Inventory management is all about ordering, organizing and using your business’s inventory. Whether you stock raw materials, work-in-process, overhaul, or finished goods, adopting an optimized inventory management system is key to keeping your company running properly and profitably.
In this overview of inventory management, we’ll dive into the definition of inventory management, then touch on why the process is so vital to each and every kind of business. Then, we’ll define key inventory management terms like safety stock and cost of goods sold. Next, we’ll provide an in-depth look into essential inventory management formulas and ratios. Finally, we’ll review different types of inventory management systems, including written inventory, inventory spreadsheets and inventory management software and apps.
Inventory Management Definition
Inventory management is the process of ordering, stocking and utilizing your business’s inventory. It is a complex, wide-reaching and highly-important aspect of supply chain management, especially if your business stocks many items across multiple locations or warehouses.
While inventory management may seem overwhelming, choosing a consistent inventory management system to track all of your company’s stuff can actually save you a ton of time, money and stress. Keep in mind that there are lots of modern tools and new technology that can shave hours off your daily, weekly, quarterly and annual inventory tasks.
Key Inventory Management Terms
If inventory management seems overwhelming, better understanding the buzzwords used to talk about managing inventory can really go a long way to boost your knowledge of the subject.
Here are some of the key terms you should familiarize yourself with:
A barcode, also known as a bar code, is a unique display of parallel lines. These lines differ in their width and their distance from each other to create a unique barcode. Barcodes contain a ton of data. They can be scanned by special equipment like a barcode scanner, or by existing equipment like a camera.
A “quick response” code, or a QR code, is a two-dimensional barcode that can store even more data than a barcode. First designed in the 1990s by Japanese automakers, the QR code has since skyrocketed in popularity in the United States. Like a barcode, it can be read by special scanners. You can also read Qr codes witheveryday equipment like a smartphone camera.
Barcode / QR Code Scanner
A barcode or QR code scanner is the device used to scan a barcode or QR code scanner. While there are many handheld devices that scan barcodes and QR codes, most smartphone cameras can also scan barcode and QR codes.
Cost of Goods Sold (COGS)
Cost of goods sold (COGS) is the sum of all the direct costs associated with producing an item sold by a company. It includes materials and labor, but not indirect costs like sales, marketing and distribution.
Deadstock is basically what you’d think it is: stock that’s, well, dead. It’s just sitting there, unsold and unused.
Carrying costs, or holding costs, refer to how much money it costs a business to carry stock until it’s used or sold.
Lead time refers to how long it takes for your vendors and suppliers to deliver the products you’ve ordered from them.
Reorder point articulates precisely when a business should reorder inventory to meet forecasted demand.
Safety stock refers to that little bit of extra inventory a business maintains, just in case there’s a shortage.
Stock Keeping Unit (SKU)
Like a serial number, an SKU is an alphanumeric tracking code unique to each of the items in your inventory.
Important Inventory Management Formulas
There are eight key formulas and ratios that can help you get a firm handle on your inventory management. These formulas will help you understand everything about your inventory, from how much of an item you should reorder to when you should reorder it.
Inventory Turnover Ratio
Inventory turnover ratio, or “stock turn”, reveals how often a product is sold and then restocked during a given period of time. Some products sell right away, and others can sit on shelves for months or years. Inventory turnover ratio is a great way to determine how important and in-demand a given product is.
Inventory Turnover = Cost of Goods Sold / Average Inventory
Cost of Goods Sold
Calculating your cost of goods sold (COGS) is an essential step to mastering inventory management. You’ll need this number to plug into many meaningful inventory management formulas, including inventory turnover.
Calculating your cost of goods sold can also help your business claim inventory as a business expense on your next tax filing. (Talk to your accountant about how, when and why you should do this!)
Cost of Goods Sold = Beginning Inventory + Purchases During Year – Ending Inventory
This formula calculates, on average, how many of a given item you have in your business’s inventory over a specific period of time, like a month or a year.
Average inventory is a key component of inventory turnover ratio. Knowing your average inventory can help you practice tighter inventory management and more effective inventory control.
To calculate average inventory, you’ll need to peer into your inventory records. Figure out how much of a given item you had at the beginning of a period, and how much you had at the end of a period. Then, divide it by the number of periods, in months.
If your automotive shop had 10 windshield wiper blades in stock on January 1st, and 14 in stock on February 28th, then your average inventory would be 12 windshield wiper blades.
Average Inventory = (Ending Inventory Balance + Beginning Inventory Balance)/Number of Periods, In Months
Days’ Sale Ratio
Days’ sale ratio can help you calculate the average number of days it takes to sell, move or use a product from your inventory. Ideally, your days’ sale ratio should be as low as possible. A low days’ sale ratio indicates that you’re moving your inventory quickly.
To calculate days’ sale ratio, divide 365 by your inventory turnover formula.
Days’ Sale Ratio = 365/Inventory Turnover Ratio
Sell-through rate clarifies the overall number of products your business is selling over a specific period of time, like a week, a month or a year. This formula can also improve your ordering protocols by determining how well your inventory moves in general.
