Inventory management is considered a complex task for both big and small business organizations. It becomes very difficult to manage, control, and valuation of inventory. To solve this problem businesses adopt different methods and techniques of inventory management.
Inventory management techniques use a variety of data to keep track of the inventory or goods as they move through the production or supply chain process.
After reading this article you will learn about different methods of inventory management such as ABC analysis, Just in Time (JIT) method, Minimum Requirement Planning (MRP), Economic Order Quantity (EOQ), LIFO & FIFO method, and Batch Tracking.
Techniques of Inventory Management
There are many methods and techniques of inventory management adopted by the business which depends on business needs, size, and stock. Some important inventory management techniques are given below.
- ABC Analysis
- Just in Time (JIT) method
- Minimum Requirement Planning (MRP)
- Economic Order Quantity (EOQ)
- LIFO & FIFO method
- Batch Tracking
Now let’s discuss all these inventory management techniques in detail.
1. ABC Analysis (Method of Inventory Management)
ABC analysis method is one of the very important inventory management methods used by organizations to manage and distribute inventory effectively and efficiently. This method is also known as selective inventory control (SIC).
ABC analysis method of inventory management divided inventory into three categories i.e. A, B, and C in descending value. The items in the A category have the highest value and are most important, B category items are of lower value than A, and C category items have the lowest value which means it is least important.
This method is significant to identify the top category of inventory items that generate a high percentage of yearly consumption. It helps the managers to optimize the inventory levels and achieve efficient use of stock management resources.
The items that fall under the A category are fast-moving inventory items which means they required frequent reorders on the other hand items under C are slow-moving and need not be re-ordered with the same frequency as item A or item B.
Advantages of the ABC Method
- It helps businesses to focus on important and frequently used items which have large amounts of capital invested in them.
- It helps in keeping track of all the inventory.
- It ensures optimum levels of stocks are maintained at all times.
- It helps to cut down storage expenses.
- There is a provision to have enough C-category stocks to be maintained without compromising on the more important items.
Disadvantages of the ABC Analysis
- It is very difficult to analyze the correct and accurate requirements of A, B, and C inventory.
- It primarily focuses on high-value items as compared to low-value items.
- This method required proper standardization in place for materials in the store which increase the operational cost of business.
- It requires a good system of coding of materials already in operation for this analysis to work.
- This method is mostly preferred by big organizations.
2. Just-in-Time Management (JIT)
The JIT method originated in Japan around the 1960s and 1970s by Toyota Motor. This method helps the business enterprise to improve its competitiveness by saving significant amounts of money and minimizing wastage by keeping only the inventory they need to produce and sell products.
This approach drastically improves production efficiency and product quality by reducing storage, maintenance, and insurance costs of excess inventory.
The just-in-time approach of the inventory management method focuses on the productive and economical utilization of labor, raw material, components, and goods used in manufacturing that is re-filled or scheduled to arrive exactly when they are required in the manufacturing process.
Advantages of Just-In-Time method
- It keeps stock holding costs to a minimum level that reduce additional cost of rent or storage cost, insurance premiums, etc.
- The released capacity results in better utilization of space and bears a favorable impact on the rent that would otherwise be needed to be made.
- It helps to eliminate unnecessary waste.
- It completely ruled the chances of expired or out-of-date products which put an additional cost burden on companies.
- It ensures the optimum utilization of working capital and provides a high ROI (Return On Investment)
- It helps drive greater efficiency and High-quality products can be derived.
- It promotes coordination between different departments of the organization.
- It ensures higher customer satisfaction due to continuous communication with the customer.
- Its elimination of possibility overproduction.
Disadvantages of Adopting JIT Systems
- This approach solely depends on an accurate and timely analysis of the demand and supply of the product which is very difficult to measure and provides a wide room for mistakes.
- The success of this method is highly dependent on the performance of suppliers which is outside the purview of the manufacturer.
- There are no buffers of raw materials when there is a spike in demand.
- It put an unfavorable effect on the production process.
- Chances are quite high of not meeting an unexpected increase in orders as there will be no excess inventory of finished goods.
- Transaction costs of raw materials or inventory would be comparatively high because of the frequent ordering of inventory.
3. Materials Requirement Planning (MRP)
This is one of the most used inventory management methods. This method is designed to ensure adequate inventory levels at the required times which depend on the sales forecast of products or services.
The business organization must require accurate sales records to plan or calculate the accurate requirement of inventory needed for production and this requirement is communicated to materials suppliers in a timely manner so they ensure inventory acquisition.
