What inventory is and why it is tricky
Inventory is the stock you hold to sell or to make what you sell: finished goods, parts, ingredients, packaging, supplies. It sits in an uncomfortable middle ground. Too little, and you lose sales, disappoint customers and scramble for rush orders. Too much, and cash is trapped on shelves, items expire or go out of style, and you pay for space, handling and sometimes insurance.
Inventory management is the routine of keeping stock close to what you actually need. You will never hit it perfectly, so the aim is to avoid the expensive extremes and make decisions from numbers rather than feelings.
Why inventory ties into cash
Stock is bought with money you could have used elsewhere. A pallet of goods that takes six months to sell has effectively locked up that cash for six months. This is why inventory and cash flow are closely linked, and why a business can look busy yet feel short of money. On a balance sheet, inventory appears as an asset, but an asset you cannot sell is not much comfort when a bill is due.
Know what you have: counting
You cannot manage what you cannot see, so start with an accurate count.
- Full count. Count everything at set times, perhaps quarterly or yearly. This is also useful for accounting and tax records.
- Cycle counting. Count a small section regularly, such as a few product types each week, so that over a month or two everything is checked. It is less disruptive than a total shutdown.
- Running records. Record each purchase received and each item sold or used, so the system’s number approximates what is on the shelf.
Differences between the record and the physical count are normal. They come from miscounts, damage, theft, unrecorded returns, or items put in the wrong place. Investigate big or repeated differences, because they point to a process problem. Your spreadsheet or tool is only as good as the habits behind it, so decide who updates it and when.
Sort items by importance
Not all items deserve equal attention. A simple sorting helps you spend effort where it pays off.
- High value or fast moving: check often, order carefully.
- Medium: review regularly.
- Low value or slow moving: check less often, order in larger lots if storage allows.
Sorting by value and by sales speed is a rough version of what is sometimes called ABC analysis. You do not need formal software to apply the idea: a quick sort of your products into three piles is enough to begin.
Reorder points
A reorder point is the stock level at which you place a new order, so that new stock arrives before you run out. It depends on three things: how fast you sell, how long the supplier takes (lead time), and how much cushion you want for surprises (safety stock).
The basic formula is:
Reorder point = average daily usage x lead time in days + safety stock
A hypothetical example. You sell about 6 units a day of a product. Your supplier usually takes 5 days to deliver. You decide to keep a cushion of 12 units in case of a slow delivery or a busy few days.
- Usage during lead time: 6 x 5 = 30 units
- Add safety stock: 30 + 12 = 42 units
So when stock drops to 42, you reorder. If everything goes as expected, the new order arrives with about 12 units still on the shelf. The numbers are invented for illustration. Use your own sales history, and revise them as demand and supplier performance change.
Safety stock is a judgment call. A more variable supplier or a more variable demand pattern calls for a larger cushion; a very reliable one needs less. Carrying more safety stock reduces the chance of running out but increases the money tied up, so it is a trade-off, not a free fix.
How much to order
Once you know when to order, you must decide how much. Larger orders often come with lower unit prices or lower shipping per unit, but they raise the amount of cash tied up and the risk of leftover stock. Smaller, more frequent orders reduce stock but add handling and shipping costs. Practical points to weigh:
- The supplier’s minimums and price breaks
- Storage space
- Shelf life or risk of obsolescence
- Your cash position
- How certain your demand forecast is
Some textbooks offer formulas for an “economic order quantity”, but for a small business a sensible rule is to order what you expect to sell in a defined period, adjusted for price breaks and cash, and then review the results.
Watching for too much stock
Signs of overstock include products that have not sold in months, crowded storage, repeated discounting to clear shelves, and a growing pile of “we might need it” items. Responses include pausing reorders, bundling or discounting slow items, returning stock to the supplier if terms allow, and being more cautious with new lines. A full discount might lower your profit margin, but it can still be better than stock that never sells. Record write-offs honestly so your accounts reflect reality.
Watching for too little stock
Signs of stockouts include lost sales, backorders, disappointed customers and rush shipping at extra cost. Causes are usually late reordering, underestimated demand, a supplier delay or a counting error. Responses include raising reorder points for popular items, adding a second supplier, and communicating honestly with customers about availability. Promising what you cannot ship hurts customer expectations more than a clear note about delays.
Seasonality and planning ahead
If sales swing by season, a fixed reorder point will not work year-round. Look at the same period in prior years if you have data, adjust forecasts, and bring forward orders when lead times are long. For a new business without history, start cautiously, track sales closely, and expand stock where evidence supports it. Planning for a product launch needs particular care because demand is a guess.
Physical organization
Keep stock tidy and labeled, with older items at the front so they are used or sold first (often called first in, first out). Store fragile and perishable items appropriately, and keep a clear place for returns and damaged goods so they do not slip back into saleable stock.
Keep it simple
You do not need a complicated system at the beginning. A spreadsheet with product name, quantity on hand, reorder point, supplier and lead time can be enough for a small range. Add tools only once the manual approach becomes a real burden. Review the numbers regularly, perhaps weekly, and when something surprises you, find out why. The goal is a steady, boring supply of what customers want, without a storeroom full of what they do not.