Sell-through rate (as a percentage) = Units Sold / Units Received
Also known as closing stock, ending inventory divulges the value of inventory remaining at the end of a certain time period, like a week, quarter or year. This formula can help you understand just how much money you have tied up in inventory that hasn’t been moved, used or sold.
Typically, ending inventory is calculated at the end of a traditional accounting period, like a quarter or fiscal year. You’ll see it reported on balance sheets, too.
Ending Inventory = Beginning Inventory + Purchases – Cost of Goods Sold (COGS)
Reorder Point Formula
Reorder point formula is a key formula for both inventory management and inventory control. It signals precisely when a business should reorder inventory to meet customer demand without overspending or overstocking.
Every different item you stock will have a different reordering point, so you’ll want to carefully calculate this number for every product you use or sell. Or at least your most important, most profitable items!
Keep in mind that your reorder point calculations won’t be perfect. They won’t always properly account for events that could temporarily change supply and demand, like holidays, weather events, pandemics, and so on.
Reorder point formula = (average daily use rate x lead time) + safety stock
Safety Stock Formula
Safety stock is that extra inventory you keep on hand, just in case something unexpected happens. That unexpected event could be anything from a road-closing blizzard to a last-minute birthday party.
Properly ordering safety stock is both an art and a science. Of course, you want enough “emergency stock” to help your business operate even if shipments are delayed or your regular inventory cannot satisfy customer demand. But you do not want to overstock, which is unnecessarily expensive and oftentimes wasteful.
One of the reasons that the safety stock formula is so helpful is because it provides clear guidelines on how to buy more than you need. You don’t have to listen to your gut, or order extra products out of fear. Just calculate your safety stock and believe it.
Safety Stock = (Maximum daily usage x maximum lead time, in days) = (Average daily usage x average lead time in days)
Different Inventory Management Systems
There are a variety of inventory management systems—at a variety of different costs—available to businesses of all shapes and sizes. From highly-specialized inventory management software systems to a good ol’ sheet of paper, there are plenty of ways to track what your business has on hand.
Pen and Paper Inventory Management
Manually managing your inventory using little more than a sheet of paper is an old-fashioned but potentially effective way to track what your business has in stock. Of course, such a system is extremely limited, and works best for businesses that stock a few dozen items and employ just a handful of people.
Here are some advantages to pen and paper inventory management:
- Virtually free
- Requires no training or technical skills
- Encourages regular, physical inventory counts and audits
Here are some disadvantages to pen and paper inventory management:
- No backup inventory if paper is lost
- Impossible to quickly generate reports to gather information, forecast, or understand data
- Requires constant updating
- Can only be accessed by one person, at one time
- Cannot feature photos, barcodes and QR codes and other non-text details
- No way to set alerts for low stock and other important dates
- Incredibly time-consuming
Spreadsheet Inventory Management
An inventory spreadsheet helps you track all the little details of your inventory, including key information like product name, location, SKU, condition, estimated value, purchase price, condition, par and expiration date.
You can easily find inventory spreadsheet templates online, or you can quickly create your own using a program like Microsoft Excel, Google Sheets or Numbers. If you create your own inventory Excel sheet, add a column for every little detail you’d like to track. Don’t forget to leave a few open-ended fields for random notes and reminders.
Ideally, you should have a template for your inventory spreadsheet as your first tab. You can print this out and fill it in when you take inventory. Then, create another tab every time you conduct a physical inventory count and date the tab. If you do this, you’ll be able to gather information about your inventory over time. And that data can help you calculate those ultra-important inventory formulas and ratios!
Of course, managing your inventory via spreadsheet has its pros and cons, too.
Here are some benefits of using an inventory sheet:
- Fairly simple
- Ultra-quick to get started
- Almost always free
- No equipment necessary
- Most employees with light computer skills can assist
Here are some cons to using an inventory spreadsheet:
- Extremely difficult to add pictures of items
- Impossible to link barcodes and QR codes to inventory
- Tired eyes can easily input data in the wrong cells or jumble numbers
- Difficult to distinguish items that have similar names
- Inventory reports must be gathered manually
- Spreadsheets not saved to the cloud can be out of date or impossible to access remotely
- Spreadsheets saved to the cloud could be corrupted, hacked or altered
- No way to set alerts for low stock and other important dates
- Very time-consuming, as inventory must be taken and then recorded later at the computer
Inventory Management Software
All Inventory management software tracks essential information about a business’s inventory. This includes stock levels, item locations, purchase price and minimum stock required. Inventory software also helps businesses both big and small save time, money and stress by creating a more modern, automated inventory management system.
There are many varieties of inventory management software on the market today. Some of this software is incredibly expensive, highly-technical, extremely complex and very, very industry-specific. But most businesses find that inventory software that costs tens of thousands of dollars a year (or more!) still doesn’t really work for them.
Many companies want simple and intuitive inventory management software that streamlines the most time-consuming parts of inventory management. They want to make their inventory management process simpler, not more complex!
