Inventory Management: Benefits, Process, and Best Methods

by Jaidyn Farar

As a thriving ecommerce business, your inventory is your greatest asset.

But it can also be your greatest liability.

When you sell and ship inventory quickly, continually replenishing it with new products, you’re not just making money—you’re also giving customers a great experience with your brand. On the other hand, if inventory runs out frequently or sits in your warehouse for months, you’re losing money and giving buyers a bad impression.

With the right inventory management techniques and technology, you’ll ensure that your inventory works for you, not against you. 

What is inventory management?

Inventory management is the process of monitoring and controlling the flow of goods through the supply chain. In addition to ordering, organizing, storing, and selling finished products, inventory management includes managing raw materials and product components.

The goal of inventory management is to achieve a balance, keeping enough stock on hand to meet customer demand without ever having too much or too little. You do this by forecasting demand, tracking inventory levels, and replenishing at the optimal times. 

Calculating inventory turnover

Inventory turnover is the rate at which you sell and replenish goods. A high inventory turnover ratio means you’re quickly selling and replenishing inventory, while a low one means you’re tying up cash in products that don’t sell.

Calculate inventory turnover using this formula:

Inventory turnover  = COGS (cost of goods sold) / average inventory

COGS represents the costs associated with producing or purchasing the goods you sell during a specific period. It includes the cost of raw materials, direct labor, and indirect expenses related to the production of goods. Average inventory can be calculated by adding your starting and ending inventory levels and dividing by two.

To optimize inventory turnover and automate the monitoring and reordering process, businesses use inventory management systems that integrate seamlessly with the other solutions in their tech stack.

Factors that affect inventory

Many factors affect your inventory, including the following: 

• Seasonality. Consumer demand fluctuates based on changing seasons, holidays, or specific times of the year. Changes in the timing and volume of product demand will require your businesses to adjust inventory levels.
• Promotions and sales. Promotions and sales often create spikes in demand. You’ll need to meet increased demand during promotional periods while avoiding overstocking once the promotion concludes.
• Supply chain disruptions. Disruptions in the supply chain, such as natural disasters, geopolitical events, or supplier issues, can impact the availability of raw materials or finished goods, leading to inventory shortages.
• Returns. Returns require you to account for returned items, assess their condition, and possibly restock or liquidate them.

What counts as inventory?

Inventory doesn’t just include finished products; it also includes the raw materials and supplies used to create those products. 

• Raw goods. Raw goods are unprocessed materials used in manufacturing, including things like wood, metal, plastic, and fabric.
• Work in progress (WIP) goods. WIPs are in the process of being manufactured but aren’t yet finished. 
• Finished goods. Finished goods have completed the manufacturing process and are available for customers to purchase.
• Maintenance repair and operation (MRO) goods. An MRO is used in production but is not part of the final product. This can include things like equipment and cleaning supplies. 

What does the inventory management process look like?

The inventory management process begins with anticipating the products you’ll sell within a set period (forecasting demand) and includes ordering, organizing, storing, monitoring, selling, and replenishing that inventory. 

1. Demand forecasting

Demand forecasting is a strategic process that involves analyzing historical sales data, studying market trends, and considering other relevant factors to predict future demand. Once a business has forecasted demand, they order new inventory to meet anticipated needs. 

Accurate demand forecasting helps organizations optimize their stock levels, focusing on products that will sell quickly and yield maximum profits.

2. Inventory delivery, inspection, and storage

Once a merchant has ordered inventory, suppliers deliver it to their facility. There, the stock is inspected to ensure nothing is missing or damaged. Afterward, warehouse staff members sort and store inventory in designated locations. In the process, new stock is entered into the warehouse management system (WMS), which logs the location of each SKU (stock keeping unit). 

3. Inventory level monitoring

Inventory visibility is crucial to a smooth order fulfillment operation, and it’s especially important for organizations that have adopted an omnichannel strategy. 

Without full visibility into stock levels, you’ll likely run into delays while picking and packing orders. Worse, you could run out of essential stock or over-order less important items. Ultimately, inaccurate inventory data can lead to costly errors and disruptions in supply chain operations.

Businesses have several options for monitoring inventory:

• Physical inventory counts. One method of monitoring inventory is physically counting all stock once or twice a year.
• Perpetual inventory management system. A perpetual inventory management system tracks inventory in real time.
• Periodic inventory management system. Unlike perpetual inventory management systems, periodic systems require physical inventory counts at the beginning and end of a period.
• Cycle counts. Cycle counting involves counting certain stock, such as fast-moving SKUs, on a regular basis. This helps verify that the information in your inventory management system is consistent with the actual inventory on hand.

