Chapter #6

17 Best Inventory Management Techniques to Effectively Manage Inventory

In this chapter, we will look at the best inventory management techniques available for your business to improve your inventory management. This chapter will help you to select the right inventory management technique.

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inventory management techniques

As your business grows, new inventory management challenges arise, and with that, you need to adapt your business operation. That’s why understanding the different inventory management techniques will help you to better manage your growth and adapt quickly.

With that, here are our 17 inventory management techniques you should know:

1. ABC Inventory Analysis

ABC inventory analysis is a technique that determines the value of inventory items based on their importance to the business by classifying them into three groups (A, B, and C) in order to help inventory managers and business leaders to understand which products or services are the most critical to the financial success of the organization.

This technique is based on the Pareto rule of 80/20 as ABC analysis identifies the top 20% of inventory items that deliver about 80% of the value.

Classes in ABC Inventory Management for inventory management techniques

ABC inventory is important because it helps companies refine operation processes such as cycle counting, reorder points, and safety stocks. This ultimately lets businesses control working capital costs more easily, reduce obsolete inventory and improve the inventory turnover rate.

The benefits of ABC analysis include:

  • Improved inventory forecasting
  • Better inventory control
  • Increased inventory optimization
  • Better pricing
  • Improved customer experience
  • Sensible stock turnover rate
  • Reduce storage expenses
  • Simplified Supply Chain Management

You can use Microsoft Excel to conduct basic ABC analysis or with modern inventory management systems such as Dynamics 365 Business Central, you will get intelligent AI technology helping you with ABC analysis and more.

abc analysis in inventory management techniques example

2. Just-in-Time (JIT) Inventory:

Just-in-time (JIT) inventory is a technique that aligns, raw-material orders from suppliers directly with production schedules in order to receive materials only when they are needed so you can reduce inventory holding costs and increase inventory turnover.

JIT inventory technique is important for businesses because it helps them to cut costs by minimizing any excess inventory and getting the precise amount of inventory leaving manufacturing companies with higher profit margins and minimal loss. It also increases the flexibility of the business to meet customer needs and improve workforce management.

The following are benefits of the JIT Inventory Management technique:

  • Avoid overproduction
  • Limit waiting time
  • Reduce inventory holding cost
  • Improve cashflow
  • Minimize excess stock and potential obsolete stock
  • Streamline production
  • Improved product quality

To successfully implement the JIT technique for your manufacturing business you will need to use a system such as an ERP inventory management system to gather information on shipping, production, customer satisfaction, loss prevention, warehousing, purchasing, reorders, goods in storage, receiving, and stock turnover and more.

3. Order Fulfillment Techniques:

Another important inventory management technique is to select the right order fulfillment technique for your business.

For businesses that are shipping their items to customers, it’s important to know who will be handling the inventory and shipment process to get your products to your customers.

Therefore, it is important to decide which order fulfillment option fits you the most.

The four types of order fulfillment are:

  • Self-fulfillment: This is when you take care of the entire process of order fulfillment by yourself in-house.
  • Third-party logistics: This is when the storing and order fulfillment is managed by a third-party vendor so you would ship your products to their warehouse instead of yours.
  • Drop shipping: This is when the product is shipped directly from the manufacturer to the customer and your store acts only as a middleman. Only when a customer makes a purchase you will order the product from a manufacturer.
  • Hybrid: This is when a combination of two or more options from the above is being used. This enables inventory-based companies to be more flexible, save costs, and expand their product catalog.

Of course, each of these options has its pros and cons and which one will be the best for you will totally depend on your requirements.

Luckily some of the best inventory management software includes features to manage multiple of these order fulfillment methods to improve business operation and add flexibility to the business.

4. VED Analysis

VED Analysis is a popular inventory management strategy that classifies material according to its criticality for the business into three categories Vital, Essential, and Desirable. This analysis usually is used to classify items for a production schedule.

  • Vital Items: These are inventory items that are necessary for production or other processes and the cost of stocking out would be disastrous. For example, for car manufacturing, tires are vital items and without that, it would stop the entire production.
  • Essential Items: These are inventory items whose stock-out cost would be very high. While these won’t shut your shop or production, customers expect these items are always in stock whether it is a retail store or manufacturing business. For example, if the same manufacturing company was missing spare parts for fixing any broken car it would negatively affect company sales and even customer experience.
  • Desirable Items: These are inventory items good to have in order to increase sales however they do not affect your business at large. In case you are out of stock of the items, it won’t negatively affect your sales or customer service. For example, if the automobile manufacturing company was missing a dashcam or other car accessories that customers like to purchase with a car.

