Calculating inventory can be one of the most frustrating parts of a retail business.
It’s time consuming, employees find it tedious, and the process can often seem pointless to the front-line staff carrying it out. Modern technology has relieved a huge part of this manual burden but it can still feel like it’s eating precious time out of every week.
Yet, this is potentially one of the most important ways you can ensure you are meeting your profitability goals.
Inventory management is really a classic, ‘goldilocks’ problem – you’re always trying to find that happy medium between carrying too much inventory (and running the risks of leakage and loss) and not carrying enough (and missing out on valuable sales because of a lack of product). There really is no magic bullet that’s going to ensure your levels are always ‘just right’ – but there are some steps that you can take to optimize your approach and minimize the pain.
The first job involved is to forecast exactly what your business is going to need day-to-day, month-to-month. You’ll want to try and forecast at least six months out to start with. Without this basic forecast, it’s impossible to plan inventory orders and make sure your shelves are full when you need them to be. It’s natural to feel like your best guess is just, well… a guess. And it is. But each time you reevaluate your inventory, you’ll be basing it on more and more past experience and concrete data. You have to start somewhere, so put your finger in the air and try to predict when, what, and from whom you’ll be ordering inventory each week/month for the next six months.
Be Organized, But Be Selective
There’s a lot to keep an eye on when you’re running your own store, so it’s important to focus your energy where it’s going to make the most difference. Entrepreneurship is often referred to as a form of controlled chaos and inventory management is a great example of how ‘selective control’ can really provide less stress and more long term benefit.
In practice this means that you need to recognize that not all inventory is of equal value to your business. The ABC technique is a trick for inventory categorization often known as ‘Selective Inventory Control’. It allows you to focus your attention on the inventory that matters most:
- A ITEMS: Very tight control and accurate records.
- B ITEMS: Less tightly controlled and good records.
- C ITEMS: Simplest controls possible and minimal records.
Once your forecast is done, go through your inventory and break your supplies into these categories. Track as appropriate.
Calculate Your Inventory Turnover Ratio and Establish the Right Cadence
The goal with inventory turnover is, at it’s heart, one of efficiency and it should be a goal of every small business owner to establish a solid, predictable and steadily increasing cadence for their inventory reorders.
The industry has developed a standard metric to keep track of how well you are managing your inventory needs and how fast you are turning over stock.
Inventory Turnover can be understood as a ratio representing how many times a company’s inventory is sold and replaced over a given period. The days in this time-period can then be divided by the inventory turnover formula to calculate the days it takes to sell the inventory on hand or “inventory turnover days.”
Inventory Turnover Ratio = Cost of Goods Sold/Average Inventory
This ratio should be compared against a relevant industry benchmark because an appropriate ratio will vary significantly by business sector.
A low turnover ratio implies poor sales and therefore, excess stock. A high ratio implies either especially strong sales or poor buying. The ratio alone won’t give you all the answers but by monitoring this number, you can make it easier to track how well you’re managing things.
Remember, if you’re carrying a high inventory level and you aren’t turning it over quickly enough, you have essentially invested money in something and returned 0% on that investment. Even worse – you risk losing money through theft, damage, or broader price drops.
Aim to steadily increase your cadence in the first six months – start lean with your inventory, ensure your sales process is working, and then you can beef up your stock while maintaining the same re-order cadence.