Inventory can be one of the most useful assets in a business — and one of the easiest to get wrong.
Have too little stock and customers may be told:
“Sorry, we’re out of stock.”
Have too much stock and you may discover that thousands of dollars are sitting on shelves, in a warehouse or in a storage room doing absolutely nothing.
And there’s the particularly annoying situation where you somehow have too much of the things nobody wants and not enough of the things everyone wants.
This is why inventory management matters.
Good inventory management is about having the right products, in the right quantities, at the right time, without tying up more money than necessary.
For a small business, getting this right can improve:
- Cash flow
- Profitability
- Customer satisfaction
- Efficiency
- Purchasing
- Storage
- Sales
- Business planning
And you don’t need a giant warehouse or an expensive corporate inventory system to do it.
You simply need a good process.
What Is Inventory Management?
Inventory management is the process of purchasing, storing, tracking and selling the goods or materials your business needs.
Depending on the type of business, inventory might include:
- Finished products
- Raw materials
- Components
- Packaging
- Spare parts
- Supplies
- Work in progress
For example, a clothing retailer’s inventory might consist of shirts, trousers and shoes.
A restaurant’s inventory might include food, drinks and packaging.
A manufacturer might hold raw materials, components and unfinished products.
A building company might hold timber, fittings, tools and construction materials.
Although these businesses are very different, they all face the same fundamental question:
How much stock should we have, and when should we buy more?
Why Inventory Management Matters
Inventory represents money.
If you purchase $20,000 of products, that $20,000 has been converted from cash into inventory.
You may eventually sell those products and turn the inventory back into cash.
But until then, your money is tied up.
This creates an important business principle:
Inventory is an asset, but it is not cash.
A business can therefore appear successful while having serious cash-flow problems because too much money is tied up in stock.
Imagine your business has:
- $50,000 in the bank
- $100,000 worth of inventory
- $80,000 of unpaid customer invoices
On paper, you may have significant assets.
But you still only have $50,000 of actual cash available to pay today’s bills.
This is why inventory management is closely connected to cash-flow management.
The Three Big Inventory Problems
Most inventory problems fall into three broad categories.
Problem 1: Too Little Stock
You don’t have enough inventory to meet demand.
This can result in:
- Lost sales
- Delayed orders
- Unhappy customers
- Emergency purchases
- Expensive express shipping
- Production delays
If customers regularly hear:
“We’re waiting for stock to arrive,”
you may have an inventory problem.
Problem 2: Too Much Stock
You purchase more than you need.
This ties up cash and creates other costs.
Excess inventory can lead to:
- Storage costs
- Insurance costs
- Damage
- Theft
- Obsolescence
- Expired products
- Discounting
- Cash-flow problems
A product sitting on a shelf isn’t necessarily an asset that is helping your business.
It may actually be costing you money.
Problem 3: The Wrong Stock
This is perhaps the most frustrating problem.
You have plenty of inventory.
Just not the inventory customers want.
For example:
You have 500 units of Product A.
Customers want Product B.
Your warehouse looks full.
Your bank account does not.
This is why inventory decisions should be based on demand, not simply on how much storage space you have available.
Know What You Have
The foundation of inventory management is knowing what is actually in stock.
This sounds obvious.
It isn’t always.
Many small businesses have inventory spread across:
- Warehouse
- Shop floor
- Office
- Vehicles
- Storage rooms
- Supplier locations
- Customer sites
If your records say you have 100 units but you can only find 63, you have a problem.
Good inventory records should tell you:
- What you have
- How many you have
- Where it is
- What it cost
- When you purchased it
- When you expect to sell or use it
- When you need to reorder
Create an Inventory List
At a minimum, maintain a list containing information such as:
| Product | Quantity | Cost | Selling Price | Reorder Level |
|---|---|---|---|---|
| Product A | 120 | $10 | $25 | 40 |
| Product B | 65 | $15 | $35 | 20 |
| Product C | 12 | $40 | $90 | 10 |
This can begin as a spreadsheet.
As the business becomes more complicated, you may want dedicated inventory-management or accounting software.
The important thing isn’t how sophisticated the software is.
It’s whether your records are accurate and up to date.
Understand Stock Keeping Units
Businesses often use SKUs, or Stock Keeping Units, to identify individual products.
For example:
TSH-BLU-M
might represent:
- T-shirt
- Blue
- Medium
A different size or colour would have a different SKU.
SKUs make inventory easier to track, particularly when you have many similar products.
Instead of saying:
“We have 27 blue shirts.”
you can know exactly which product and variation you’re talking about.