In addition to your inventory management system, supply chain analytics tools like EasyPost Analytics provide valuable insights into inventory data. These tools provide real-time visibility into available inventory, including stock location, in-stock rates, and inventory depth.

4. Order placement and processing

With inventory levels being continually monitored and updated, online shoppers can easily see what’s available to purchase. When these customers place online orders, they initiate the order processing stage. 

Order information is sent to the warehouse system, which generates a picking slip that shows staff where products are located. Workers identify products using SKU numbers, pick them from stock, and bring them to the packing station, where they’re placed in the appropriate packaging. From there, packages receive a shipping label, and carriers pick them up to deliver them to customers.

5. Inventory replenishment

As stock is sold, the inventory management system automatically updates to reflect current stock levels and proactively identifies low-stock items. When inventory of products nears or drops below certain predetermined points, the system sends an alert that it’s time to reorder.

The benefits of inventory management in logistics

Effective inventory management will help you save time, optimize your warehouse operations, and provide a top-notch customer experience.

• Avoid stockouts and overstocking. Stockouts and overstocks are both problematic—depending on the situation, you’ll either miss out on revenue or restrict your cash flow. With proper inventory management, you won’t have to worry about either. 
• Avoid spoilage and dead stock. If you sell perishables like food, overstocks can lead to expired products that can’t be sold. Similarly, dead stock can’t sell because it’s gone out of style or become obsolete. Inventory management helps you anticipate demand and buy only what you can sell within a specified timeframe.
• Cut storage costs. You pay to store every SKU in your warehouse—and warehouse space doesn’t come cheap. Managing inventory helps you optimize storage space, thereby cutting costs.
• Improve cash flow. By keeping a leaner inventory (like Targetopen_in_new and other big brands have focused on in 2024), you’ll be able to stay profitable without tying up cash in inventory that doesn’t sell. 
• Increase customer satisfaction. Good inventory management on your end contributes to a better buying experience for customers. With a well-stocked, well-organized warehouse, you’ll be able to fulfill orders quickly and accurately.

Now that we’ve covered the importance of inventory management, let’s look at some of the challenges that might stand in your way—plus solutions for overcoming them.

Inventory management challenges

The most significant inventory management challenges organizations face include overstocks and stockouts, lack of inventory visibility, inefficient processes, and poor inventory distribution.

Overstocks and stockouts

Overstocks tie up capital and warehouse space, while stockouts result in lost sales, dissatisfied customers, and a damaged reputation. Though overstocks and stockouts can be caused by several factors, the best solution is to implement demand forecasting and inventory analytics tools to better predict demand and adjust inventory stock accordingly. 

Lack of real-time stock visibility

Without real-time visibility into inventory levels, businesses may struggle with inefficiencies, delayed order fulfillment, and increased risk of stockouts or overstocks. Implementing an integrated inventory management system with barcode scanning and RFID technology can provide real-time visibility into stock levels across warehouses and distribution centers.

Inefficient processes

Inefficient inventory management leads to wasted time, increased labor costs, and mistakes in order fulfillment. In turn, these seemingly small inefficiencies can contribute to delayed order processing, poor customer service, and higher operational expenses. 

One potential solution? Streamline and automate inventory management processes with advanced software systems and workflow automation tools. Conducting regular process audits and employee training programs can also help identify and address inefficiencies.

Inventory distribution

A distributed inventory strategy involves storing and shipping inventory from several distribution centers located in different geographic areas. When executed well, this strategy helps businesses effectively meet demand in varying parts of the country, shipping orders quickly and reducing shipping costs. 

Unfortunately, failure to have inventory readily available where it's needed can have the opposite effect: delayed order fulfillment, increased shipping times, and higher delivery costs. Using data analytics and demand forecasting techniques can help in identifying high-demand regions and adjusting inventory placement accordingly.

Inventory management methods and techniques

Organizations use a variety of inventory management methods and techniques. The following strategies can help you manage your inventory effectively, overcoming the challenges discussed above. 

ABC analysis

ABC analysis categorizes inventory items into three groups based on their importance, with A being the most important and C being the least. 

• A stock represents 80% of your revenue
• B stock represents 15% of your revenue
• C stock represents 5% of your revenue

Because the A category consists of the most valuable inventory, it requires tighter inventory control and greater attention to avoid stockouts; you never want to run out of these products. On the other hand, products in the C category should probably be discounted to help them sell faster. 

Batch tracking

Batch tracking involves grouping items with similar properties—such as expiration date or manufacturing location—in order to ensure product quality. If you discover that a product is defective, batch tracking can reveal the source of the issue and streamline the recall process.

Bulk shipments

Bulk shipping involves transporting large quantities of inventory items in a single shipment. Because it’s cheaper to ship more items at once, ordering inventory in bulk will reduce transportation costs. If you place a large order, suppliers may even give you a discount on the goods themselves.

