A Guide to Inventory Control for Small Businesses

During my stint as a textbook publisher, I dealt with college bookstores across the country, and my favorite bookstore manager was at a small technical college in Texas. Flo had almost 50 years in the book business, and talking with her was like visiting your grandmother.

Flo’s inventory control process consisted of handwritten notes in a succession of Big Chief tablets. This system met her needs, but when she retired, her successor had no idea what to make of her chicken-scratch handwriting or what the store did or didn’t have in stock.

He needed a couple of months and trial runs of several inventory management systems before he dragged the bookstore into the new millennium.

The moral of the story? As nice as Flo was — and she always had a plate of homemade cookies on her desk when I stopped by — don’t use her pencil-and-paper inventory control system.

Instead, leverage the power of inventory management software to keep up-to-date inventory information and enjoy the other benefits it provides. We’ll cover the basics of inventory control as well as its different processes so you can see how it benefits your small business.

Overview: What is inventory control?

Inventory control consists of the processes to purchase, ship, receive, and store products and supplies, track their turnover, and reorder as necessary.

Inventory control identifies slow-moving products to prevent you from ordering and storing stock you don’t need, and likewise, fast-selling products that require more frequent replenishment, so you don’t run out.

You track inventory using either periodic or perpetual methods. Periodic inventory counts take place on a predetermined schedule: weekly, monthly, quarterly, or annually. Perpetual inventory uses software integrated with a point-of-sale (POS) system to keep a running record of stock levels.

Inventory control vs. inventory management: What’s the difference?

Inventory control and inventory management are often used synonymously, but they’re different. Inventory control focuses on inventory in stock, so you can pick, pack, and ship orders, receive more inventory, and process purchase orders.

Inventory management deals with the big picture: ensuring you have the correct quantities of stock on hand at the right locations. Inventory management includes optimizing your warehouse layout, streamlining the reordering process, and identifying obsolete inventory.

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Inventory control and management software benefits include:

  • More efficient reordering: Know what you need to order, and when to schedule reorders.
  • Reduced risk of overselling: Avoid stockouts of your best-selling products.
  • Lower warehousing costs: Only pay to store products that sell quickly.
  • Increased accuracy: Access 24/7 inventory numbers that don’t rely on periodic manual counts.
Five benefits of inventory control software — real-time inventory, sales analytics and forecasting, discrepancy identification, stockout prevention, and reduced time for manual inventory counts — displayed in a row with illustrative icons above each one

Inventory control software provides information that directly affects your bottom line.

When you started your business, inventory control and management may have consisted of eyeballing the number of boxes or pallets of stock in your corner of a warehouse. That quickly becomes cumbersome as you add more products, increase sales, and have too many things going on to manage them in your head.

What are the inventory control processes?

Inventory control management processes allow you to look at your stock levels from all points of view so you can gain actionable insights for how to best maintain it.

1. Set safety stock levels

Safety stock is extra product to set back in case of an emergency or unexpected sales surge. Never use it for daily sales because it’s meant to tide you over in a worst-case scenario until new stock arrives.

Use this formula to calculate the safety stock required for each product:

Safety Stock = (Maximum Daily Sales x Maximum Lead Time) – (Average Daily Sales x Average Lead Time)

Lead time is the number of days for delivery after placing an order.

Let’s say you typically sell five widgets per day with an average lead time of seven days, and the most you’ve sold in a single day is 15 with a maximum lead time of 14 days. Now you can calculate your safety stock:

Safety Stock = (15 x 14) – (5 x 7) = 201 – 35 = 175 Widgets

This number might seem excessive given that you sell five widgets on average per day; then again, empty store shelves during the COVID-19 pandemic demonstrated the value of safety stock.

2. Calculate reorder points

Inventory reorder points are another important calculation. If you order stock too often, your warehousing costs go up, and you tie up capital in unnecessary inventory. Order too infrequently, and you’ll lose sales — and customers — because you’re out of stock.

Use this formula to calculate each product’s reorder point:

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Reorder Point = (Average Lead Time x Average Daily Sales) + Safety Stock

Using the numbers from our earlier example to determine widget safety stock, calculate the reorder point:

Reorder Point = (7 x 5) + 175 = 210 Widgets

Calculating safety stock levels and reorder points illustrates an important fact: Stock control requires more than handwritten notes or estimating rough figures based on a cursory walk through a warehouse.

