Retail inventory management is something we’ve discussed in depth, however, we barely touched the topic of inventory management methods. This is because we had to create a separate guide to make a clear distinction.
There is no one hard and fast set of inventory management methods that all retailers, distributors, and wholesalers must follow. These are just the general classifications of the various techniques that can be used for managing one’s inventory.
In this article, we’ll go through all the industry-standard inventory management methods and techniques we were able to find, online and by learning from hundreds of our retailer, wholesaler, and distributor clients who love and use ProfitBooks Inventory Management Software, that solve complex inventory problems, simply!
Let’s get started!
What Is Retail Inventory Management?
Retail inventory management refers to the strategic process through which retailers, wholesalers, and distributors monitor, control, and optimize their stock of goods.
It involves efficiently handling the procurement, storage, and distribution of products to meet customer demand while minimizing costs and maximizing profits.
The process incorporates advanced technologies like inventory management software and barcoding systems for real-time tracking, enabling businesses to enhance operational efficiency and customer satisfaction while navigating the complexities of supply chains and market dynamics.
The 2 Common Retail Inventory Management Techniques
There are two widely-used approaches to handle inventory: Periodic and Perpetual. Let’s break down the distinctions.
Periodic Inventory Management
Periodic inventory management involves assessing inventory and its value at scheduled intervals. With this method, the staff physically counts every item in stock, usually at the end of an accounting period. This process yields an ending inventory balance, which can be compared to the opening inventory balance to determine the average inventory.
This average inventory is then utilized alongside inventory accounting metrics like Cost of Goods Sold (COGS) to compute figures such as the inventory turnover ratio.
Perpetual Inventory Management
On the other hand, perpetual inventory management is a method where inventory and its value are consistently measured. In perpetual inventory systems, the quantity or volume of goods is tracked in near-real time, and stock-on-hand values are continuously updated. COGS is often calculated using the average landed cost methodology, considering a weighted average of different prices paid for goods to ascertain their value.
The 7 Major Inventory Manegement Methods We’ve Identified
In the realm of business and product analysis, companies employ diverse inventory management methods tailored to their specific needs. The gamut of options includes just-in-time (JIT) manufacturing, materials requirement planning (MRP), economic order quantity (EOQ), days sales of inventory (DSI), as well as established practices like First-in-First-out (FIFO), Last-in-First-out (LIFO), and Dropshipping.
While there exist other approaches, these seven represent the most prevalent inventory management methods in use today. Notably, some methods are innovative, exclusive to the 21st century, while the majority are tried-and-true inventory management methods that have withstood the test of time.
The strategic application of these inventory management methods is crucial for businesses aiming to streamline operations, minimize costs, and optimize their supply chains.
1. Just-in-Time Management (JIT) Inventory Management Methods
This strategy enables companies to save substantial funds and minimize waste by only maintaining the necessary inventory for production and sales. By doing so, it cuts down on storage and insurance expenses, along with the costs associated with disposing of excess stock.
By the way, this manufacturing concept emerged in Japan during the 1960s and 1970s, with Toyota Motor (TM) playing a pivotal role in its evolution.
However, just-in-time (JIT) inventory management carries inherent risks.
A sudden surge in demand can pose challenges, as manufacturers may struggle to procure the required inventory promptly, potentially harming their reputation and diverting business to competitors. Even minor delays can be troublesome; a delay in a crucial input’s arrival, not happening “just in time,” can create bottlenecks in the production process.
2. Materials Requirement Planning (MRP)
This approach to managing inventory relies on sales forecasts, indicating that manufacturers need precise sales data to effectively plan their inventory requirements and communicate these needs to suppliers promptly.
In practical terms, let’s consider a bicycle manufacturer utilizing this system. They would keep materials like steel, rubber, gears, and frames in stock based on projected orders. If there’s a lapse in accurately predicting sales and planning for inventory procurement, it could lead to the manufacturer being unable to meet customer orders promptly.
In essence, the success of this method hinges on the manufacturer’s ability to stay ahead of market demand, ensuring a seamless flow of materials for production and timely delivery of quality products.
If you’re considering integrating an MRP system into your company, it’s crucial to understand its functioning beforehand.
Step 1 – Explosion:
This involves utilizing the Bill of Materials (BOM), outlining the components required for manufacturing a single item.
Step 2 – Netting:
The net material quantity is determined by calculating the difference between the available stock in the factory and the overall gross requirement, as derived from the explosion.
Step 3 – Offsetting:
Estimating the lead time for the entire operation enables practitioners to calculate the expected manufacturing duration. It also provides guidance on when to initiate the manufacturing process to ensure items are ready by the promised date.
3. Economic Order Quantity (EOQ)
In the realm of inventory management, this approach involves using a model to figure out how many units a company should include in each batch order. The goal is to cut down on overall inventory costs while maintaining a consistent level of consumer demand. The model factors in expenses related to holding and setup.
(source: BlueCart)
Essentially, the EOQ model is one of those inventory management methods that strives to strike a balance.
It aims to ensure that a company orders the optimal quantity of inventory in each batch, preventing the need for frequent orders or the accumulation of excess stock.
The key assumption is that there’s a trade-off between the costs of holding inventory and the costs associated with setting up new inventory. The model’s objective is to minimize total inventory costs by simultaneously minimizing setup costs and holding costs.
How to calculate EOQ?
Here’s the straightforward formula to calculate EOQ in inventory management methods:
EOQ = √ (2 x Demand x Order Cost / Holding Cost)
To figure out the economic order quantity, start by gathering some key details related to demand and expenses.