Count Your Inventory
Your accounting records may say you have 500 units.
But how do you know?
You count them.
This is called a stocktake or physical inventory count.
During a stocktake, you physically count the inventory and compare it with your records.
If the numbers don’t match, investigate why.
Possible causes include:
- Theft
- Damage
- Incorrect deliveries
- Data-entry mistakes
- Items used internally
- Unrecorded sales
- Returns
- Counting errors
Don’t simply change the spreadsheet to make the numbers match.
Find out why they didn’t match.
How Often Should You Count?
There are several approaches.
Annual Stocktake
Everything is counted once a year.
This may be appropriate for a small business with limited inventory.
Periodic Stocktakes
Different categories are counted throughout the year.
Cycle Counting
Small quantities are counted regularly.
For example:
- High-value products: weekly
- Important products: monthly
- Low-value products: quarterly
Cycle counting can be particularly useful because it spreads the work across the year.
Classify Your Inventory
Not all inventory deserves the same level of attention.
A useful approach is to divide inventory into categories based on importance.
One common method is ABC analysis.
A Items
These are usually high-value or highly important items.
They deserve close monitoring.
B Items
Moderate importance.
They need regular but less intensive management.
C Items
Lower-value or less important items.
They can usually be managed with simpler controls.
The idea is straightforward:
Spend the most management effort on the inventory that matters most.
You don’t need to spend an hour every week carefully analysing a $2 item if you have a $5,000 component that could shut down your business if you run out.
Understand Your Best and Worst Sellers
Sales data can tell you a great deal about inventory.
Identify:
Fast-moving products
These sell frequently.
You need to make sure you don’t run out.
Slow-moving products
These sell occasionally.
Be careful about ordering too much.
Dead stock
These haven’t sold for a long time.
This inventory deserves immediate attention.
Ask:
“Why are we still holding this?”
Dead Stock: The Inventory Nobody Wants
Dead stock can quietly destroy cash flow.
Imagine you purchased $15,000 of a product that you expected to sell quickly.
Two years later, $9,000 remains.
That $9,000 isn’t doing much for you.
You might eventually need to:
- Discount it
- Bundle it
- Sell it to another business
- Return it to the supplier
- Repurpose it
- Write it off
Sometimes the best decision is to accept a loss and turn the stock back into cash.
Holding unwanted inventory simply because:
“We paid good money for it.”
doesn’t recover the money.
That money is already spent.
The question is:
“What is the best use of this inventory now?”
Calculate Your Reorder Point
One of the most useful inventory concepts is the reorder point.
This tells you when you should place another order.
A simple formula is:
Reorder Point = Average Daily Usage × Supplier Lead Time + Safety Stock
For example:
You sell 10 units per day.
Your supplier normally takes 7 days to deliver.
You therefore need approximately:
10 × 7 = 70 units
during the delivery period.
If you want 20 units of safety stock:
70 + 20 = 90 units
Your reorder point would therefore be approximately 90 units.
When your inventory reaches 90 units, you place another order.
What Is Safety Stock?
Safety stock is extra inventory held to protect against uncertainty.
For example, perhaps your normal demand is 10 units per day.
But occasionally:
- Sales increase
- A supplier is late
- A delivery is damaged
- A customer places an unusually large order
Safety stock provides a buffer.
Too little safety stock increases the risk of stockouts.
Too much safety stock increases the amount of money tied up in inventory.
The objective is to find a sensible balance.
Understand Supplier Lead Time
Lead time is the time between placing an order and receiving it.
For example:
You place an order Monday.
The supplier delivers Friday.
Lead time = four days.
But don’t simply use the supplier’s advertised lead time.
Look at the actual historical lead time.
If a supplier says delivery takes five days but it regularly takes eight, plan around eight.
Reliable data produces better inventory decisions.
Don’t Ignore Seasonal Demand
Many businesses experience seasonal changes.
For example:
A retailer might sell more products during December.
A tourism business might have a busy summer.
A school supplier might experience a surge before the academic year.
A landscaping company might have different demand during different seasons.
Look at historical sales data.
Ask:
- When does demand increase?
- When does it decrease?
- Which products are seasonal?
- When should we order?
- How early should we prepare?
Good inventory planning happens before the busy season arrives.
Use Sales Forecasting
Inventory decisions should be based partly on what you expect to sell.
Look at:
- Previous sales
- Current orders
- Customer trends
- Seasonal patterns
- Marketing campaigns
- New customers
- Product launches
- Market conditions
Suppose you normally sell 500 units per month.