Having a proper understanding of your vital, essential, and desirable items will ultimately improve your supply chain management and better manage your cash flow in order to minimize any disruptions and keep your sales high.

Maintaining inventory has its costs, and hence, this analysis bifurcates inventory into three parts to help in managerial decisions on inventory maintenance.

5. Inventory Turnover Ratio

The Inventory Turnover Ratio is a financial formula to measure how quickly your inventory is sold and replaced during a given period. The ratio considers the cost of inventory sold relative to its average inventory for a year in any set period of time.

This ratio is important because it can indicate that some items may be turning over quite rapidly whereas others might have failed to sell at all. The ratio is also useful when compared to the previous year’s ratio as well as the competitor’s ratio in order to analyze any trends, and business performance and it gives an idea of how efficiently your company is managing its inventory.

The following are the benefits of inventory turnover ratio:

  • Evaluate Company’s efficiency: it is the tool that investors can use to evaluate the company’s performance. The company needs to minimize the inventory level without any impact on sales.
  • Manage inventory: Store too much inventory will impact on company’s working capital. The company will face the risk of market price fluctuation and obsolete. However, too little inventory will impact sales and customers’ waiting time. So, we need to balance these two issues.
  • Manage working capital: Company needs to spend money on the purchase and keep the inventory which will help to generate a sale. If the inventory only stays in the warehouse, it means the company cash will be stuck too. The cash should be used for another purpose that generates profit for the company.

Here is the inventory turnover ratio formula.

inventory turnover ratio formula for inventory management techniques

6. Inventory Demand Forecasting:

Demand forecasting is a process of using historical data to estimate and predicts customers’ future demand for a product or service in order to have the right amount of inventory to avoid stocking out or overstocking.

Inventory demand forecasting allows you to efficiently serve customers’ needs without investing capital in large amounts in stock and effectively helps you lower your overall operational costs. It plays a critical role in effective stock management.

Great forecasting enables you to hold the right amount of inventory without over or under-stocking, for optimum inventory control.

According to Gartner, companies that excel at demand forecasting have:

  • 15% less inventory
  • 17% better order fulfillment
  • 35% shorter cash-to-cash cycle times
  • 60% higher profit margins
  • 1/10th the stock-outs of their peers

Accurate demand forecasting also helps reduce risks and make better financial decisions that increase profit margins, cash flow, improve resource allocation, and create more opportunities for growth.

And there are two demand forecasting techniques, the survey technique which is based on researching the market, and the statistical technique which is based on your own data to make the predictions.

Also, a modern ERP inventory management software will collect your data and automatically analyze it to create forecasts.

7. Inventory Consignment:

The inventory consignment method is a popular retail technique focusing on a supply chain model in which a product is sold by a retailer, but the ownership is retained by the supplier until the product has been sold.

This supply chain management technique helps reduces the retailer’s risk since the retailer does not pay for the product unless is sold and they increase the variety of their products while reducing the amount of capital being tied up to an inventory. This is especially useful when the customer demand is uncertain.

From a supplier perspective, this can help them increase the awareness of their product by placing their products in front of a larger number of prospects.

The benefits of inventory consignment are:

  • A streamlined supply chain
  • Avoid inventory carrying costs
  • Test market interest

With that, because the consignment method is different from the traditional inventory management method to purchase and store inventory, it’s important to use a robust consignment inventory management system.

Order management system such as Dynamics 365 Intelligent Order Management, Dynamics 365 Business Central, or Dynamics 365 Supply Chain Management allows you to effectively collaborate with your suppliers while having complete control and view of the inventory. Learn more about Dynamics 365.

8. Cross-Docking:

Cross docking is a logistics procedure where products from a supplier or manufacturing plant are distributed directly to a customer or retail chain with marginal to no handling or storage time.

cross docking is an important inventory management technique

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Cross-docking solutions allow companies to expedite shipments to customers, which means that customers often get what they want when they want it — the goal of an optimized supply chain.

Overall, there are several main benefits to incorporating cross-docking:

  • Streamlines the supply chain, from point of origin to point of sale.
  • Reduces labor costs through less inventory handling.
  • Reduces inventory holding costs by reducing storage times and potentially eliminating the need to retain safety stock.
  • Products reach the distributor, and consequently the customer, faster.
  • Reduces or eliminates warehousing costs.
  • May increase available retail sales space.
  • Less risk of inventory handling.
  • No need for large warehouse areas.
  • Easier to screen product quality.

