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Inventory Management: A Short Guide for SMEs

Small Business Inventory and Inventory Management Tips

Inventory management is a crucial process for many businesses. It involves managing completed or semi-completed products or components, or raw materials, that are used to make finished products. It also must have been purchased to be considered inventory, also called stock. For example, if you are selling something on consignment for another business, it’s not classified as inventory.

Why is inventory management important?

Having the right level of stock is a key to business success. If stock levels are too high, it’s costing you in storage and finance expense. If you have insufficient stock, you will miss out on sales to customers who can’t or won’t wait for the items you sell. Either way, it represents an opportunity cost where you are missing out on potential profit.

Various types of inventory

There are various types of stock. Understanding these will help you value and manage it. They include:

  • Raw materials – these are used in creating other products. For example, the fabric used by a clothing manufacturer is a raw material. 
  • Work-in-progress – this includes semi-finished products and components that need to be combined. An example is pharmaceutical products that are manufactured but need to be packaged to be sold. 
  • Finished products  – this is inventory that is ready for sale, whether to consumers or to other businesses. 

Materials, repair and operation (MRO) supplies – these are used in the production process in manufacturing but are not part of the finished goods being made. These include repair tools, valves, compressors and machinery. Although not sold, this stock plays a crucial role in creating the products that are sold.  

Inventory management

Good inventory management can make or break a business. Getting caught with overstock or not enough stock to meet demand is one of the last things a business owner wants. The carrying costs of storing and maintaining excess stock can eat into your working capital and negatively affect profits. Alternatively, under-ordering can result in missing out on potential sales. Accurate forecasting can make both sales spikes and slower periods more manageable and minimise any profit losses.

The best place to start would be to look back at your monthly sales for the past 12 months. From there:

  • Attempt to determine peaks and troughs in sales and identify patterns.
  • Take into account seasonality (weather, holidays, peak commercial periods).
  • Use tools like Google Trends to find specific search demand related to your product or service throughout the year.

Some inventory management systems have forecasting capabilities built in, which help you to plan without the headache of using spreadsheets.

It’s also important to look at the big picture of supply chain management. If suppliers can’t deliver what you need when you need it, this can hurt your business. 

These are just a few methods to stock prioritisation. Implementing one, or all of them will help optimise your sales and allow you to identify your strongest products. Conversely, reviewing your product line will, in some cases, also expose underperforming products that you may need to cut altogether.

The inventory turnover ratio is one way to measure how quickly inventory is moving into and out of a business.

Prioritise inventory management

Classifying and prioritising your stock on hand can help dramatically boost sales efficiency. Depending on your business, there are a few different inventory management techniques you can apply:

  • The 80/20 Rule finds that 80% of a businesses profits are generated from only 20% of its products. This is actually true for the majority of businesses so identifying these products and focusing sales and capital on them can often result in increased profits.
  • Implement an ABC Classification. As another layer of prioritization, organise your stock based on value and consumption. For example, A products make up the smallest percentage of stock but have the largest annual consumption value to C products that have the largest percentage of stock but make up the lowest annual consumption value.
  • A FIFO (First In, First Out) method is particularly handy for businesses selling perishable products. Stock should be sold in the same chronological order as it comes in, as any stock that sits around can become damaged, outdated or otherwise unsellable.

These are just a few methods to stock prioritisation. Implementing one, or all of them will help optimise your sales and allow you to identify your strongest products. Conversely, reviewing your product line will, in some cases, also expose underperforming products that you may need to cut altogether.

The inventory turnover ratio is one way to measure how quickly stock is moving into and out of a business, and it can be applied to individual products.

Use inventory management software

First things first, you should definitely subscribe to some sort of online or cloud-based inventory management software. Most digital accounting platforms, like Xero and MYOB, offer basic inventory management features as part of their overall service. So if you already use one of their accounting services, then you should be able to jump into their small business inventory management features. If not, then there are still many third-party inventory management apps that integrate into your accounting software. These include:

  • Xero Inventory Management Add Ons
  • MYOB Inventory Management Add Ons
  • Quickbooks Inventory Management Add Ons

Depending on the nature of your business, you may need more or less from your inventory management tools as well. A basic management tool for stock counts, orders and tracking could be enough, or you could need features like POS (point-of-sale) integration. Either way, spreadsheets just won’t cut it – digital inventory management is the way to go.

Get finance to purchase inventory

A lack of funds can be a challenge for inventory management. For many businesses, there is a large gap between purchasing stock and selling it. This is especially true for manufacturing companies that purchase raw materials that are used to create products. Business loans are one way to get the funds needed to purchase stock. If finance is needed quickly, unsecured finance can be the best solution. Learn more about inventory finance from Moula.

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Business content for Australian SMEs. Sharing guides, growth hacks, and expert tips on finance, sales and marketing, and tech.

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