Consignment inventory

Under the consignment model, suppliers send inventory to your business but don’t transfer ownership until products are sold. This provides you with a wider product selection and reduces the upfront cost of purchasing goods from suppliers. 

Cross-docking

Cross-docking is a logistics strategy where goods are unloaded from inbound transportation and immediately loaded onto outbound transportation, bypassing storage. This reduces inventory holding costs, minimizes handling, and speeds up order fulfillment. 

Demand forecasting

Demand forecasting involves predicting future demand for products based on historical sales data, market trends, and other relevant factors. 

With accurate forecasting, you’ll optimize inventory levels, reduce stockouts, and improve customer satisfaction by having the right products available at the right time. On the other hand, inaccurate forecasts can lead to overstocking or stockouts.

Dropshipping

Dropshipping is a fulfillment method where businesses sell products without keeping them in stock. When a customer places an order, the merchant purchases the product from a supplier, who ships it directly to the customer. 

Dropshipping reduces inventory holding costs and eliminates the need for warehousing, but it decreases your control over product quality and fulfillment times.

Economic order quantity (EOQ)

EOQ is a formula used to determine the optimal amount of inventory a company should order to meet demand and minimize holding costs. It helps you strike a balance between ordering too much, leading to excess inventory, and ordering too little, resulting in stockouts. Keep in mind that EOQ works best for situations where demand doesn’t fluctuate much.

FIFO and LIFO

FIFO (first in, first out) and LIFO (last in, first out) are inventory valuation methods that determine the cost of goods sold and the value of ending inventory. 

FIFO assumes that the oldest inventory is sold first, while LIFO assumes that the newest inventory is sold first. Each method has tax and financial reporting implications, and the choice can impact profitability and inventory valuation accuracy.

Just-in-time (JIT) inventory 

JIT is an inventory management approach where businesses keep inventory levels as low as possible to still meet demand. 

When goods are acquired only as needed, you minimize inventory holding costs and reduce waste. This improves efficiency, but it requires very precise demand forecasting. If you face unexpected supply chain disruptions, your business could end up unable to meet customer demand. 

Lean manufacturing

The goal of lean manufacturing is to minimize waste and maximize efficiency in production processes by eliminating non-value-added activities. It improves inventory management by reducing excess inventory, lead times, and production costs while increasing flexibility and responsiveness. 

Materials requirements planning (MRP)

MRP is a software-based inventory management system that helps businesses plan and manage materials needed for production based on demand forecasts and production schedules. The system helps ensure the availability of materials at the right time and in the right quantity.

Perpetual inventory management

Perpetual inventory management involves continuously updating inventory records in real time, providing accurate and up-to-date inventory information. This enables better inventory control, reduces the risk of stockouts or overstocks, and improves decision-making. However, it requires robust inventory tracking systems that may require lots of resources to maintain.

Reorder point formula

The reorder point formula calculates the inventory level at which a new order should be placed to replenish stock before it runs out. Considering factors like lead time, demand variability, and safety stock, the formula helps businesses maintain adequate inventory levels to meet consumer demand. 

Safety stock

Safety stock is extra inventory held to decrease the risk of stockouts. It acts as a buffer, keeping popular products in stock and available even if demand fluctuates or your supply chain is disrupted. A word of caution, though: holding too much safety stock can tie up capital and increase holding costs.

Six Sigma

Six Sigma is a data-driven methodology that helps businesses optimize inventory management. Because implementing Six Sigma can require significant investment in training and resources, it may not be the right option for every organization.

Choosing the right  inventory management software

An inventory management system is essential for monitoring stock levels and movement and letting you know when it’s time to replenish. With the right inventory management software, you’ll keep your most popular products available across all sales channels.

Smaller businesses sometimes often use periodic inventory management systems, which require occasional manual inventory counts. But at the enterprise level, you need a perpetual system that continually tracks stock levels in real time. 

Choosing the right inventory management software is an important decision. If you’re not sure how to approach it, consider bringing in an outside expert to make sure you’re getting exactly what your business needs. 

Streamline logistics from start to finish with EasyPost Analytics

Streamlined logistics operations start with the right data. When used strategically, data improves every supply chain decision you make, from your warehouse locations and layouts to your inventory management methods to the shipping carriers you work with.

EasyPost Analytics is a modern analytics platform that gathers all your warehouse and inventory data in one place, allowing you to make more informed decisions. The platform can help with the following (and much more):

• Tracking the quantity, location and status of inventory items in the warehouse
• Maintaining accurate inventory records, including verifying physical counts
• Identifying opportunities for process improvement

Inventory management is just the beginning. Talk with one of our data experts to learn what you can accomplish with EasyPost Analytics.