Table of Contents

• What is inventory management?
• Why is inventory management important?
• Benefits of inventory management
• Inventory management techniques
• Inventory management challenges
• Upgrade your inventory management technique
• Frequently asked questions

Canadian businesses, from retail and manufacturing to shipping/logistics, must know how much inventory they have on hand at all times. This allows you to create, ship, and fulfill orders quickly — without the burden of back orders or cancellations.

In turn, being mindful of your inventory directly relates to profitability, the ability to scale output, and being financially successful as a small to medium-sized business.

What is inventory management?

Simply put, inventory management reflects having enough products in stock to meet customer needs. This means continually managing the incoming ebb and outgoing flow of products (or supplies to make your products) and sales.

Inventory management requires monitoring how much inventory you have on hand, where it's stored, and tracking its progress through the sales and shipping cycle. You'll also monitor the performance of your inventory to learn which products sell best — so you can invest in more of those.

Why is inventory management important?

Finding the right method to manage inventory for your business helps you learn how much product you can stock without loss of profitability.

It also helps you determine the amount of storage or warehouse space you truly need. It might be less than what you have, so a downsize can save on the operating budget.

Benefits of inventory management

Inventory management is more than just keeping track of your stock. It’s a powerful tool that can drive your business forward.

Here are some key benefits of effective inventory management:

• Better decision-making: Access to accurate, real-time inventory data allows you to make informed decisions. Whether you're planning your next order or launching a new product, having reliable data at your fingertips supports smarter, more strategic choices.
• Competitive advantage: Businesses that manage their inventory efficiently can respond quickly to market changes and customer demands. This agility gives you a competitive edge, enabling you to capitalize on new opportunities faster than your competitors.
• Increased efficiency: Streamlined inventory processes save time and reduce the administrative burden. Automation and inventory management tools reduce manual work and errors, allowing you to focus on growing your business.
• Accurate financial reporting: Proper inventory management ensures that your financial statements reflect the true value of your inventory. This accuracy is crucial for financial planning, securing loans, and meeting regulatory requirements.
• Scalability: As your business grows, efficient inventory management systems can scale with you. Whether you’re expanding your product line or entering new markets, robust inventory management techniques support seamless growth.
• Reduced stockouts and overstock: By closely monitoring your inventory levels, you can avoid the pitfalls of having too little or too much stock. This balance helps maintain steady sales and reduces the risk of lost revenue.

Inventory management techniques

As your business grows, determine which type of inventory management method will work best for you. Your needs will change as you develop and increase the number of products you sell, as your purchasing budget changes, and as your storage situation increases.

Some businesses track inventory on multiple products, including raw materials, works in progress, finished salable goods, and items returned for repairs or disposal.

First in, first out (FIFO) inventory management

The FIFO inventory management technique is based on the idea that the first products you create or purchase are the first ones offered for sale. This is most common among retailers such as grocers, farmer's market vendors, food trucks, or coffee shops with perishable food items. It's simple and straightforward. Most Canadian businesses use this method.

When it comes to inventory valuation, the value is higher in the FIFO method, which looks favourable when applying for bank financing to stimulate business growth.

Weighted average cost (WAC) inventory management

If the FIFO method doesn't make sense for your small to medium-sized business, the WAC inventory management technique might be a better fit.

In this approach, the cost of goods sold (COGS) and ending inventory are calculated based on the average cost of all items available for sale in a specific time period. This evens out price fluctuations and makes it easier when selling weighted goods, such as fuel sold by the litre or livestock feed sold in bulk.

Lean/Six Sigma inventory management

When your business faces labour shortages or an increase in raw materials costs, it might be time to implement a combination Lean/Six Sigma inventory management system to improve outputs in difficult times.

The key here is implementing a strategy to improve your processes and reduce defects. Can you identify inefficiencies and resolve them? Can you reduce waste or remove low-selling products in the inventory system (and the associated costs)?

In turn, these improvements bolster customer relations and drive new business growth. 

Just-in-time (JIT) inventory management

Does your business sell high-dollar items? Keeping too many products on hand can put a dent in your working capital and stretch your budget too thin.

Just-in-time inventory management solves these issues. With JIT, you order and receive the products close to when you know they will sell, or as needed.

For example, a small car dealership or home appliance store might operate a business with this inventory method by having showroom models for shoppers to view, then ordering the items once customers choose the makes and models that fit their needs.

Materials requirement planning (MRP)

Materials requirement planning is an inventory control system that covers the production and manufacturing process of goods sold by your company.

This method plans for inventory needs in advance, with the goods being produced beforehand to meet the expected demand of the market.

Ask yourself:

• What is needed? Take stock of the materials on hand.
• How much is needed? Identify additional stock required.
• When is it needed by? Schedule the production or purchase of the materials.

