Objectives of inventory management
- Match supply with demand: Avoid both overstocking and running out of stock.
- Use capital efficiently: Reduce money tied up in inventory to improve cash flow.
- Lower costs: Cut expenses related to storage, insurance, damage, and obsolete stock.
- Maintain availability: Ensure products are available to meet customer orders on time.
- Support business planning: Provide accurate inventory data to help with production planning and sales forecasting.
Importance of inventory management
In 2024, inventory mismanagement—having either too much or too little stock compared to demand—was estimated to cost global retailers $1.7 trillion, according to IHL Group. For Indian businesses, this highlights why effective inventory management is crucial. Companies that manage inventory well can see improvements in three key areas: financial performance, operational efficiency, and customer satisfaction.
Financial performance: Proper inventory management strengthens a company’s finances. It optimises cash flow, reduces costs for storage and insurance, and protects the value of stock. It also ensures that products are available when needed, avoiding expensive emergency shipments to replenish suddenly empty inventory.
Operational efficiency: Indian businesses benefit when they have a clear view of what stock they have and where it is. Efficient inventory management shortens lead times, prevents bottlenecks in production and distribution, and makes supply chains more reliable. This allows decision-makers to streamline workflows, reduce waste, and improve overall operational efficiency.
Customer satisfaction: Customers get frustrated when products are out of stock or delivery is delayed. Companies with strong inventory management can maintain accurate stock levels, update online availability in real time, and strategically allocate inventory for faster fulfilment, improving the customer experience.
In India, while public companies must maintain accurate inventory records to comply with regulatory requirements under the Companies Act, 2013 and relevant tax rules, failing to do so can result in penalties and compliance issues.
Types of inventory management
Businesses use different types of inventory management systems depending on their operations. The main types are manual inventory, periodic inventory, and perpetual inventory. Manual systems are the simplest but least accurate, while perpetual systems are the most advanced and precise.
Manual inventory system: Stock is counted physically and recorded on paper or in a spreadsheet. Small businesses often use this simple method.
Periodic inventory system: Stock is counted at regular intervals, either manually or with some automation. Movements of items in and out of inventory are recorded during these counts. Barcodes and basic databases can help track stock levels and locations more efficiently.
Perpetual inventory system: Stock is tracked in real time using automated scanners, sensors, or software that continuously update inventory records whenever items move. This method provides the most accurate and up-to-date stock information.
Inventory Management Methods and Techniques
Technique
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Description
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Best For
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JIT (Just-in-Time)
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Orders inventory only when needed
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Businesses with reliable supply chains
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MRP (Material Requirements Planning)
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Uses demand forecasting to plan materials
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Manufacturing operations
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EOQ (Economic Order Quantity)
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Calculates the optimal order quantity
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Businesses with consistent demand
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ABC Analysis
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Categorises inventory by value
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Companies with a wide product range
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FIFO (First-In, First-Out)
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Sells oldest inventory first
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Perishable goods
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LIFO (Last-In, First-Out)
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Sells newest inventory first
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Non-perishable goods
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Dropshipping
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Supplier ships products directly to customers
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Businesses aiming to reduce overhead
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Safety Stock
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Maintains extra inventory as a buffer
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Markets with demand or supply volatility
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Cross-Docking
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Transfers goods directly without storage
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High-volume, fast-moving products
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Inventory Management System Types
Inventory systems can vary from basic manual methods to advanced real-time solutions:
- Manual: Suitable for very small shops with limited stock.
- Periodic: Inventory is counted at fixed intervals to update records.
- Perpetual: Provides real-time tracking and is ideal for expanding businesses.
Types of Inventory
A business handles four major types of inventory:
- Raw materials for production
- WIP items under process
- Finished goods ready to sell
- MRO supplies needed for daily operations
Benefits of inventory management
A company’s inventory is one of its most valuable assets. In sectors like retail, manufacturing, and food services, raw materials and finished products form the core of the business. Running out of stock at the wrong time can be extremely harmful.
