AcctVantage ERP’s Complete 2022 Inventory Guidebook
We’ve posted quite a few articles recently that cover inventory-related topics. We work with a lot of warehouse and production managers in distribution and manufacturing businesses, so we tend to talk about it a lot.
We wanted to give you a convenient place to access the entire collection of those posts, so you’ll find a complete list of them at the bottom of this post.
We’ll update this page as we continue to post more content, so check back here if you’re ever worried that you missed an inventory article.
What’s the Difference? Stock, Inventory, and Other Confusing Terms
In different industries, sectors, or even individual businesses, certain core terms can be used in pretty different ways. Is stock the same thing as inventory? What’s the difference between inventory management, inventory control, and inventory tracking?
So, here are the primary terms and their most widely used definitions. First off, Inventory is pretty much anything your company keeps on hand in any of its locations for any business-related purposes. This ultra-broad term breaks down into five slightly-less-broad categories:
- Maintenance, repair, and operating (MRO) goods: Equipment, machinery, spare parts, janitorial supplies, stationery, and whatever else that you don’t intend to sell, but you still need in order to keep your business running.
- Raw materials: Components and materials that you acquire from your vendors so that you can turn them into something you can sell.
- Work in progress (WIP): Builds that either aren’t yet complete or just haven’t made it through your quality assurance and other processing steps.
- Damaged/returns: Anything that didn’t make it off the assembly line in the correct number of pieces, or got sent back by an unsatisfied customer.
- Finished goods (stock): Completed products that are only sitting on your shelves because you haven’t sold them. Yet.
All of these are part of your inventory, and you need systems to manage all of them.
On that note, what do terms like inventory management, inventory control, and inventory tracking mean? Are they all the same thing?
Well, yes and no. They’re nested subjects.
These terms are notoriously hard to pin down, but most experts fit them together like this:
All of these terms relate to the processes that you use to keep track of your inventory, purchasing, manufacturing (if applicable), and sales to avoid stockouts and overages.
Inventory management generally refers to that entire, broad concept in the abstract. This umbrella term includes so many nuances and overlapping principles that you can literally get a Master’s degree in it.
Inventory control is a slightly narrower term that’s usually applied to the system of inventory management processes within one company, or more narrowly within one warehouse, fulfillment center, or other business location.
Inventory tracking is basically inventory control but with added specificity of location. That is, an inventory tracking system will be able to tell you that the item you're looking for is on this particular shelf of that single aisle, on the third pallet from the back.
How much you’ll need of each of these – and what forms they’ll take – will depend on your business needs. But there are some approaches that are almost always better than others.
3 Major Inventory Pitfalls That Growing Businesses Step In
For a growing business, a quick decision, even if it’s not the optimal decision, can often be preferable to taking too long to make up your mind. You usually just don’t have the time to waste.
That said, as your company grows and more inventory management solutions are needed, quick thinking can lead to some critical mistakes.
Luckily, we’ve already scouted the path ahead of you, and we know which spots you shouldn’t step in.
Pitfall #1: Periodic Inventory and Why You Probably Shouldn’t Do It
Another piece of vocab for you: periodic versus perpetual inventory systems.
A periodic inventory system involves regular, manual checks of current inventory levels. If you know what was on your shelves at the beginning of an accounting period and at the end, you can calculate how much you sold.
With that information, your accountant only has to keep a record of all the purchases you’ve made, and from there it’s all simple math.
A perpetual system solves that equation the other way around.
In a perpetual inventory system, sales are tracked as they occur. That tracking process will look pretty different from one business model to the next, but it usually includes a network of point-of-sale (POS) systems, scanners, etc. all communicating with a central database.
With this sales data, plus purchasing data and an initial count when you set up the system, the system can work out how much you currently have.
Assuming that your initial inventory account is mostly accurate (and that there’s minimal loss and/or theft), the system should be able to keep the database accurate and up-to-date at all times.
You’re probably still going to want to perform manual checks every once in a while, to verify your data, but these disruptive counts go from making up a central part of your inventory management scheme to a system of more localized audits.
The advantages of a perpetual inventory system, at least for the appropriate kind of business, are pretty obvious.
