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By Roy Rasmussen Updated on October 11, 2021

Inventory Optimization for Small Businesses

Inventory optimization is crucial for small businesses. Here’s our guide of strategies and software to bolster your inventory management.

We’ll walk you through:

  • What inventory optimization is
  • How optimizing inventory cuts business costs
  • Effective inventory-optimization strategies
  • Software to help you optimize your inventory

What Is Inventory Optimization?

Inventory optimization, by definition, is a business-management strategy to ensure inventory levels match supply-and-demand trends.

For example, a retail business that relies heavily on holiday sales needs inventory placement optimization to make sure that popular gift items are in stock in November and December. Failing to do so could result in significant lost revenue as well as lost customers upset about items they want not being available.

On the other hand, if the same company were to keep these items stocked at the same levels in July, when no one is buying them, it would be a waste of valuable warehouse space. Overstocking one item could prevent other items that customers do want from being stocked.

Retail inventory optimization ensures products are available in sufficient quantities when customers are ready to buy them, but not overstocked when they aren’t in high demand.

Benefits of Inventory Optimization

Business managers use inventory optimization for a number of reasons. It helps businesses:

  • Keep high-demand supplies in stock when customers want them
  • Prevent overspending on excess stock
  • Avoid wasting shelf space on low-demand items
  • Save time by automating the process of determining which items need to be restocked
  • Cut shipping costs by optimizing inventory order scheduling
  • Avoid wasting money on excessive shipments of returns

These benefits make inventory optimization an important strategy for companies of all sizes. For large retailers, inventory optimization is absolutely essential to meet demand and contain costs. For smaller businesses, inventory management can save both time and money, while ensuring stock levels keep pace with customer demand for products.

For smaller businesses, inventory management can save both time and money.

How to Optimize Inventory

To optimize inventory levels, business managers use a combination of strategic best practices and inventory-management software. For best results, select the strategies you will use first, then choose software that supports your plan.

Inventory Optimization Strategies

You don’t necessarily need to employ all inventory-optimization strategies at once. Instead, select a few priorities most applicable to your business model, implement them and monitor your results. As you successfully consolidate one strategy, consider deploying others.

Track Your Inventory

Tracking your inventory forms the basis for most other inventory optimization techniques. If you aren’t keeping records of your inventory, attempts to keep your supplies at optimal levels will be guesswork.

Companies use various methods to track inventory, each with their own pros and cons. Some of the most popular include:

  • Manually tagging items and having cashiers remove tags at the point of purchase. This is an inefficient method for tracking inventory, but it has some appeal because it requires the least technological know-how.
  • Electronically updating inventory records when items are sold using bar codes. This saves time, but it isn’t entirely reliable because of issues such as data entry errors or employee theft (referred to as shrinkage), so it usually gets supplemented by other methods to verify actual inventory counts.
  • Conducting a full manual inventory count annually, monthly or during another set interval. A downside of this is that it requires you to pause sales activity or pay for overtime so your staff can count inventory.
  • Counting a percentage of your inventory daily, weekly or monthly, known as “cycle counting.” Companies that use cycle counting establish cycle schedules by determining which items get sold most frequently or generate the highest revenue and counting those items more often. While this can be less accurate than full manual counts, it avoids the need to pause sales to count inventory.

Link Your Inventory Software to Your Point-of-Sale Software

Whichever inventory tracking method you use, you can save time updating your counts by connecting your inventory-management software to your point-of-sale software through your bar-code system. This will automatically update your inventory count each time you make a sale in your store.

If you sell products online, you can link your online payment processing system to your inventory software.

Forecast Demand-and-Supply Trends

Business intelligence analytics tools allow you to make more precise predictions about when demand for products will peak as well as how much stock you’ll have on hand in proportion to demand. Analytics software identifies trends in your sales and inventory data and uses it to make predictions about future trends. Applying analytics can help you ensure supplies are sufficient to meet demand while avoiding overstocking.

Use Just-in-Time Shipping

Having excess inventory on your shelves when it isn’t being sold takes up space that could be used by items customers are currently buying. Just-in-time inventory is a strategy that addresses this issue by using business intelligence forecasts to schedule delivery when it is needed and not prematurely. Effective just-in-time deployment depends on good use of automation tools for accurate predictions and on-time shipping.