At the same time, inventory can become a liability. The longer it sits in storage, the higher the risk of spoilage, theft, damage, or shifts in customer demand. Companies must pay for storage and insurance, and unsold stock may need to be discounted or even discarded.
This is why inventory management is critical for businesses of all sizes. Decisions about when to restock, how much to purchase or produce, and when to sell can quickly become complex. Small businesses may track stock manually and use spreadsheets to calculate reorder points and quantities. Larger businesses often rely on ERP (enterprise resource planning) software, while big corporations may use customised SaaS solutions and even artificial intelligence to optimise inventory processes.
Inventory strategies differ by industry. For example, an oil depot can store large quantities for long periods, waiting for demand to rise. Although storing oil is expensive and risky—a fire in the U.K. in 2005 caused millions in damages and fines—there is no risk of the product spoiling.
By contrast, businesses dealing in perishable goods or time-sensitive products, such as calendars or fast-fashion items, cannot afford to hold excess stock. Misjudging timing or order quantities can be costly.
For companies with complex supply chains or manufacturing processes, balancing the risks of overstocking and stockouts is particularly challenging. To manage this, they may use methods like just-in-time (JIT) or materials requirement planning (MRP).
Inventory management methods
Depending on the business type or product, companies use different inventory management methods. The four most common are Just-in-Time (JIT), Materials Requirement Planning (MRP), Economic Order Quantity (EOQ), and Days Sales of Inventory (DSI). Here’s an overview of each:
1. Just-in-Time (JIT)
Originating in Japan in the 1960s–70s, with Toyota leading its development, JIT focuses on keeping only the inventory needed to produce and sell products within a short time frame. This reduces storage, insurance, and disposal costs.
However, JIT carries risks. Unexpected spikes in demand or small delays in supply can create bottlenecks, harm customer satisfaction, and push business to competitors.
2. Materials Requirement Planning (MRP)
MRP relies on sales forecasts to determine inventory needs. Manufacturers use historical sales data to plan purchases and communicate requirements to suppliers. For example, a ski manufacturer may stock materials like plastic, wood, or aluminum based on forecasted orders. Poor forecasting can lead to stock shortages and unfulfilled orders.
3. Economic Order Quantity (EOQ)
EOQ calculates the ideal order or production batch size to minimise inventory costs, assuming steady demand. It balances holding costs and setup costs, ensuring that a company neither orders too often nor holds excess stock. The goal is to keep total inventory costs as low as possible.
4. Days Sales of Inventory (DSI)
DSI measures the average number of days it takes to convert inventory, including work-in-progress, into sales. A lower DSI usually indicates faster stock turnover and better liquidity, though the ideal value varies by industry. It is also called days inventory outstanding (DIO), days in inventory (DII), or average age of inventory.
Inventory management challenges and solutions
The main challenges in inventory management are having too much stock that doesn’t sell, running out of stock to meet orders, and not knowing exactly what inventory you have or where it is stored. Other common difficulties include:
- Keeping accurate stock records: Without reliable information on stock levels, it’s impossible to know when to reorder or which items sell fastest.
- Inefficient processes: Old-fashioned or manual methods can lead to mistakes and slow down operations.
- Changing customer demand: Customer preferences change quickly. If your system cannot track trends, you won’t know when or why demand shifts.
- Effective use of warehouse space: Time is wasted when products are hard to find. Good inventory management ensures better organisation and faster operations.
Inventory Management Technologies
Businesses today have a range of tools to manage inventory efficiently and accurately in real time. The following five technologies can improve inventory control, automate operations, and enable faster, data-driven decisions:
1. Barcode scanners:
Barcodes convert printed patterns into digital data that inventory systems can track. Scanners range from handheld units to fixed systems that automatically read codes as items move. When used with mobile devices, automated checkpoints, and cloud software, barcodes speed up stock counts and provide detailed tracking across multiple locations.
