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Inventory Management for Small Business

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Inventory Management

Presented in this Small Business Inventory Management guide is a sampling of information that should be helpful to business owners and managers in dealing with small business inventory management problems. Included is a balanced selection in terms of emphasis on techniques, on the one hand, and general management principles on the other.

"Inventory" to many business owners is one of the more visible and tangible aspects of doing business. Raw materials, goods in process, and finished goods, all represent various forms of inventory encountered in a manufacturing organization. Each type represents money tied up until the inventory leaves the factory as a purchased product. Likewise, merchandise stocks in a retail store contribute to profits only when their sale puts money into the cash register.

In a literal sense, inventory refers to stock of anything necessary to do business. These stocks represent a large portion of the business investment and must be well managed in order to maximize profits. In fact, many small businesses cannot absorb the types of losses arising from poor inventory management. Unless inventories are controlled they are unreliable, inefficient, and costly. In attempting to control inventories, managers usually lean towards keeping inventory levels on the high side, yet this greater investment (given a constant amount of profit), yields a lower return on the dollar invested. This is one of the contradictory demands made upon the manager with respect to keeping inventory, others include:

  • Maintain a good assortment of products - but not too many;

  • Increase inventory turnover - but only at a good profit level;

  • Keep stocks low - but not too low;

  • Make volume purchases to obtain lower prices - but don't overbuy; and

  • Get rid of obsolete items - but not before their replacements have taken hold in the market.

Successful Inventory Management

Successful inventory management involves simultaneously attempting to balance the costs of inventory with the benefits of inventory. Many business owners often fail to appreciate fully the true costs of carrying inventory - which include not only direct costs of storage, insurance, taxes, etc., but is also the cost of money tied up in inventory. And it is often not realized that small reductions in inventory investment may result in large percentage changes in the company's total cash position. For example, one reward of improved inventory management may be an increase in working capital without the necessity of having to borrow money.

Computation of the Inventory Turnover Rate

One commonly used, simple measure of managerial performance is the inventory turnover rate. This value gives a rough guideline by which managers can set goals and measure performance, but it must be realized that the turnover rate varies with the function of inventory, the type of business, and how the ratio is calculated (whether on sales or cost of goods sold). For example, on a cost of goods sold basis, the average inventory turnover rate for manufacturers of paperboard containers ranges from 4.5 to 21.0.

Values such as these are published periodically by the trade associations and professional organizations; they can be useful in setting guidelines for one's own company, but must be used with care.

Manual Record keeping Methods

At a very basic level, business inventory records provide the information needed to make decisions about inventory management. But the number and kinds of records maintained, as well as the type of control system needed, depend upon the type and size of inventory. In very small businesses where visual control is used, records may not be needed at all or only for slowly moving or expensive items. But in a larger organization where many items from various suppliers are involved, more formal inventory records, such as kardex files, are appropriate. In such a case, regardless of the type of records maintained, the accuracy and discipline of the recording system is critical. It is important to remember, however, that in many cases attempts to improve management and reduce costs fail, not simply because of insufficient records, but rather because of inaccurate and carelessly recorded inventory data.

Many small manufacturers, wholesalers, and retailers with relatively few items in inventory use manual inventory control system. They use card records, inventory tags and accounting data to capture the information necessary to establish economic order quantities, order points, and other parameters for effective inventory control. However, as the number of item, supplies, and general importance of inventory increases, it is often desirable to consider use of a computerized system for inventory control.

Using Computers in Inventory Management

Today, the use of computer systems to control inventory is far more feasible for small business than ever before, both through the widespread existence of computer services organizations (listed in the yellow pages of many telephone directories) and the decreasing cost of PC computers. Often the justification for such a computer-based system is enhanced by the fact that company accounting and billing procedures can also be handled on the computer.

Most computer manufacturers offer free, written information on the inventory management systems available for their computers. In addition, computer service companies often have material readily available describing the use of their particular computer "software" programs for inventory management. These companies provide a good source of information on general descriptions of particular inventory management techniques, as well as help on specific inventory management problems.

Whether a manual or computerized inventory management system is used, the important thing to remember is that inventory management involves two separate, but closely related elements: the first is knowing what and how much to order, when to order and what price to pay; the second is making sure that the items, once brought into inventory, are used properly to produce a profit.

Meir Liraz

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