If you have a high sales volume, even if each individual sale is relatively low value, a periodic system would amount to simply not knowing what you have on hand halfway through the month. It would also mean less detailed error-tracking, which could get disastrous if left unchecked.
On the other hand, if you’re running, say, a car dealership, you probably don’t need an entire network of computers (and the IT staff to match) when your sales volume is so relatively low and your inventory is so easy to count.
Pitfall #2: Manual Inventory Management and Why You Absolutely Shouldn’t Do It
That said, if you want to implement an inventory management system without any computers at all, you’re going to have to give up on having any particularly deep features. You’re not going to be able to implement any level of inventory tracking, for example.
Well, okay, you absolutely can implement a 100% manual inventory tracking system. Here’s how:
- Set up a central spreadsheet or master inventory document, including amounts and locations.
- Make sure that every employee with access to inventory can edit this document.
- Ensure that edits to the master document happen in the exact same order as the real-world transactions they represent.
- Train your employees to update the master document every time they make any change to the amount, state, or location of inventory on hand. Every. Single. Time.
- Cross your fingers and hope for the best!
If that doesn’t sound like a sufficiently reliable process to you, then you might want to go for a partially automatic inventory tracking method.
Pitfall #3: Patch Piling and Why You Shouldn’t Have Done It
In many fast-growing businesses, problems are solved as they come up.
When Accounting needs a more robust feature set, they find a software package that fits their requirements, or they make one themselves. When a Warehouse Manager needs to compile data from her entire team, she calls a quick meeting and hashes out a system with that team. And who knows how Sales is tracking their leads and opportunities.
All of these systems have significant overlap in inventory management, but each one has its own quirks, and they probably don’t talk to each other.
This is fine for a while, as long as there’s one person at the wheel who knows how it all works. But eventually, if the business keeps growing, that’s not going to be feasible anymore.
The disconnects that come from piling patches on top of each other in this way can lead to missed sales opportunities, insufficient stock, annoyed customers, and uninformed business decisions.
When you notice these problems creeping up on you, your best bet is to get all the decision-makers in a room together and settle on one integrated system that can meet everybody’s needs while synchronizing information across all departments.
Once you have a system like that in place, you’re really off to the races.
What to Do When You’ve Done It All: Cycle Counting and Inventory Optimization
So, say you’ve been at this for a while. You’ve got a robust, integrated inventory management system that everyone on your team is happy with.
You never have to manually enter the same data twice, and you always know exactly what you have, how much you have, and where you put it. All that’s left to do is maximize efficiency.
Where do you start?
Efficiency Drain #1: Full Inventory Counts and How to Avoid Them With Cycle Counting
A full inventory count is an absolute pain.
There’s really no getting around that. Some large, inventory-centric businesses need to shut down operations for an entire week to perform a full physical inventory count.
That kind of all-encompassing disruption to a warehouse has a high opportunity cost.
The obvious-on-paper solution is to switch from a warehouse-wide audit to a series of localized audits, moving to different sections over successive cycles. That way, the warehouse as a whole is still mostly operational at all times.
The main question, of course, is how.
Broadly speaking, cycle counting is a three-step process. First, you sort your inventory into “groups” to be counted one-by-one. Next, you develop a schedule for which groups get counted when. Lastly, of course, you execute that schedule.
There are plenty of different philosophies for how you should select your groups and build your schedule. Here are some of the most common methods:
- Control group cycle counting: Any good experiment has a control group as a point of comparison. If you’re just starting out with cycle counting, it might be a good idea to use a control group to work out the kinks in your process. Usually, this means you pick a small group of items and count them over and over and over again. Any inefficiencies in your process or discrepancies in your results should point you to parts of your methodology that can be improved.
- ABC analysis cycle counting: The most popular cycle counting framework is based on the Pareto principle: 80% of the outcomes stem from 20% of the causes. So, in theory, 80% of your counting efforts should focus on 20% of your inventory. So how do you pick the right 20%? Typically, you would sort your inventory into a tier list with your most valuable (meaning most expensive, most in-demand, highest turnover, or some other metric of your choice) items being A-Tier and your least valuable being C-Tier. Then you can set up a schedule where your A-Tier items get counted, say, once a month, B-Tier once a quarter, and C-Tier once or twice a year. Of course, be prepared to shift some items from one tier to another and to adjust your cycle schedule as needed.
