Inventory Management and Best Practices for Small Businesses

If you’re a small business that sells a product to customers, you probably know that managing inventory is an art form. It’s a delicate balance; accumulating too much inventory can lead to cash flow problems, but not having enough inventory might cause you to lose out on sales! Good inventory management is about forecasting demand accurately, so you don’t put your sales or cash flow in jeopardy. When you’re just starting out, you may develop a certain feel for this, but as your business grows, it’s essential that your inventory management techniques evolve with it. Here are a few key things to consider when you’re managing inventory.

What is Inventory?

When most people think of inventory, often the first thing that comes to mind is stock – goods which are ready to sell to the customer. However, if a business includes some manufacturing as well, inventory can include the raw materials to make those goods – so, for example, a person who sells handmade furniture would also include the raw materials such as wood, the unfinished furniture, and the furniture that’s ready for sale.

What is the Difference between Inventory and Stock?

Since they’re often used interchangeably, a quick point about inventory and stock – they’re not the same thing!

• Stock refers to all goods which are ready to sell to the customer.
• Inventory, as you’ll see below, includes stock but can include raw materials and goods involved in making the products, particularly in manufacturing businesses.

What are the Main Types of Inventory?

Inventory can be classified in a lot of different ways, but usually falls under one of three main types: raw materials, work in progress, and finished goods. Whether or not your business has all three types will depend on what type of business you have and what goods you sell. Generally, businesses involved in the manufacturing process will have all three:

• Raw Materials
  include any raw materials needed to make the finished product; for example, a potter might include clay in their raw materials inventory. Note that this differs from equipment, but may include materials indirectly used to make products such as glue or finishing products.
• Work In Process Inventory
  includes inventory in the production process, but not yet ready to be sold. For example, wine aging in barrels would be part of the winery’s work in process inventory.
• Finished Goods Inventory
  includes all inventory your business is ready to sell to customers. Many storefront retailers who buy wholesale goods to sell to walk-in customers only have this category of inventory.

Keep in mind that these categories can vary greatly depending on the type of business – for example, a flower shop that arranges bouquets to order has a very quick processing time, and may not need the work in process category of inventory. A restaurant may need to pay diligent attention to their raw materials inventory since they are perishable, but don’t need categories for work in process inventory or finished goods. Other categories of inventory might also be helpful, such as packing materials inventory for a business that ships most of their products, or a maintenance, repair, and operating (MRO) inventory for a business that has a production line. Inventory tracking software may come with default categories installed, but it’s up to you to make sure they best fit your business type.

5 Tips on Inventory Management

The number one rule of inventory management is to tailor it to your business type. For example, someone who sells handmade goods online but doesn’t have a physical store isn’t likely to need point of sale inventory software, whereas someone with a retail storefront will likely need a more fine-tuned system to keep track of what they have on hand and what they may need to order in. Inventory management should be specific to the type of business you run and what your sales numbers are like.

Here are five things to consider when setting up a system to manage inventory:

1. What inventory categories do I need?
   As described above, the categories you use will depend on your type of business and how you manufacture and distribute your goods. Choosing the right categories and keeping track of them can identify inefficiencies in your process, so make sure to choose carefully.
2. How often do I need to update inventory?
   This may vary greatly depending on what type of business you have. If you are selling large items infrequently, such as art pieces, you may not need a complex system for keeping track of inventory. However, the owner of a restaurant may need to check their inventory daily to make sure the necessary ingredients are on hand.
3. What kind of inventory management software do I need?
   Once you know what categories of inventory you have and how often you’ll need to check it, you’ll need to decide what type of inventory management software is best for you, or if you can manage inventory on your own.
4. Do I need any other processes in place to track inventory?
   Businesses like storefront retail, where theft may be an issue, should periodically conduct a physical check of their inventory to make sure it lines up with the numbers in their inventory software. In addition to ensuring they have stock for customers, this practice can also highlight items that are commonly stolen and may need to be kept in more secure areas, such as behind locked display cases. Keep in mind that software doesn’t always give you everything you need to manage inventory and adjust your processes to suit your business.
5. Do I need SKU numbers? If so, how should I set them up?
   Stores with a lot of stock will often assign a unique SKU (Stock Keeping Unit) number to each item they sell to help keep track of them in inventory software. If you’re using this approach, it’s a good idea to create a system ahead of time so that your SKU numbers have a logical structure and make the items easily identifiable in your system.

If there’s one true piece of advice about inventory management out there, it’s this: it depends. Inventory management depends on what you’re selling and how you’re selling it—so to manage it the best way you can, make sure to do some research on inventory management practices in your industry. And remember that, at the end of the day, you’re the one who will have to live with the system you set up! Make sure it works for you.