These include the yearly product demand in units, the cost incurred for each order, and the annual holding cost per unit. Once you’ve got this information in hand, it’s a straightforward process of plugging these numbers into the formula we mentioned above.
4. Days Sales of Inventory (DSI)
This financial metric reveals the average number of days it takes for a company to transform its inventory, including works in progress, into actual sales. DSI, or Days Sales of Inventory, goes by various names such as average age of inventory, days inventory outstanding (DIO), days in inventory (DII), and days inventory. Its interpretation varies, touching on different aspects.
Essentially, DSI signals the liquidity of a company’s inventory, representing the number of days its current stock is expected to last. In general, a lower DSI is preferable as it suggests a quicker turnover of inventory.
However, it’s important to note that the acceptable average DSI can differ from one industry to another. This metric serves as a valuable gauge of a company’s efficiency in managing and selling its inventory.
Here’s the simple formula that you can use to calculate your inventory’s DSI in inventory management methods:
(source: WallStreetMojo)
5. First-in-first-out (FIFO) – Inventory Management Methods
(source: Investopedia)
First In, First Out (FIFO) is among the inventory management methods that prioritize using the oldest stock before newer items.
Operating on a principle similar to a grocery store checkout line, FIFO ensures that the goods received first are sold or used first.
This method facilitates a chronological flow of inventory, effectively minimizing the risk of product obsolescence and spoilage.
Particularly beneficial in industries with perishable goods or evolving product specifications, FIFO stands out among various inventory management methods due to its practicality and widespread application.
6. Last-In-First-Out (LIFO) – Inventory Management Methods
(source: Investopedia)
Last In, First Out (LIFO) is an inventory management method where the latest acquired or produced goods are the first to be sold or used.
Picture it like a stack of goods; the newest ones are the ones on top, and those are the ones you sell first. In a professional context, LIFO is a cost accounting approach. It assumes that the most recent items in inventory are the ones sold first, impacting financials by attributing the latest costs to goods sold.
While it mirrors real-world scenarios, it’s less common due to tax implications and the potential distortion of financial statements.
We have compared FIFO and LIFO inventory management methods in one of our guides. We’d recommend that you go through it, if you’d like to know more about this method of managing your retail inventory.
7. Dropshipping
In the dynamic landscape of retail, dropshipping has emerged as a modern and highly effective inventory management method, revolutionizing the 21st-century approach to commerce.
Originating as a streamlined solution to the challenges of traditional inventory management, dropshipping gained prominence in the early 2000s. The concept involves a retailer partnering with suppliers who directly ship products to customers, bypassing the need for the retailer to stock inventory.
How does dropshipping work?
The process kicks off when a customer places an order on the retailer’s platform, which can be an ecommerce platform like Shopify.
Instead of the retailer physically housing the products, the order details are relayed directly to a network of suppliers or wholesalers.
These suppliers, often manufacturers or third-party vendors, are responsible for packaging and shipping the product directly to the end customer.
This seamless arrangement not only minimizes the retailer’s involvement in warehousing but also significantly reduces upfront costs and risks associated with maintaining large inventories.
Dropshipping’s appeal lies in its simplicity and efficiency.
Retailers can offer a wide range of products without dealing with physical stock, giving them flexibility in responding to market trends. This approach is especially useful for startups and small businesses entering e-commerce without the usual financial constraints of inventory management.
In essence, dropshipping represents a symbiotic relationship between retailers and suppliers, creating a nimble and scalable model well-suited to the digital age.
10 Lesser-Practiced Inventory Management Methods Retailers Should Know
- ABC Analysis: This approach identifies the popularity of items by considering inventory value, cost significance, and annual consumption units.
- Batch Tracking: A quality control method, Batch Tracking groups similar items for monitoring, enabling the tracking of defective items back to their batch or management of inventory expiration.
- Bulk Shipment: This method involves buying and shipping items in bulk to reduce costs, commonly used for high-demand goods. However, it may increase warehousing costs due to large inventory holdings.
- Consignment Inventory: Involves a wholesaler placing goods with a retailer but retaining ownership until sold, allowing the retailer to purchase only the sold stock.
- Cross-docking: This technique minimizes inventory holding by sorting and preparing products for immediate shipment upon arrival at a warehouse.
- Cycle counting: A method involving periodic small-scale inventory counts to regularly validate accurate inventory levels in management software.
- Lean Manufacturing: A set of management techniques aimed at increasing efficiency by eliminating waste and non-value-adding activities.
- Safety Stock: Ordering extra inventory to prevent stockouts caused by inaccurate forecasting or unexpected changes in consumer demand.
- Six Sigma: A technique empowering businesses to enhance performance and reduce surplus inventory.
- Lean Six Sigma: Combines Six Sigma with the lean method to optimize stock flow and further reduce surplus inventory.
Conclusion
Recognizing the significance of inventory management is crucial.
Whether operating as an online business, brick-and-mortar store, or utilizing various sales channels, maintaining proper inventory management methods is essential for competitiveness and providing a satisfactory consumer experience.
Opting for specialized inventory management software stands out as the optimal solution for efficient inventory control and wise investment in stock. Identifying the right time to implement such software is a vital milestone in your company’s growth.
Ensure that the chosen inventory management software excels in fundamental inventory management principles, serving as a catalyst for your business expansion, such as ProfitBooks Inventory Management System.
ProfitBooks’ 100% FREE solution to retailers, wholesalers, and distributors has won the trust of hundreds of retailers and suppliers all over the globe, in the last decade that we’ve been in business.