibility place if you have problems with theft. You should fit expensive, high-end items such as computers and electronics with RFID tags that can add security. An alarm will sound if they are removed. Be sure to secure deliveries after their arrival. Before you log items into your system is a prime time for them to get lost or stolen. Dispose of any additional packing materials, so thieves do not get the idea that a delivery just took place. If possible, install closed-circuit television (CCTV), also called video surveillance, in your parking lots and other vulnerable locations to deflect potential theft. An outside threat isn’t the only security concern you should have. Staff can steal, too. Train your team on the security systems in place and policies that address theft and its discipline. Many people are unaware of the toll theft takes on a business, including the costs of staff turnover and job security. So, train your staff to understand the true effects of stealing. By setting up procedures that prevent theft, you can stave it off before it occurs. For example, staff who oversee stock should not also monitor the company’s financial records. Restrict access areas to personnel, and distribute responsibility. Consider whether all staff require access to every portion of your warehouse or every supply cupboard. Assign staff responsible for auditing to assist other staff with their supply needs. Regularly reassign staff to stock control to prevent collusion. Finally, consider if you’re using the functions in existing software to their best ability. The National Retail Federation finds that internal theft is down a minimum of 11% in businesses that use inventory management software. NetSuite Can Help Provide Visibility Into Your Inventory Control ProcessProperly managing inventory can make or break a business, and having insight into your stock at any given moment is critical to success. Regardless of the type of inventory control process you choose, decision-makers know they need the right tools in place so they can manage their inventory effectively. NetSuite offers a suite of native tools for tracking inventory in multiple locations, determining reorder points and managing safety stock and cycle counts. Find the right balance between demand and supply across your entire organisation with the demand planning and distribution requirements planning features. Learn more about how you can use NetSuite to manage inventory automatically, reduce handling costs and increase cash flow. |