What are the functions of inventory in operations management?

Inventory is a primary asset of any retail business. Efficient inventory management and control keep business on a profitable path, help to maximize profits, make the most of inventory use, avoid overstocks, and reduce write-offs.

What is inventory control?

Inventory control can sometimes be synonymic to inventory management, as both inventory management and inventory control help to keep business financially sustainable and meet customer demand.

It is a complex chain of operations that oversees products storage, replenishment, classification, warehousing, turnover and tracking. Inventory control is a multi-functional and multi-dimensional process.

Elements and functions of inventory control

Main functional aspects of inventory control system include:

• specification of goods, their ID numbers and their types;
• keeping information on goods serial numbers;
• barcodes implementation and control;
• ABC goods prioritizing;
• replenishment process;
• managing inventory lists;
• real-life real-time warehouse reports;
• real-time goods location tracking;
• inventory storage oversight;
• accounting and tax operations associated with warehouse management;
• synchronizing warehouse stock with sales.

Importance of inventory control system

If business does not control its stock, this can result in backorder or overstock, both being risky for financial performance and customer loyalty. Overstock causes an excess of unsold goods which freeze operating capital, and eventually become dead stock that should be written off or liquidated. Backorder, in its turn, leads to customer dissatisfaction, as you as a seller can’t supply them with needed items in due time. If inventory control is duly implemented, business takes a full oversight over its stock and takes advantage of its rational use.

By optimizing inventory control processes, businesses can also streamline supply chain processes, reducing logistics, storage and transportation costs.

Inventory control methods

So, the primary functions of inventory control systems are clear, they help retailers to effectively spend their money on warehouse replenishment and restocking and to increase cash flow by rationally controlling the warehouse internally. Let’s talk about the main methods these systems use:

1) EOQ or Economic order quantity

This formula calculates the amount of stock you need using the following indicators:

• Q - economic order quantity (units);
• S - ordering cost per purchase;
• D - demand in units;
• H - carrying cost per unit.

Read more about this formula here.

2) Reorder time formula

While the Economic order quantity formula points to the cost-effective amount of stock needed, Reorder time formula calculates the right time to order the goods. Here is a formula:

Lead time demand + Safety stock = Reorder time

You need two indicators - a lead time demand and safety stock.

Lead time is a number of days needed for the stock order to be delivered into your warehouse after you have put an order to your supplier. For businesses dealing with Chinese markets and shipping their stock from China, this indicator is crucial. We are talking about routine regular orders, imagine how important it becomes during any logistics breakdowns, strikes, demand surges or seasonal deliveries.

To calculate the lead time demand, multiply two numbers: lead time for a particular item and average daily consumption of this item

Safety stock is a cushion, a buffer of goods available in your warehouse. To calculate it, multiply the highest (maximum) daily consumption of an item and the highest lead time for this item (in days). Then multiply the average daily consumption of an item and average lead time (in days). Finally, subtract the latter from the first number. Voila, this difference is your safety stock number - in items/units.

Example:

You sell mobile phone cases and accessories in the United States. Your supplier works in China. Usually, it takes 30 days to ship your goods from China to the US (this is your average lead time). Sometimes, during Christmas holidays, or demand surges, or strikes or whatsoever it takes 50 days to ship your goods (so, this is your highest lead time).

You sell 5 cell phone cases per day on average (this is your average daily consumption), and the highest sales level you observe during Black Friday or holiday periods is 10 cell phone cases per day (this is your highest daily consumption). So, your safety stock formula looks like this:

10x50 - 5x30 = 500-150 = 350 (units)

Importantly, efficient stock control needs a combination of these two methods, of both EOQ and Reorder time.

One of the benefits of inventory control systems is that they perform these calculations automatically and all you have to do is to turn on automated notifications - the system will automatically update you on reorder time and quantity!

INVENTORY CONTROL PRACTICES AND KPIs

Proper KPIs are fundamental to efficient inventory management, as these indicators drive future performance and profit. Most KPIs are coupled with Inventories as a primary asset of the retail business and with Sales as the ultimate result in retail. 

It is also worth understanding that many KPIs «dilute» everyone's contribution, and too few do not give the whole picture. So it is worth determining both the quality and quantity of KPIs in each business area you manage. 

Typical indicators are: 

1. INVENTORY COSTS. It gives a general idea about the company's investment in inventory at the moment and over time. In addition to tracking this indicator in the moment and dynamics, the assessment of the inventory structure demonstrates how much the company is worth in terms of insurance stock, inventory, surplus, and the actual stock for sales. 

Below are examples of the inventory structure of two grocery retailers (a gray area - insurance and on-shelf inventory, a green area - sales inventory, and a purple area - excess inventory):

1. SALES. Sales in purchasing prices (cost of sales) and selling prices. In essence, everyone in the retail company works for sales. Regarding category management, sales are analyzed by category in terms of outlets, suppliers, and other analytics. 