3. Determine economic order quantity

Beyond safety stock and reorder points, you must know how much inventory to order — your economic order quantity (EOQ) — to prevent storing excess stock.

Use this formula to calculate EOQ:

EOQ = Square Root of ((2 x Annual Unit Sales x Cost Per Unit) / Annual Storage Cost Per Unit)

If you sell 3,000 of our widgets above per year that cost $5 each and require $3 to store, you can calculate your EOQ like this:

EOQ = Square Root of ((2 x 3,000 x 5) / 3) = Square Root of 10,000 = 100 Widgets

EOQ has caveats based on the assumptions that sales, unit order costs, and storage costs remain the same even though different factors may affect each one, such as volume order discounts.

4. Use first-in, first-out order fulfillment

First-in, first-out (FIFO) has less to do with formulas than warehouse setup and logistics because inventory is not created equal. Your natural inclination is to stack new stock in front of the old when it’s delivered for ease of unloading.

The longer stock sits in a warehouse, though, the likelihood increases that it will deteriorate, become damaged by environmental conditions, or pass a use-by date.

If you bought a head of lettuce last week and another one this week, you may reach for the newer one because it’s closer to the front of the refrigerator. The older one, though, will probably go bad before you use it, which doubles the real cost of the new lettuce.

For perishable goods such as your lettuce, use the first-expired, first-out (FEFO) method, a more pointed variation of FIFO.

5. Conduct manual stock reviews

Fancy formulas and acronyms aside, you should manually check your inventory at least once a year. Electronic inventory records are only as good as the data they’re given, so inevitable discrepancies — miscounts, theft, unsellable goods — must be identified and resolved.

  • Quarterly: Coincides with standard accounting cycles because theft is tax-deductible.
  • Seasonal: Verifies stock for upcoming sales periods — such as college textbooks at the beginning of a semester — and provides info about items to discount, such as winter coats when spring arrives.
  • Annual: Reconciles end-of-year physical inventory with electronic records.
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You may think you have a handle on your inventory, but nothing beats looking at it unit by unit at least once a year. Forbes recently estimated that most retail store inventory control is only 60% to 70% accurate, which increases financial losses due to inventory mismanagement.

3 tips for implementing inventory control within your small business

Putting a comprehensive inventory tracking system into place is a complex undertaking. These tips will make your efforts efficient and productive.

Tip 1: Create a plan

Inventory control and management require upfront planning to succeed. The first step is conducting a needs assessment that identifies your current inventory processes, warehouse layout, stockout frequency, inventory turnover ratio, and your goals and performance metrics for a new inventory system.

Tip 2: Implement inventory management software

Inventory management software is a must. Without it, you’re operating blind with your inventory. Many point-of-sale systems come with inventory management features or, like with Shopify, you can add that functionality with third-party integrations such as Stocky.

The Stocky inventory dashboard provides multiple stock metrics and reporting options.

Stocky creates reports for low stock, best sellers, lost revenue, and more.

No one goes into business to obsess over inventory reports, but paying attention to the ins and outs of your inventory metrics will benefit your bottom line.

Tip 3: Use barcodes and radio frequency identification (RFID) tags

Barcodes increase inventory accuracy and decrease the time required to monitor stock because they are:

  • More accurate than manual counts when receiving inventory or performing periodic inventory checks
  • Automatically update inventory with each sale when used with a POS barcode scanner
  • Scalable as your business and inventory grows

Radio frequency identification (RFID) tags take barcodes a step further. An RFID reader can read tags from 40 feet away, which eliminates climbing up and down ladders to scan barcodes. You can also read tags for all items or boxes on a shrink-wrapped pallet without scanning each one individually.

Lower your costs with inventory control

Pen and paper may have worked when you logged your first inventory shipment, but you must upgrade to an inventory control system or suffer unnecessary costs.

You’ll also have a system that works independently of who’s using it instead of being limited to the one person who can read their own handwriting (a-hem). That said, if you can make cookies as good as Flo’s to keep in your office, I can promise you’ll be more popular.

View more information: https://www.fool.com/the-blueprint/inventory-control/

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