9. Cycle Counting:

Cycle counting means taking a small part of your inventory in the warehouse and counting it on regular basis with the goal of counting the entire inventory over a set period of time in order to ensure your physical inventory counts match your inventory records.

With cycle counting, companies are able to track their inventory records more accurately while reducing the amount of time of doing inventory audits. This will give you a better view of inventory in your storage and improve your purchase planning as you know whether you have enough or not enough stock for your operation.

Cycle counting has become a popular inventory management strategy for companies across all industries. Other benefits include:

  • Improvement of the closing process.
  • Higher order fulfillment rates.
  • A more efficient operation overall.
  • Possible elimination of annual counts
  • Better customer service levels.
  • Decreased audit fees.
  • No employee overtime costs.
  • More accurate inventory assessments.
  • Higher sales.
  • Fewer errors.
  • More time between physical counts.
  • Fewer inventory write-offs and obsolete inventory.

And cycle counting is an easy method that can be performed by anyone or any business. It’s an efficient and quick way to manage and optimize your inventory.

10. Bulk Shipments

Bulk Shipments is the transportation of goods in large quantities, usually not packed but loaded directly into a vessel. Such goods are grains, petroleum products, iron ore, and more. As such, these products are sent without any protective packaging or packing, and the object transporting them, usually the ship’s hold, acts as the container.

Bulk shipment allows companies to save on transportation costs by transporting a huge amount of inventory at once. Often this is suitable for the production of stable products such as grains for food, steel for different types of products, and other items that are distributed across many different manufacturing companies.

It is an essential logistic technique for our modern society to allow companies across the world to access materials and products from the worldwide market in order to create cheaper or higher quality products by sourcing the right materials.

11. Inventory Automation

Inventory automation means using an inventory management system that is capable of automating manual and repetitive tasks on its own with little human effort in order to increase business performance, reduce human errors and increase productivity.

An inventory automation system that automates tasks and creates workflows is used by retailers, manufacturers, wholesalers, distributors, and other businesses that manage inventory.

Using inventory automation is an essential step for every growing business. The more inventory the business handles, the more complex processes become, and the more workforce is required to manage the growing inventory.

So in order to cope with it, businesses introduce automation to solve some of the challenges with growing business and inventory management such as complex financials, keeping inventory records, managing purchase orders, and more.

Here are some of the biggest inventory automation benefits:

  • Reduce human errors.
  • Time savings.
  • Real-time inventory visibility.
  • Increase business and employee productivity.
  • Further support business growth.
  • Improve collaboration across departments.

With that, selecting the right inventory management software can be a challenging task and it depends on many different factors which one is the best for your case. For example, Dynamics 365 Business Central comes with advanced inventory and warehousing modules that are suitable for SMBs who are searching for a complete ERP system to centralize the entire operation.

12. Backordering

Backordering is a process that allows businesses to take orders even if they don’t have sufficient stock in inventory. This process is very common among retailers or manufacturers to better manage orders.

backordering process is important inventory management technique

Backordering increases sales for your business and prevents your customers from going to your competitors. It also offers a few other essential benefits:

  • Reduced costs.
  • Less waste by reducing the need of overstocking this having a lot of obsolete inventory.
  • Increased product and brand value.
  • Provide more customization for your products.

And while the backorder process can be hugely beneficial to your business, it can also bring many challenges for your business as the more sales orders you receive from different customers including different inventory that needs to be backorder, the more complex it becomes to track everything.

Thus, to effectively implement backorder, you will need an inventory management system that is capable to consolidate all your sales orders, automatically create purchase orders for the missing items and once the inventory arrives from the supplier, it will need to be easily tracked back to match the inventory with the sales orders so you can deliver your products to the right customers.

That’s why this inventory management technique is often used only by businesses that are already using inventory management software.

13. Economic Order Quantity

Economic Order Quantity (EOQ) is a calculation formula for companies to find out an ideal order size for every product in order to have the right amount of inventory, meet demand, and avoid overstocking or stock shortages and issues associated with it.

Inventory managers calculate EOQ to minimize the risk of purchasing and managing inventory to reduce holding costs and excess inventory.

EOQ is one of the key metrics your business should be tracking in order to avoid ordering too much or too little stock. In case of overstocking, it will help you reduce your inventory holding cost and put too much capital into inventory while in case of having too little inventory it will help you minimize the risk of losing sales revenue and potential customers to your competitors.