Advantages of the MRP method
- It sure to timely availability of materials and components when needed in the production process.
- It minimizes customer lead times to improve customer satisfaction.
- It reduced inventory costs.
- It minimizes the risk of stock-outs which not only improves customer satisfaction but also increase sales and revenue.
- It improves the manufacturing efficiency of the organization.
- It ensures accurate production planning and scheduling to optimize the use of labor, equipment, and raw material.
- It improves labor productivity and the wastage of raw materials.
- It decreases production costs and makes product pricing more competitive.
Disadvantages of the MRP Method
- A highly experienced person is required to forecast accurate demand.
- Some organization used different software to maintain sale records which increase the cost.
- Sometimes inefficiency of factory workers or issues can delay the delivery of materials.
- This method is highly dependent on having accurate information about key inputs, especially demand, inventory, and production, and errors in data may not provide the desired result.
- It is very difficult to calculate the inventory needed only based on sales records.
- It required data integrity and data management to ensure the effective use of the MRP method.
4. Economic Order Quantity (EOQ) Technique
This model of inventory management is used to calculate the right amount of inventory that should be ordered in each batch order so it not only reduces the total costs of inventory but also focuses on the organization not having excessive inventory while assuming constant consumer demand. This method also covers costs of inventory holding and inventory setup costs.
A company’s inventory costs may include holding costs, shortage costs, and order costs.
The EOQ model seeks to ensure that the right amount of inventory is ordered per batch so a company does not have to make orders too frequently and there is not an excess of inventory sitting on hand. It assumes that there is a trade-off between inventory holding costs and inventory setup costs, and total inventory costs are minimized when both setup costs and holding costs are minimized.
- Where, √ = Square
- H= Holding costs of inventory (per year, per unit)
- S= Setup costs (per order, generally including shipping and handling)
- D = Demand rate (quantity sold per year)
Advantages of the EOQ method
- It helps companies to purchase the ideal order quantity in order to minimize inventory costs.
- It helps companies in ordering, storing, and use of inventories.
- It improves customer satisfaction by ensuring the availability of products on time.
- It optimized order schedules in such a way that it cut down excessive costs of real estate, utility, security, insurance, and other related costs.
- It aids in ordering inventory that matches demand, so fewer products are stored.
Disadvantages of the EOQ method
- It does not consider all factors affecting the inventory management of business such as competition, demand variability, and seasonality of the product.
- The poor availability of data makes EOQ calculating less meaningful and challenging.
- The EOQ formula is based on assumption that there is constant demand which is wrong.
- This method may lead to shortages of inventory in the business.
5. LIFO & FIFO – Inventory Management Technique
The LIFO (Last in, first out) and FIFO (first in, first out) one of the oldest and most basic methods of inventory management. Business enterprises use the principle of first in, first out to value inventory.
FIFO assumes that the first goods the business manufactures or purchases should become the first goods sold. This method is very useful for perishable products like food, vegetable, and beverage or product subject to obsolescence like tech products and designer fashion items.
Whereas, In the LIFO (Last in, first out) method of inventory management assume that the last goods the business manufactures or purchases should become the first goods sold. It uses the current prices to calculate the cost of goods sold. This method of inventory management is better for nonperishable goods.
6. Batch Tracking (Inventory Management Technique)
In simple words, batch tracking is a kind of traceability system that enables businesses to group together a set of inventory items that share similar properties in a batch. Inventory batches comprise a specific number of items received on a particular date, for a definite cost.
Basically, batch tracking optimizes the way inventory is managed throughout the distribution chain, as it helps to trace your products from start to finish – the complete production and distribution process, till it reaches the end consumer.
Batch tracking offers better visibility and makes it possible to track the expiry date of products and trace defective units back to the specific batch it belonged to.
Advantage of the Batch Tracking Method
- It ensures faster trackability of inventory by providing a specific number to inventory.
- It reduces the cost of inventory management by minimizing wastage.
- It helps businesses to exercise more control over the quantity and quality of inventory by enabling them to not only track batch movement but also track product development from start to finish.
- It ensures higher efficiency and quality control.
- It is important for both B2C and B2B businesses.
Disadvantages of the Batch Tracking Method
- The batch tracking method is costly it requires computers, software, and trained operators.
- It scope is only limited to the management of physical inventory.
- It plays no role in purchasing and analyzing the demand for inventory.