One of the most significant benefits of using inventory management strategies like MRP is the improvement in production efficiency and productivity for companies.

Businesses must consider the cost of labour, materials needed in the supply chain, and current and future demand from customers before undertaking the production process and creating or purchasing what they need.

Such precautionary planning means fewer mistakes and less waste of materials and labour.

Economic order quantity (EOQ)

Economic order quantity is about ordering the ideal quantity of inventory with the lowest associated overhead costs, such as order costs, shortage costs, and holding costs.

The EOQ method is mainly used as an inventory management technique that seeks to balance out inventory holding costs with inventory set-up costs.

With order quantities in mind, your business will seek to order the exact amount of inventory needed for each batch to cover the market demand without causing excess inventory that must be stored. The main objective is to minimize costs and meet demands with the precise inventory quantity.

To calculate the EOQ, you will need to collect specific information: set-up costs (all costs connected to ordering inventory), demand rate (the amount of inventory the business sells each year), and holding costs of a product (costs connected to the storing and handling of excess inventory).

The formula is as follows:

EOQ = Square root of (2 x Demand rate x Set-up costs + Holding costs)

This formula and the EOQ is an essential cash flow tool, especially when dealing with inventory expenses.

When employed well, this strategy allows a company to minimize inventory buying and storing costs while acquiring and selling the optimum quantity of goods to fulfill customer demand.

Day sales of inventory (DSI)

Day sales of inventory refers to the average time it takes for your business to sell off all its stock, including all goods still in the production phase. Basically, DSI is a measurement used to determine how long your company’s current stock will last.

DSI lets your business know how long its cash will be tied up in the inventory. Typically, businesses aim for a lower DSI, which illustrates a shorter time needed to sell out their stock for a higher turnover rate, meaning more profits.

A high DSI number could illustrate that a company is having a harder time selling off excess inventory, or maybe they're retaining inventory for an upcoming sale or busy season.

The reason for a higher day sales of inventory number varies by company. Depending on the context of the industry and inventory type, the DSI metric will differ.

Day sales of inventory can be calculated using this formula:

Day sales of inventory = (Average inventory / Cost of goods sold) x 365 days

DSI offers a snapshot of the company’s inventory system management for a day. This metric is beneficial, as it shows businesses how effectively they are managing — and turning over — inventory compared to their competitors.

ABC analysis

This inventory categorization technique classifies your inventory based on the value of the goods, placing them in A, B, or C categories. This analysis works for inventory management because it identifies your business’s most important products, which can then be prioritized over less valuable stock goods.

When classifying goods into categories, this analysis uses the Pareto principle, or 80/20 rule, whereby 80% of the value to the business is held within 20% of the goods.

If your business chooses to use this inventory technique, consider splitting your goods into:

• Category A: Includes the highest valued goods (smallest category)
• Category B: Includes the slightly lower valued goods (higher quantity of products)
• Category C: Includes the lowest valued goods (largest quantity of products)

These categories create a quick and simple way to prioritize your workload and focus greater inventory control on the more important goods. However, the categories do not change even when variables come into play, so it could be considered an oversimplified metric in some instances.

Overall, ABC analysis provides a clear view — and control — over the inventory for improved efficiency and fewer chances for a stockout.

Inventory management challenges

Here are some challenges to consider:

Demand forecasting: Accurately predicting customer demand is a constant challenge. Overestimating demand can lead to overstocking, while underestimating it can result in stockouts. Both scenarios can hurt your bottom line.

Inventory tracking: Tracking inventory across multiple locations and sales channels can be complex and can lead to discrepancies, making it difficult to know what you have in stock at any given time.

Supplier reliability: Dependence on suppliers means that any delays or issues on their end can disrupt your inventory levels.

Inventory turnover: Balancing inventory turnover is tricky. High turnover rates can strain your supply chain, while low turnover rates can result in obsolete stock. Striking the right balance is key to maintaining efficient operations.

Storage costs: As your inventory grows, so do your storage costs. It can be a tough balancing act to manage these costs without compromising product availability.

Inventory shrinkage: Losses due to theft, damage, or errors can impact your inventory levels and profitability. Implementing effective security measures and employee training can help reduce shrinkage.

Seasonal variations: Adjusting inventory levels to match seasonal demand without over-committing resources is a constant challenge that requires careful planning and flexibility.

Regulatory compliance: Ensuring that your inventory management practices comply with industry regulations and standards can be complex. Staying updated on relevant laws and maintaining compliance can be resource-intensive.

Upgrade your inventory management technique

If you're looking for a tool to make inventory monitoring simple — and at your fingertips — consider QuickBooks. The inventory tracking feature lets you know at a glance what's in stock and what's on order from your suppliers in real time. You can run reports to identify your best sellers and current sales totals.

Learn more about QuickBooks' inventory management solutions today to help your business operations flow smoothly.