- Opportunity-based cycle counting: You might want to mark a group for counting after a large change, such as a re-order, relocation to another area in the warehouse, random surge in sales, etc. These large changes are the most likely times to cause errors in your records, and the easiest place for those errors to hide, so it’s a good idea to double check.
- Process-based cycle counting: Sometimes it’s best to just let the people on the floor make the decisions. The process-based approach lets managers decide which items or areas get counted next. They do naturally have the most detailed knowledge of the goings-on in the warehouse, so they know where their attention is most needed.
- Location-based cycle counting: From a purely statistical standpoint, the most accurate sample is truly random. If you let a software system select a random section of the warehouse, with the eventual goal of making a full pass of every shelf in the building before looping around again, you introduce the minimum possible amount of human bias. You also guarantee that you get the most out of the “less disruption” benefit of cycle counting.
Of course, these methods aren’t mutually exclusive, and the optimal cycle counting scheme for your business may well involve a mix of some or even all of these approaches.
Efficiency Drain #2: Overages and How to Avoid Them with Inventory Optimization
According to the US Census Bureau, in 2021 the average American business was holding $1.39 worth of inventory for every $1 worth they could expect to sell.
Inventory optimization is how you get your 39 cents on the dollar back.
Concepts like inventory management, while plenty broad, are mostly internally focused. It’s about knowing what’s going on in your warehouse and improving your business’ efficiency.
That’s all great (and very important), but if you’re meeting your progress metrics on all that, what’s left? Do you just stop improving?
Of course not.
If you’re already doing everything right on your end, it’s time to identify what everyone else is doing wrong, and get ahead of it.
Inventory optimization involves analyzing every foreseeable factor in your supply and demand, as far into the future as you can.
Ideally, you can know the future well enough to prepare for it well ahead of time, and never have more on your shelves than you can sell.
It boils down to three general elements:
- Demand forecasting: Using demand data from previous periods and foreseeable outside forces to predict demand fluctuations well before they happen. Much like weather forecasting, this is never going to be 100% accurate. There are just too many variables. But the process is getting more reliable all the time, and not trying at all could be a major mistake.
- Inventory policy: What you keep in stock when, how much of it you keep on hand vs. in storage, and where you keep it in your warehouse(s). The approaches to inventory policy range from straightforward to straight-up Byzantine. Generally, you’ll need a more complex inventory policy if you stock a lot of seasonal products, or if many of your products have unusually short life cycles (like a cutting-edge tech company).
- Replenishment: First, you use demand forecasting to figure out what you need to order and how much. Then, your inventory policy determines how much of it will go on your shelves, in storage, into your assembly line, etc. as well as when it moves from one of those places to another. Finally, after all that data gathering and planning, replenishment is the process of actually ordering, tracking, and receiving new inventory from your suppliers. This is where you factor in supplier lead time and supplier reliability.
Once you have all three of those systems in place, it’s time to start the ongoing cycle of self-improvement, using old predictions and old realities to adjust new predictions.
With enough practice, eventually you’ll practically be able to see the future!
Until you do become psychic, though, feel free to stick around here to learn more about inventory and other important topics for growing businesses.
The Masterlist: Everything We’ve Ever Said About Inventory
- Inventory Control Systems Defined: A simple, straightforward introduction to inventory control systems
- Your Inventory Tracking Options: A quick overview of the approaches to inventory tracking in use today
- Manufacturing Inventory Management Crash Course: A simple look at modern inventory management solutions
- Cloud Inventory Management: Pros and Cons: Is cloud-based inventory management software right for your business?
- Perpetual Inventory: The Real Benefits And How To Get Them
- How To Use Inventory Cycle Counting To Optimize Your Warehouse
- Why You Need a Stock Control System
- 3 Elements of a Successful Inventory Optimization Technique
To find out how AcctVantage ERP can support your ongoing business growth and success, click here to get in touch with us.