Let’s talk about inventory…
No matter the business model or area of business the definition of inventory has remained the same.
In this article we’re going to cover everything you need to know about inventory in simple terms. That way you can learn as much as you can and continue learning about starting a business.
Understanding inventory is one of the first lessons you learn about running a business. If you run out of inventory you can lose out on sales. But if you carry too much inventory then you’re wasting money and precious resources.
So how do you balance the two?
That’s what we hope to explain later in the article. But for now let’s go over some of the definitions and different functions of the business term inventory.
What is Inventory (In Simple Words)
Inventory is all of the physical products a business owner has in storage that they’ve already paid for. It’s everything from raw materials to assembly components and final products.
Products the business owner pays for, keeps in storage and actively sells is considered inventory. Notice how that covers a lot of potential scenarios. That’s why it’s important to closely watch inventory levels and have systems in place to monitor your business.
Benefits of Inventory Management
Monitoring your inventory levels is Inventory Management and it’s necessary to operate your business. It allows you to control the amount of stock and raw materials. That way you never have too much and waste money or run out and lose sales. You’ll know when to place new orders and when to slow down marketing efforts.
Holding more inventory than necessary doesn’t help a business for 3 main reasons:
- High storage costs
- Products can deform or damage in storage
- After long enough products becomes obsolete
That’s why it’s important to continually audit your inventory levels, liquidate products that don’t sell and double down on products that make sales. The goal of inventory management is to predict future orders, plan for them and lower inventory costs while increasing profits. It sounds like a small online business wouldn’t need to know about this but inventory management is the lifeblood of an online business.
For example, if you’re selling products on Amazon and you run out of inventory, Amazon will hide your listing until your product is back in their warehouse. There’s no waiting list or way for you to let your customers know that products are on their way. You lose out on making a lot of sales because of poor inventory tracking.
Inventory Management Methods
There are 3 ways that you can track and value inventory costs:
- First-in, first-out (FIFO): Here the idea is that the cost of goods sold (COGS) is calculated from the earliest bought materials but the cost of holding inventory is based on the most recently purchased materials.
- Last-in, first-out (LIFO): Here the idea is that the COGS is calculated using the most recently purchased materials. But the value of the current inventory is calculated by the earliest purchased material.
- Weighted Average: A simpler method where the value of the inventory and the COGS is based on the average cost of all the materials purchased.
3 Different Types of Inventory (With an Example)
There are three different types of inventory to track. Remember, you can go deeper on this subject but for most small businesses you only need to know these three.
- Raw materials: This is all the individual components and materials that are required to manufacture a product. We’re talking about the basic raw components of a product. (Wood, metal, leather, zippers, or fabric)
- Work in progress: Anything that’s still in the production process but not fully finished is considered a (WIP). When you’re doing production planning this is important to track to estimate shipping dates. (Cars on the assembly line)
- Finished goods: This is the final product that’s ready to be sold to distributors, wholesalers or straight to the customer. There’s no more processing and it’s sitting in storage. (Products ready to be in retail stores)
Difference Between Inventory and Stock
There’s a big difference between inventory and stock but mostly with brick and mortar retailers. Online businesses tend to consider everything inventory or everything stock.
Inventory is the total amount of products in storage for the retail store to sell to customers. While stock is only what is available for daily use, what’s currently on the shelves. That’s why retail associates “stock shelves”. They won’t put all of their inventory out, only the stock needed to sell throughout the day.
In retail stores, sometimes, stock sells out, inventory replaces the stock and there’s nothing sitting in storage. But normally stock is for daily business functions and inventory is what’s in storage.
Wrapping This Up
Why is learning about inventory important? Because it’s how you keep your costs low and business running smoothly. It’s not something that anyone can understand right away but something you work every day to optimize.
You don’t want to leave your customers asking for products you don’t have in stock but you also don’t want a warehouse full of inventory that doesn’t sell. There’s a happy medium that every business needs to learn to manage properly.
If you need help there’s software out there that can help you predict and forecast future inventory levels based on demand and place orders to your supplier for you. It might be just what you need to level up your business.