14. Minimum Order Quantity

Minimum Order Quantity (MOQ) is a minimum required order set by a supplier to be purchased in order to minimize time and resources wasted on orders with little to no profit.

MOQ is important for wholesalers and manufacturing from running net loss on sales, especially on low-cost items where profit margins are razor thin. MOQ also helps businesses to move their inventory faster, improving their supply chain, minimizing handling inventory costs, and maximizing their profit.

A great example of using minimum order quantity is manufacturing companies using Alibaba.

alibaba using moq very often inventory management techniques

15. FIFO and LIFO

FIFO and LIFO are methods used in the cost of goods sold calculation. FIFO (“First-In, First-Out”) assumes that the oldest products in a company’s inventory have been sold first and goes by those production costs. The LIFO (“Last-In, First-Out”) method assumes that the most recent products in a company’s inventory have been sold first and uses those costs instead.

16. Lean Six Sigma

Six Sigma is a method that provides organizations with tools to improve the capability of their business processes. This increase in performance and decrease in process variation helps lead to defect reduction and improvement in profits, employee morale, and quality of products or services.

The current levels of excess and obsolete inventory are usually addressed, but not the root causes of the problem, and Lean Six Sigma methods have been shown to be very effective in finding and eliminating root causes, thus preventing arbitrary year-end reductions in inventory investment.

Inventory management plays two critical roles in Lean Six Sigma. Firstly, the management of raw materials and semi-finished goods in the lean manufacturing process. Secondly, inventory control of finished goods is held in a warehouse. In both cases, you should keep a sufficient stock level to minimize inventory carrying costs.

17. Reorder Point Formula

Reorder Point Formula (ROP) helps you to establish a minimum stock level a specific product can reach before the stock needs to be replenished. In other words, it tells you when to place an order so you won’t run out of stock.

ROP is an important technique helping businesses to improve their inventory control in order to limit excess and obsolete stock, thus, high handling cost or stockout, thus, losing sales to your competitors.

Setting a reorder point helps you optimize your inventory, replenish your stock of individual items at the right time, and meet your market demand without going out of stock.

reorder point formula calculation for inventory management techniques

It’s also often recommended for businesses to calculate reorder points with safety stock in order to manage any spike in sales for certain items.

reorder point formula calculation with safety stock for inventory management techniques

Nowadays, modern ERP and inventory management systems help you with intelligence notification when is the best time to reorder your stock based on your historical data. This goes beyond just the classic reorder point formula as the AI can look at the past trends and seasonability and adjust your inventory levels based on that.

Final Word

As you can see, there are many different techniques, methods, and strategies to manage your inventory, and not all of them will be suitable for your business.

Every technique has its pros and cons and depending on the type of business you are you, different inventory management techniques will be more suitable than others.

Learn more about Microsoft Dynamics 365 Inventory Management Applications

Dynamics 365 is a portfolio of business applications that meets organizations where they are—and invites them to digitally transform. Each app is designed to remove the barriers and eliminate silos within organizations by working together with existing systems—or the entire portfolio of Dynamics 365 apps—for outcomes you simply can’t get unless every part of the business is connected seamlessly. Dynamics  365 offers several options for an inventory management system, each to fit your needs. Contact us to get personalized suggestion based on your needs, budget and industry.

Microsoft Dynamics 365 Business Central- inventory management solution

Dynamics 365 Business Central is an all-in-one enterprise resource management System for Small-Medium Size Businesses to centralize, simplify and automate your business processes across Finance, Supply Chain, Sales, Inventory & Warehouse Customer Service, Manufacturing, and Projects.

Microsoft Dynamics 365 Supply Chain Management - inventory management system

Dynamics 365 Supply Chain Management transforms your manufacturing and distribution operations and predicts disruptions and responds fast by digitizing your supply chain, warehouse and inventory management, enhancing visibility, improving planning, and maximizing asset productivity.

Microsoft Dynamics 365 Commerce - Inventory Management System

Is Customer Automation and Customer Management system. Differentiate your brand by taking advantage of built-in intelligence to deliver faster, more personalized service and add value to every customer interaction.

Microsoft Dynamics 365 Field Service

Provides complete field Service Management including service agreements, predictive maintenance, preventative maintenance, work order management, resource management, product inventory, scheduling and dispatch, mobility, collaboration, customer billing, and analytics.

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