2. RFID tags:
Radio Frequency Identification (RFID) tags are small chips attached to products that store item-specific information. They can be read without a direct line of sight, allowing inventory inside boxes or behind other items to be tracked easily. RFID also reduces theft risk and helps locate missing items without manual searching.
3. Automated Guided Vehicles (AGVs):
AGVs are driverless machines that transport inventory along pre-set routes in warehouses. They can move pallets, load and unload materials, place items on racks, and handle vertical or horizontal storage. AGVs also allow remote monitoring of warehouse operations.
4. Predictive analytics:
Predictive analytics uses historical and market data, often with AI or machine learning, to forecast demand and identify potential supply chain issues. It helps businesses plan safety stock, prevent shortages, and develop contingency strategies.
5. ERP software:
ERP systems centralise inventory data across purchasing, production, warehousing, logistics, and finance. They provide a complete view of stock levels, track performance, identify bottlenecks, enforce quality checks, and guide staff during stock counts, making inventory management more efficient and accurate.
What Is an Inventory Management System?
An inventory management system monitors the movement of goods across the supply chain, keeping real-time records of stock levels, item locations, and replenishment needs. Key features include:
- Tracking and traceability: Systems track serial numbers and batches, so businesses always know where products are. This also helps isolate defective items for repair, avoiding costly recalls.
- Multi-location inventory management: For companies with multiple warehouses, stores, or fulfilment centres, the system provides a unified view of stock. This enables strategic allocation based on regional demand, customer proximity, and fulfilment costs.
- Order management: Integrated systems route customer orders to the best fulfilment location, considering shipping costs and warehouse location, while keeping customers and internal teams updated.
- Cycle counting: Modern systems replace manual stock counts with automated methods using scanners, robots, or software to adjust records as orders are processed.
- Reporting: Dashboards display key metrics customised for different roles. Alerts flag urgent issues and suggest actions before problems escalate.
- Purchasing: Systems generate purchase orders when stock falls below reorder points and track vendor performance, including on-time delivery and order accuracy.
- Inventory visibility: Advanced systems provide item-specific details like dimensions, expiry dates, and mobile access for faster decision-making.
- Replenishment: When stock drops below set levels, the system can auto-trigger orders or flag them for approval. Reorder points can be adjusted as demand changes.
- Shipping: Systems identify the most cost-effective carriers, container sizes, and configurations, while automatically generating packing slips, invoices, and customs documents.
How inventory management works
Inventory management is about knowing where your items are, where they’re going, and when you need to restock. This involves a series of connected processes, starting with counting existing stock—either manually or using an automated system. When inventory reaches predefined minimum levels, new orders are placed with suppliers. Once delivered, items are received, checked, recorded, and stored in designated locations until they are used in production or sold to customers.
Many of these steps can be automated with inventory management software, which combines demand forecasts, procurement data, production schedules, and warehouse information into a single system. Businesses also use barcode scanners, cloud platforms, IoT devices, and other technologies to track inventory efficiently and quickly identify any inefficiencies.
How to choose an inventory management system
Choosing an inventory management system means identifying the features your business actually needs. Do you need to track stock movements and locations within a warehouse, plan inventory and monitor trends, or both? Is the system scalable and within your budget? What is the vendor’s record for updates and support? Can it be deployed on the cloud to serve a distributed workforce?
When evaluating a system, businesses should focus on three key capabilities: real-time demand planning, data analysis, and real-time reporting.
Real-time demand planning: Systems with this feature let businesses adjust purchasing and warehouse operations as demand changes. The software should integrate well with existing systems, since delays between demand shifts and operational responses can result in empty shelves or excess stock.
Data analysis: The system should collect and analyse data on finances, customer behaviour, inventory levels, supply chain performance, production efficiency, and warehouse operations. This helps align inventory strategies with overall business goals. For example, a retailer can compare customer buying patterns with surplus stock to make targeted decisions and clear out seasonal inventory.
