Small Business 101: Inventory Management

While it seems simple, the idea that a business should have the products their customers want, when they want them, and in whatever quantity they desire is often lost in the swirl of running your own company. Many of us were raised  with an ethic that waste is bad, while some of us were raised with the notion that plenty is a sign of success. When I walk into many small businesses today, I am most often confronted by a massive assortment of goods that don’t sell (recognized by the dust they accrue), in combination with empty shelves were the store’s best items live.

There are two simple laws that must be recognized when managing your inventory; inventory costs money over an above what you buy it for, and being out of stock on items in your firm’s top 20% is a sin of the highest order. This two laws may seem to be contradictory, but an owner or manager can use them to his/her advantage by following a few simple guidelines. What I call the seven secrets of inventory management are posted after the break.

  1. Referring to last week’s post which you can read here, managers should have a reasonable forecast of absolute customer volume that enables them to make a guess on volume for individual products or categories. Simply put, get in the habit of making reality-based sales forecasts.
  2. Establish minimum values for your inventory. These values should account for the average sales (or use, if you are charting supplies) between orders, the time between an order and delivery, and the appearance of the product on the shelf. Shelves that look full and organized draw customers, shelves that are picked over or dirty say, “If you buy this, you are getting leftovers!”
  3. A simple order can be made by adding your sales forecast to your minimum stock, and subtracting your current inventory.
  4. Remember, out of stocks are bad, it is never a good thing to suggest to a customer that they be happy when a product happens to be there. Regular customers are in your business out of habit, if you break their habit by not having what they want, when they want it, they won’t be regulars anymore.
  5. Remember, while out of stocks may be bad, if you are ordering a product that you receive once per week from your vendor, you don’t need to order a months worth of inventory. Vendor “sales” are opportunities that should be considered, not jumped at. They are trying to use your inventory dollars to finance their product pipeline…period. Sometimes the deal makes sense, such as when you have the volume in the product to move it quickly and take advantage of a discount. Doing your friendly salesmen or driver a “favor” sounds good, but you are in fact loaning them money on the cheap.
  6. The salespeople who call on your store are wonderful people with families who live and work in your community. They are also in your store to put bread on THEIR table. They may want to help you, they may even be your friends, but their responsibility is to their products and companies, not yours. The message is, either supervise their orders, or do your own.
  7. Understand how much your inventory costs you to hold; in most retail settings, inventory can cost 0.5%-1.0% per WEEK to hold. If you have a $10 item that you plan on selling for $15, and you hold it for 3 months, you are likely giving up $0.60 to $1.20 of your planned margin. This is the major reason why you see stores go through regular markdowns. The lower your business’s base margin is, the higher you want your turnover to be.

In profiling this list, note the rule on out of stocks regarding the top 20% of your items. It is a solid rule of thumb that those items will account for 80% or more of your business. This is called the “80/20 rule” in business schools, and a blessing in the real world. The rule means that the detail oriented manager or owner can spend most of their effort on a small fraction of items in their business, and still get maximum benefit from the work.

The RM is open for business….