New versions of inventory management software, which look and feel like inventory apps, offer many of the same features and functions of traditional inventory management software at a fraction of the price. Some inventory apps, like Sortly, offer a forever-free version and a two-week free trial of its premier product.
Inventory Management Software Features
The key features of inventory management software are: barcode and QR code scanning, ability to add tons of item details and pictures, automatically-triggered reminders and alerts, customizable folders and tags, secure and easy-to-sync data, remote access, customizable user permissions, robust reporting and true ease-of-use.
Here’s a little bit more about each of these essential features:
Barcode and QR Code Scanning
Whether you use an inventory management app or a highly-technical, pricy piece of inventory management software, you should absolutely insist on an inventory system that offers barcode and QR code scanning. Scanning codes instead of manually updating and entering data does more than just save time: it reduces costly human errors, too.
Wondering what’s in that random box at the very top of your storage closet? Simply scan the QR code using the in-app camera for details. Need to check out an item as you relocate it from your warehouse to a jobsite? Check it out in a split-second with your tablet.
Whether you keep physical or perpetual inventory, barcode and QR code inventory automation can shave hours off your inventory cycle counts and audits.
Plus, if you stock items that don’t come with a barcode or QR code, you can use a barcode/QR code generator to create your own. Sortly allows customers to create, link and even print QR code labels for every item in their inventory. You can even choose what size label to print and add your company’s color and logos.
Customizable Item Details
Your inventory management software should allow you to add item details to each product in your inventory.
Your item details are similar to the information you’d put in columns of a written inventory or an inventory spreadsheet. That means everything from product name to how much you paid for it can be quickly recorded, accessed and updated.
However, unlike written and spreadsheet inventories, your inventory management software or app should allow you to upload lots of high-resolution pictures. These photographs can help you visualize your inventory without rummaging through your stockroom, and can be especially helpful if you stock items that sound alike but look different.
Low Stock Alerts
The right inventory management app will also alert you the moment an item in your inventory falls below a customized, user-determined threshold. You can also set reminders for other important dates, like warranty ends or expiration dates.
These alerts can be sent to you within the inventory management software system, or via email. You can also elect to have them sent to the right people, like your warehouse manager or your colleague at another site.
Folders and Tags
Folders help you organize your inventory in a way that makes sense to you and your team. You can create folders for categories, locations, departments, employees… whatever you wish! You can reassign items to different folders and subfolders at any time, so don’t worry if you change your mind.
Customizable tags allow you to apply even more categorical organization to your inventory. A home stager, for example, could apply tags like “mid-century” and “farmhouse” to her inventory, even if it was stored in the same location-based folder.
Secure, Syncable and Remotely-Accessible Data
If you’ve got a team that works all over the country, or inventory across multiple locations, an automatically-synced inventory is absolutely crucial. Unlike written inventories, the best inventory management software automatically syncs to the cloud. This provides you with uninterrupted access to your inventory—anytime, anywhere.
Customizable User Permissions
If you have co-owners, colleagues, employees or even guests accessing your inventory, look for inventory management software that allows you to set customized permissions for every user. From read-access to restricted view to full administrative capabilities, you can decide how much (or how little) each user can see and do.
You’ll also want to find an inventory app that creates a detailed user history report, so you can track who did what and when.
Another major benefit of inventory management software: customizable, data-rich reports.
With the right inventory app, you’ll be able to get all the information you need to make smart decisions about what you order next. You’ll have all the numbers you need to calculate important information like average inventory and cost of goods sold. You’ll be able to know exactly what your inventory turnover ratio is.
Best of all, you’ll be able to use all your findings to practice truly optimized inventory control. And who doesn’t love to keep their profits healthy and their customers happy?
Ease of Use
When searching for the right inventory management software, don’t forget to prioritize usability. After all, the key to effective inventory management is consistency! If your team members find your inventory software too difficult to use, you probably won’t see compliance.
Inventory apps like Sortly were designed for everybody, including people with little to no technological knowledge. That means you can forget about full-day training sessions, frustrating manuals and onboarding processes that make no sense.
Small Business Inventory Management
Small businesses often rely on free or inexpensive systems to track their inventory. Printed inventory lists—which are really little more than a sheet of paper—and basic inventory spreadsheets are classic approaches to inventory management for small businesses looking to cut costs.
Unfortunately, manual inventory tools leave a ton a room for error. Tired eyes can easily misread serial numbers, and many boxes, names and products look and sound alike. And who among us hasn’t jumbled up a couple cells while transposing data onto an inventory excel sheet?
Reasons like this are exactly why inexpensive or free inventory apps like Sortly are changing inventory management for small businesses. These inventory apps offer many of the same key features of expensive inventory management software that can cost tens of thousands of dollars a month.
Start Managing Your Inventory Today
Ready to take control of your inventory? You can get started with Sortly today! Our top-rated inventory app— which works on regular computers, smartphones and tablets—is designed to get you organized in minutes.