Real-time reporting: Built-in reporting and dashboards provide timely insights into inventory trends, such as frequent stockouts or supplier delays. These insights help teams take corrective action before small problems turn into costly issues.
Inventory management examples
Retailers rely on real-time tracking, manufacturers use JIT and work-in-progress control, food businesses depend on FIFO to avoid spoilage, and healthcare uses RFID for monitoring high-value items. Each industry applies inventory methods suited to its specific requirements.
Lead time in Inventory Management
Lead time is the total duration from placing an order to receiving the stock. It includes processing, supplier turnaround, shipping, and quality checks. Shorter lead times help prevent stockouts and enhance operational efficiency.
Difference between Inventory Management and Other Inventory Process
Feature
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Inventory Management
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Inventory Control
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Inventory Planning
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Inventory Tracking
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Scope
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Broader and more strategic, encompassing the entire product lifecycle from procurement to sale across all locations.
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Narrower and more tactical, concentrating on the physical stock within a specific warehouse or storage facility.
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A subset of inventory management focused specifically on forecasting demand and procurement.
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A fundamental element for physically monitoring the quantity, location, and movement of goods in real time.
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Focus
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Long-term strategy aligned with business objectives and customer demand.
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Day-to-day operations centred on stock accuracy and movement.
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Future demand forecasting based on historical data and market trends.
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Real-time monitoring and reporting of inventory levels and transactions.
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Key Activities
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Demand forecasting, setting reorder points, managing supplier relationships, and optimising inventory levels and costs.
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Receiving, storing, organising, fulfilling orders, and preventing stock loss, damage, or theft.
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Analysing sales data, calculating optimal order quantities, and determining reorder cycles.
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Using barcodes, RFID tags, or software to record stock transactions and verify physical counts.
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Objective
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Maximise profitability by balancing supply and demand, reducing costs, and ensuring customer satisfaction.
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Maintain accurate stock counts and prevent discrepancies, shrinkage, and waste.
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Ensure the right quantity of each product is ordered at the right time to meet demand.
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Provide accurate data to support inventory control and management processes.
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Relationship
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The overarching strategy that incorporates all other inventory processes as components.
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A day-to-day function ensuring the physical integrity of stock, guided by inventory management.
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The strategic framework for purchasing that drives the execution of inventory management.
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A critical tool that delivers the real-time data necessary for inventory control and planning.
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Future of Inventory Management
Inventory management systems are becoming increasingly sophisticated, adding intelligent and responsive features that help businesses handle inventory and supply chain challenges more effectively.
AI: Advanced AI algorithms can identify patterns and analyse complex factors, such as weather, social media trends, and economic changes, that affect inventory levels. By continuously learning from data, these systems allow businesses to adjust operations proactively, preventing problems before they arise.
Automation: Autonomous vehicles, drones, and picking robots work alongside staff to maintain smooth operations, even in remote or difficult locations. Smart sensors in self-monitoring systems can also automatically reorder or redistribute inventory when stock levels fall.
3D printing: 3D printers produce small-batch parts or custom components on demand, reducing the need for large stockpiles, warehouses, and carrying costs. By producing items onsite from digital designs, businesses can streamline supply chains and lower transportation expenses.
Reverse logistics: Modern inventory platforms integrate reverse logistics, helping businesses manage returns through refurbishing, recycling, or resale. This reduces waste, lowers material costs, and helps companies limit their environmental impact.
Conclusion
Strong inventory management is the backbone of any successful business, regardless of size or industry. From ensuring timely procurement to controlling costs and boosting customer satisfaction, an efficient system helps businesses operate smoothly and stay competitive.
For businesses looking to improve inventory efficiency or scale operations, accessing the right financial support is equally important. A business loan can help cover costs related to system upgrades, technology investments, or bulk purchases. To make informed borrowing decisions, it is important to understand the applicable business loan interest rate and associated charges.
With the right mix of strategy, tools, and financial planning, your inventory management process can become a key driver of sustainable growth.