Next month you are launching a major advertising campaign.
It would be foolish to assume next month’s demand will automatically be 500.
Your marketing activity may increase demand.
Inventory planning needs to consider what is likely to happen, not just what happened last month.
Don’t Buy Inventory Just Because It’s Cheap
Suppliers sometimes offer attractive discounts.
For example:
Normal price: $10 per unit
Bulk price: $7 per unit if you buy 1,000
It sounds like a bargain.
But suppose you normally sell only 50 units per month.
You’ve just purchased approximately 20 months of inventory.
The $3 saving per unit might be less valuable than the cash you have tied up for nearly two years.
Before accepting a bulk discount, ask:
“How quickly will we actually use or sell this inventory?”
A cheap product that sits in your warehouse isn’t necessarily cheap.
Understand Inventory Turnover
Inventory turnover measures how quickly your business sells and replaces its inventory.
A simplified formula is:
Inventory Turnover = Cost of Goods Sold ÷ Average Inventory
For example:
Annual cost of goods sold = $600,000
Average inventory = $100,000
Inventory turnover:
$600,000 ÷ $100,000 = 6
The business therefore turns over its average inventory approximately six times per year.
Generally, faster turnover can indicate efficient inventory management, although the ideal figure varies significantly by industry.
A supermarket will naturally have very different inventory turnover from a furniture retailer.
Use the measure to understand your own business and track trends over time.
Understand Days of Inventory
Another useful measure is Days Inventory Outstanding, often simplified as days of inventory.
A basic formula is:
Days of Inventory = Average Inventory ÷ Cost of Goods Sold × 365
For example:
Average inventory = $100,000
Annual cost of goods sold = $600,000
$100,000 ÷ $600,000 × 365 ≈ 61 days
This suggests the business holds approximately 61 days’ worth of inventory based on its average cost of goods sold.
Again, there is no universally perfect number.
The goal is to understand whether inventory levels are appropriate for your business.
Watch Your Inventory-to-Sales Relationship
One of the warning signs of an inventory problem is inventory growing much faster than sales.
Imagine:
Sales increase 5%.
But:
Inventory increases 30%.
That deserves investigation.
Perhaps you’re preparing for future growth.
Perhaps you’re buying in bulk.
Or perhaps you’re simply purchasing more inventory than the business needs.
Don’t automatically assume that increasing inventory is a sign of growth.
Sometimes it is a sign of poor purchasing decisions.
Improve Your Purchasing Process
Inventory management begins before the stock arrives.
Create a purchasing process.
For example:
- Review current inventory.
- Check sales trends.
- Review outstanding customer orders.
- Check supplier lead times.
- Calculate required stock.
- Check available cash.
- Obtain supplier pricing.
- Place purchase order.
- Record expected delivery.
- Check delivery when received.
This prevents employees from simply ordering stock whenever they think something looks low.
Check Deliveries Carefully
When inventory arrives, don’t simply sign the delivery note and put everything away.
Check:
- Quantity
- Product
- Condition
- Quality
- Purchase order
- Supplier invoice
If you ordered 100 units and received 90, the discrepancy needs to be identified immediately.
Good receiving procedures prevent inventory records from becoming inaccurate.
Store Inventory Properly
Inventory management isn’t just about spreadsheets.
Physical organisation matters.
Your storage area should make it easy to:
- Find products
- Count products
- Receive deliveries
- Pick orders
- Rotate stock
- Identify damaged goods
Use clear labels.
Keep frequently used products accessible.
Maintain sensible storage locations.
If employees regularly ask:
“Where is this?”
your storage system may need improvement.
Use FIFO When Appropriate
FIFO means First In, First Out.
The oldest inventory is used or sold first.
This is particularly important for products that:
- Expire
- Deteriorate
- Become obsolete
- Have limited shelf life
For example, a food business shouldn’t place new products in front of older products and then discover months later that the older stock has expired.
FIFO helps reduce waste.
Watch for Inventory Shrinkage
Shrinkage is the difference between what your records say you should have and what you actually have.
It can result from:
- Theft
- Damage
- Administrative errors
- Incorrect receiving
- Incorrect counting
- Unrecorded usage
Track shrinkage over time.
If losses suddenly increase, investigate.
Inventory disappearing is not simply an accounting problem.
It may indicate a process or security problem.
Connect Inventory With Accounting
Your inventory system and accounting system should ideally work together.
When inventory is purchased, sold or used, the financial records need to reflect what happened.
