Retail businesses have an average of 20% inventory to sales ratio. This I/S ratio compares the value of your inventory with the amount you make from selling your goods. The I/S ratio is arrived at by dividing the revenue made from overall sales by the value of the stock that’s kept. So, with a 20% I/S ratio, if you make $100 from selling your items, your stock would be valued at $20. More simply, the I/S ratio here would be five (revenue made from sales divided by value of stock). Maintaining the I/S ratio that’s best for your business is key to maximizing profit. If there’s too much stock, profits are compromised; if there’s too little stock, orders might not be filled. Optimization is the key. What are the best ways to optimize inventory? And, what are the five elements of an optimized inventory management system? Let’s find out.
If you are a businessperson, deciding the amount of inventory you should keep on hand is crucial. If your stock runs out, or if you have too much of it, the consequences could be serious. There could be financial losses and your reputation could be damaged. The only way to avoid this is by having optimum inventory on hand, or the right amount you need. This article will help you to understand what inventory optimization is and explain the five elements of an optimized inventory management system.
What is inventory optimization?
Inventory optimization means maintaining an optimum amount of stock, stock being defined as all the stock-keeping units (SKUs) that are being held by a business. When a company has an optimum level of stock, its working capital is being used to its best advantage.
Overstocking inventory can result in
- Working capital being tied up in unneeded stock.
- Stock going out of fashion and becoming unsellable.
- Workers spending time and energy unnecessarily.
- An elevated risk of loss of goods to theft or accidents.
- Valuable storage space being used unnecessarily.
On the other hand, understocking and stockouts can result in
- Turnover being halted.
- Company reputation being damaged.
- Production lines being broken.
- Workers’ time being lost.
Inventory optimization can eliminate these losses. Put another way, when optimal levels of inventory are maintained, resources, like physical space, labor, and capital, can be used in their most efficient ways.
5 elements of an optimized inventory management system
As we saw earlier, it is crucial to optimize the amount of inventory you keep at all times. But in order to do this right, what should you be focusing on? Let’s look at the key areas in detail.
Graded policies for inventory management
First, your stock policies should be clearly defined, and you should let the relevant people know about them well in advance. It isn’t helpful if the purchasing department is kept in the dark about these policies.
The inventory turnover ratio indicates the liquidity of the inventory, or the number of times the average inventory is sold during the year. It shows the efficiency and effectiveness of the company in investing its funds.
Inventory turnover time is the number of times a company replenishes its stock in a given period, generally a year. In other words, if you sell stainless steel spoons, the inventory turnover of finished product — spoons — is the number of times you sell out of spoons and replace them. The following formula shows how to calculate the inventory turnover ratio:
|Inventory turnover ratio =||Cost of goods sold|
|Average value of inventory|
|Average inventory =||Opening inventory + closing inventory|
Cost of goods sold = Opening inventory + purchase – closing inventory
Now you know how many times a year you have to refill your inventory. The following categories of inventory are dependent on this ratio.
- Fast moving – Fast-moving inventory is that which is used or sold in a short or easily known period of time. This period is different for every industry. The inventory turnover ratio will be higher for goods in this category.
- Slow moving – Slow-moving goods are those that stay in your warehouse for a more extended period of time. The inventory turnover ratio for these types of goods will be lower.
- Non-moving – Non-moving or obsolete goods are those stored in your warehouse for a long time because there is no market for them. This inventory is also known as dead stock.
These three categories should be a major consideration when making purchases. Separate your stock into each one, and invest more in goods that are fast moving than those that are slow-moving.
Realistic demand forecasting
Forecasting demand is, perhaps, the first step when it comes to good inventory management. Forecasting demand accurately is not an easy task, however. There are many aspects that have to be considered: historical sales data, customer biases, future demand, and growth. Additionally, it is crucial to take technological advances and trends into account.
How can you predict demand for your products accurately? Well, quality software can help. Cin7’s system generates reliable demand forecasting reports. Cin 7’s forecasting demand report can make your job a lot easier.
Determining product life cycle
The term product life cycle is defined as the period between the product’s initial production to the time it is no longer sold. If you launch a new product, sooner or later it will stop trending and your customers will move on to something else. There are five stages to a product’s life cycle that impact your inventory management:
- Introduction – There is less awareness at this stage, so the demand is less, and there is no need to stock a lot of products.
- Growth – Awareness of the product is on the rise, and the company should be prepared to fill more orders.
- Maturity – This is when demand reaches a plateau. Demand will still be high, so the company won’t have to make changes to the level of stock it maintains.
- Decline – Here, the company realizes that demand is dropping. Customers have had enough of the product and are buying less of it. When this point is reached, the company needs to reduce production and focus on replacing it with something new. This is also the time to push more of the product by offering discounts and rewards.
- Obsolete – Now the product is totally out of demand. Any remaining inventory you have becomes dead stock.
The life cycle of a product can be short (a few months) or long (spread over years). These life cycles have to be taken into account when forecasting demand for your product. Doing this accurately will prevent overstocking or understocking,
Your purchase department should have clear restocking instructions. Every item in the inventory should have a specific reorder point (ROP), a predetermined level of goods at which they have to be restocked. When determining this reorder point, you should consider:
- Safety level for stock: This is the minimum amount you will need on hand to tide you over until your new order arrives. You don’t want to run out of stock.
- Logistics: You have to consider the time it takes to get your goods to your factory or warehouse.
- External factors: These include weather, political upheavals, and labor issues. Any one of them can affect your delivery time.
- Supplier lead time: This is the time it takes your supplier to dispatch your products. Suppliers have different lead times.
Management needs to be aware of ROP to ensure stock is replaced in a timely manner. Inventory management software like Cin7 can send alerts that let you know when you reach this ROP.
Investing in reliable inventory management software
If you find inventory management challenging and are intimidated by the sheer number of calculations that have to be made, here’s an easy solution: Cin7. This versatile and easy-to-use software can help you manage your inventory easily. Among the features it has to make your life easier are
- Determining reorder levels,
- Alerting you when you reach ROP,
- Sorting third-party logistics (3PL),
- Helping you with B2B ecommerce,
- Generating reports on COGS, forecasting, cashflows, and inventory on hand, and
- Integrating with other software and mobile OS.
The following video shows how Cin7 inventory management software can help you take your business to the next level:
One of the significant advantages of Cin7 is its inventory management app. This app lets you connect to your inventory management program from anywhere.
Final take on inventory optimization
While inventory optimization is a crucial element of a successful business, it is also painstakingly tricky and complex. Overstocking can lead to losses, while understocking can damage your reputation. How can you overcome these dilemmas? Cin7 inventory management software turns the whole ordeal into a piece of cake.
Why wait? Contact our experts for a demo, and unlock the true potential of your inventory.