Automate Your Reordering Process

Manually reordering items can be tedious, time-consuming and inefficient. Automating the process can save labor and time and help ensure that stock stays replenished on schedule. You can set up inventory-management software to detect when stock levels are falling low and automatically place orders for replacement stock.

Explore Supply Chain Alternatives

Conventional supply chains rely on common warehousing and shipping strategies that can be inefficient, slow and expensive. For instance, you may be paying to store inventory in a warehouse long before it’s ready to be sold or your inventory shipments may be delayed because of the distance between your supplier’s warehouse and your store.

To address these issues, it’s prudent to explore alternatives to conventional supply chains. For instance, to minimize warehouse and shipping costs, you can rent shared warehouse space on an on-demand basis, meaning you only pay for the space and amount of time you need rather than paying for an entire warehouse for a long-term contract.

On-demand supply chains often use a distributed warehousing model. Here, rather than relying on one or two warehouse supplies, your products are stored at multiple hubs in a network. This can enable quicker shipping.

On-demand supply chains often use a distributed warehousing model.

Develop an Emergency Supply Plan

It’s important to have a strategy in case critical inventory runs low. One component of a sound plan is keeping emergency stock on hand. To determine how much stock you should keep available, you can use business analytics tools to help you forecast how much lead time it will take for stock reorders to arrive.

Another best practice is cultivating relationships with backup suppliers. This can help you maintain stock levels if your primary supplier runs low.

Track Inventory Management Performance

For optimal inventory management, set goals and track your performance so you can make adjustments. You can track your performance by establishing key performance indicators (KPIs), which measure the success of your inventory management in specific areas.

Some important standard inventory KPIs include:

  • Inventory accuracy: This compares how closely your manual inventory counts tally with what you have on your books
  • Inventory turnover (days on hand): This measures how often an item gets sold and replaced over a given time frame, which lets you know whether you’re making too few sales or you’re overstocked
  • Average days to sell inventory: How long it takes to convert inventory into sales
  • Average inventory: This lets you know how much inventory on average you’re carrying at a given time, helping you manage fluctuations.
  • Cost of carrying inventory: This tells you what it costs to store inventory for a given period, helping you decide how to manage costs.
  • Stock-out: This tracks how often you’re unable to fulfill orders because of low stock, letting you know how much inventory issues are hurting your revenue.
  • Perfect order fulfillment: This track how frequently you deliver items to their correct locations on time with no mistakes, which can have a significant impact on customer-satisfaction levels.

How to Calculate Optimal Inventory Level

A useful concept for inventory management is optimal inventory level. This involves calculating the ideal inventory level that matches your revenue goals to the level of demand for your products.

If you are exceeding this level, you are holding onto inventory you aren’t selling. If you are falling short of it, your customers are demanding more inventory than you have.

To calculate this, you can compare:

  • The number of sales you’ll need to make to achieve your revenue goals for a given time frame
  • The number of actual purchases and orders your customers are making over the same time frame
  • How your average inventory level during this time frame compares to these two numbers

This is a very simple calculation of optimal inventory level. More complex formulas may be used. You also can break down your numbers by inventory for individual products for a more detailed perspective. This can be important for products that follow seasonal fluctuations in demand.

Inventory Optimization Software

To support inventory optimization, business software manufacturers have designed inventory optimization tools. Many different inventory-management software programs are available, but they generally share some common features:

  • Demand forecasting tools which analyze historical data and other data entered by managers
  • Inventory level projections based on current inventory, projections and supply data
  • Order planning tools which suggest what items need to be reordered when and help you create an order schedule
  • Alerts when you run out of stock or when you overstock products
  • Key performance indicators analyzing your inventory management
  • Reports based on KPIs
  • Software integrations with related apps such as accounting, warehouse management and enterprise planning software

Some software companies market and sell separate inventory-management programs. Others build them into more comprehensive enterprise-resource-planning programs that can be integrated with related business software.

Roy is a respected, published author on topics including business coaching, small business management and business automation as well as an expert business plan writer and strategist.
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