For businesses holding significant inventory, accurate accounting is particularly important because inventory affects:
- Assets
- Cost of goods sold
- Gross profit
- Taxes
- Cash flow
Work with your accountant or bookkeeper to make sure your inventory accounting method is appropriate for your business and complies with applicable accounting and tax requirements.
Technology Can Make Inventory Easier
As your business grows, spreadsheets may eventually become difficult to manage.
Inventory software can provide features such as:
- Real-time stock levels
- Barcode scanning
- Purchase orders
- Reorder alerts
- Sales integration
- Supplier management
- Stocktake tools
- Inventory reporting
Some accounting systems also include inventory management.
The important principle is:
Choose technology that reduces complexity rather than adding to it.
Build an Inventory Dashboard
A useful inventory dashboard might show:
Stock on hand
How much inventory do we currently have?
Stock value
How much money is tied up in inventory?
Low-stock items
Which products are approaching their reorder points?
Dead stock
Which products haven’t sold recently?
Fast-moving products
Which items need close attention?
Inventory turnover
How quickly are we selling our inventory?
Stockouts
How often are we running out of important products?
A simple dashboard can turn inventory management from guesswork into decision-making.
The Cash-Flow Connection
Inventory management has a direct relationship with cash flow.
Imagine you purchase $50,000 of inventory today.
Your bank account falls by $50,000.
You may not receive that money back until the inventory is sold and the customer pays.
If the inventory sits for six months, you’ve effectively financed that inventory for six months.
This is why growing businesses sometimes experience a strange problem:
Sales are increasing, but cash is becoming tighter.
Why?
Because they’re buying more inventory to support the growth.
Growth can consume cash.
Good inventory management helps reduce the amount of cash unnecessarily trapped in stock.
A Practical Example
Imagine you operate a small electronics retailer.
You sell three major products:
| Product | Monthly Sales | Inventory Held |
|---|---|---|
| Product A | 500 | 600 |
| Product B | 100 | 800 |
| Product C | 50 | 40 |
At first glance, you might think the business is well stocked.
But look more closely.
Product A
Sales = 500 per month.
Inventory = 600.
That’s a relatively healthy level if supplier lead times are short.
Product B
Sales = 100 per month.
Inventory = 800.
You have approximately eight months of inventory.
That’s potentially a lot of cash tied up.
Product C
Sales = 50 per month.
Inventory = 40.
You may need to monitor this product closely to avoid running out.
The lesson is important:
Inventory should be managed according to demand, not simply according to how much stock looks comfortable.
Create an Inventory Management Routine
A simple routine might look like this.
Daily
- Record sales
- Record inventory movements
- Check urgent stock issues
Weekly
- Review low-stock products
- Review outstanding purchase orders
- Check fast-moving products
- Investigate stock discrepancies
Monthly
- Review inventory value
- Review slow-moving stock
- Review inventory turnover
- Review supplier performance
- Review purchasing decisions
Quarterly
- Review product performance
- Review reorder levels
- Review dead stock
- Review seasonal requirements
- Review the overall inventory strategy
This creates a rhythm for managing inventory instead of waiting for problems to appear.
Your Inventory Management Checklist
- Create an accurate inventory list
- Give products clear SKUs
- Know the quantity of each product
- Know the value of your inventory
- Identify fast-moving products
- Identify slow-moving products
- Identify dead stock
- Establish reorder points
- Calculate appropriate safety stock
- Monitor supplier lead times
- Track seasonal demand
- Create a purchasing process
- Check deliveries carefully
- Organise storage areas
- Conduct regular stocktakes
- Investigate inventory discrepancies
- Monitor inventory turnover
- Track stockouts
- Review inventory’s effect on cash flow
- Consider inventory-management software
- Review your inventory strategy regularly
Final Thoughts
Inventory management is ultimately about finding a balance.
You need enough stock to satisfy customers and keep your business operating.
But you don’t want so much inventory that your cash is sitting on shelves.
The goal is not:
“Have as much stock as possible.”
And it isn’t:
“Have as little stock as possible.”
The goal is:
Have the right stock, in the right quantity, at the right time.
Good inventory management means knowing what you have, understanding what you’re likely to need, ordering intelligently, monitoring sales and getting rid of stock that isn’t earning its keep.
For a small business, these improvements can have a surprisingly large impact.
You may discover that better inventory management doesn’t just reduce warehouse clutter.
It can free up cash, reduce waste, improve customer service, reduce stress and increase profitability.
And perhaps best of all, you can stop opening the storeroom door and wondering:
“Why on earth do we have 400 of these?”