ABC(D) analysis report in Leafio Inventory Optimization system

1. OVERSTOCKS. Shows the % and value of inventories that have been formed as a result of increased orders or a significant drop in consumer demand. In addition to the surplus itself, it is also worth assessing how long this surplus has been in the store or the warehouse. 

The average surplus for the set period report in Leafio Inventory Optimization system

1. LOST SALES. Show the % and value of statistically potential sales that did not occur due to out-of-stocks. It isn't easy to get an accurate % of missed sales due to the specifics of the indicator itself. But this does not mean that when analyzing the effectiveness of inventory management, we should abandon taking this indicator into account at all.

LEAFIO Inventory Optimization system has a special report on the statistics and causes of missed sales, which shows the changes in the dynamics of the indicator as a separate category of products and groups.

Lost sales for the set period report in Leafio Inventory Optimization system

1. SERVICE LEVEL. It's a % of availability of goods from the assortment matrix on the store shelves. It is similar to missed sales but measured in units rather than money.

1. INVENTORY TURNOVER. The ratio of inventories to sales shows how many days of sales the current balance will be enough. 

To summarize, the KPIs above hold the potential to drive retail profits up and give clarity on operational performance at a time when circumstances change constantly.

Implementing inventory control software for your business

Each business is unique, with its individual needs, KPIs, targets and strategies. Inventory control techniques and methods vary, while all of them are acceptable. The use of each method depends on your business size, model, policies and financial objectives. You may combine different methods in your strategy, however keeping in mind that switching between inventory control methods too often may have a detrimental impact on financial reporting, accounting and analytics, as different methods use different approaches and principles.

Here is the very guide which takes you to the basics of implementing an inventory control system in your company. So, to get started:

1. Define your goals and objectives

In terms of inventory, turnover metric is one of the most common, critical and useful indicators that shows the number of times inventory is being sold per year/quarter/etc. To set ideal inventory turnover goals, you have to take into account the benchmarks across your industry or sector, calculate profit margins for the whole inventory and each SKU in particular.

There is a bunch of other metrics to consider and monitor, such as inventory carrying cost, sales of inventory per day, the ratio of inventory to sales conversion, etc.

2. Organize your warehouse

Efficient warehouse management, including goods movement, transfer and storage, is one of the most important elements of inventory control. It’s all about common sense - if your warehouse is messy or the products are placed chaotically, you can hardly ensure a steady flow of sales, deliveries and inventory movement. Consider cycle counting as a way to perform stock counts and keep an eye on goods quantities.

3. Invest time and efforts into products labeling and categorization

If products are difficult to find and identify, you will need more manpower and more time for order fulfillment and logistics. If products are being searched and the “in and out” movement is controlled manually, the possibility of human error increases. To stay cost-effective and reduce the effects caused by human-caused error, create a user-friendly and easily categorized system for all your goods and products. ABC method of inventory classification and analysis based on goods profitability and sales value is one of the most efficient options to consider.

4. Keep an eye on new inventory management technology

Some owners of micro- or small businesses are running their control processes using an Excel spreadsheet that has 2-3 functions, and manually fill in all warehouse data by hand. Manual inventory control requires investment into human capital, as a person responsible shall fix even the smallest movements of goods, keeping track of goods names, types, locations, numbers etc.

On the contrary, automated inventory control systems can perform the following functions in seconds, saving time and costs. New technologies can automatically prevent overstock and backorders, track consumer demand and align inventory levels correspondingly, predict the next warehouse order by analyzing sales and goods movement, manage warehouse and barcode systems, and even analyze future sales trends.

Based on the many years of experience of our customers from different retail areas, we have analyzed all the weaknesses of the business and created the most effective inventory management system - Leafio Inventory Optimization Solution.

This cloud-based solution will help you to identify areas that require special attention quickly and accurately. This will help streamline ordering and delivering in the shortest possible time, which will lead to the successful implementation of the company's subsequent development strategy.

Besides, with the Leafio Inventory system, you can minimize the human error factor when generating orders, based solely on accurate data from complex algorithmic calculations to identify the real need for an individual SKU at each stock holding point.

Read also what effects our client Agrohub achieved by implementing Leafio Inventory Optimization Solution.

Conclusion

Always remember to use a properly integrated inventory control system in your operations. Forecasting demand, keeping records of warehouse data and replenishing it on time is tiresome work that requires precise planning. Integrated stock management system is a helping hand to you. It will not only keep your cash flow steady, your stock managed, your barcode scanner system efficient and customers happy, but also maintain relationships with suppliers and synchronize all warehouse processes.

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