Loading the player...

What is 'Inventory Management'

Inventory management refers to the process of ordering, storing and using a company's inventory: raw materials, components and finished products.

BREAKING DOWN 'Inventory Management'

A company's inventory is one of its most valuable assets. In retail, manufacturing, food service and other inventory-intensive sectors, a company's inputs and finished products are the core of its business, and a shortage of inventory when and where it's needed can be extremely detrimental. At the same time, inventory can be thought of as a liability (if not in an accounting sense). A large inventory carries the risk of spoilage, theft, damage, or shifts in demand. Inventory must be insured, and if it is not sold in time it may have to be disposed of at clearance prices – or simply destroyed.

For these reasons, inventory management is important for businesses of any size. Knowing when to restock certain items, what amounts to purchase or produce, what price to pay – as well as when to sell and at what price – can easily become complex decisions. Small businesses will often keep track of stock manually and determine reorder points and quantities using Excel formulas. Larger businesses will use specialized enterprise resource planning (ERP) software. The largest corporations use highly customized software as a service (SaaS) applications.

Appropriate inventory management strategies vary depending on the industry. An oil depot is able to store large amounts of inventory for extended periods of time, allowing it to wait for demand to pick up. While storing oil is expensive and risky – a fire in the UK in 2005 led to millions of pounds in damage and fines – there is no risk that the inventory will spoil or go out of style. For businesses dealing in perishable goods or products for which demand is extremely time-sensitive – 2017 calendars or fast-fashion items, for example – sitting on inventory is not an option, and misjudging the timing or quantities of orders can be costly.

For companies with complex supply chains and manufacturing processes, balancing the risks of inventory gluts and shortages is especially difficult. To achieve these balances, firms have developed two major methods for inventory management: just-in-time and materials requirement planning.

Just-in-Time

Just-in-time (JIT) manufacturing originated in Japan in the 1960s and 1970s; Toyota Motor Corp. (TM) contributed the most to its development. The method allows companies to save significant amounts of money and reduce waste by keeping only the inventory they need to produce and sell products. This approach reduces storage and insurance costs, as well as the cost of liquidating or discarding excess inventory.

JIT inventory management can be risky. If demand unexpectedly spikes, the manufacturer may not be able to source the inventory it needs to meet that demand, damaging its reputation with customers and driving business towards competitors. Even the smallest delays can be problematic; if a key input does not arrive "just in time," a bottleneck can result.

Materials Requirement Planning

The materials requirement planning (MRP) inventory management method is sales-forecast dependent, meaning that manufacturers must have accurate sales records to enable accurate planning of inventory needs and to communicate those needs with materials suppliers in a timely manner. For example, a ski manufacturer using an MRP inventory system might ensure that materials such as plastic, fiberglass, wood and aluminum are in stock based on forecasted orders. Inability to accurately forecast sales and plan inventory acquisitions results in a manufacturer's inability to fulfill orders.

RELATED TERMS
  1. Inventory

    Inventory is the term for merchandise or raw materials on hand.
  2. Average Inventory

    Average inventory is a calculation that estimates the value or ...
  3. Average Age Of Inventory

    The average age of inventory is the average number of days it ...
  4. Business Inventories

    Business inventories is an economic figure that tracks the dollar ...
  5. Holding Costs

    Holding costs are a major component of supply chain management ...
  6. Inventory Reserve

    An inventory reserve is a contra asset account on a company's ...
Related Articles
  1. Investing

    Measuring Company Efficiency To Maximize Profits

    Efficiency ratios can provide indications of profitability, shows how efficiently a company is being managed, utilizes its assets and handles liabilities.
  2. Investing

    U.S. Crude Oil Inventories Up (XOM)

    U.S. crude oil inventories are at “historically high levels” for this time of the year, according to the Energy and Information Administration.
  3. Investing

    Can Oil’s Strong Recovery Last? (XLE, USO)

    New data shows weaker oil inventories, boosting energy companies and oil futures.
  4. Investing

    Best Time to Buy a House? NOW

    If you're looking to buy your first home, fall is the season when inventories are at their peak. The best time to buy a house could be right now.
  5. Investing

    6 Cities Where Real Estate is a Buyer's Market

    In January real estate sales hit a 10-year high, but not all markets have a housing inventory shortage.
  6. Investing

    U.S. Oil Inventory Piles Up, Prices Decline

    As U.S. oil inventories continue to increase and no supply cut coming from other oil producing nations, the oil prices will remain pressurized.
  7. Personal Finance

    Why Create a Financial Inventory?

    Tom Zgainer of America's Best 401k shares why it's important for investors to take a financial inventory.
  8. Investing

    Crude Oil Headed Lower for the Week

    EIA reports rising U.S. crude inventories for the week and IEA sees lower oil demand in 2017
  9. Investing

    Liquidity Measurement Ratios

    Learn about the current ratio, quick ratio, cash ratio and cash conversion cycle.
  10. Investing

    Who Are Costco’s Main Competitors?

    Explore information about the three major discount retailers, Costco, Target and Wal-Mart, and learn how they stack up competitively.
RELATED FAQS
  1. How to calculate the inventory turnover ratio?

    The inventory turnover ratio is a key measure for evaluating how effective a company's management is at managing inventory ... Read Answer >>
  2. How do you calculate inventory turnover?

    Inventory turnover measures how many times inventory has sold during a period and provides insight into a company's inventory ... Read Answer >>
  3. How is the economic order quantity model used in inventory management?

    Understand what types of costs make up total inventory costs, and learn how the economic order quantity model is used to ... Read Answer >>
  4. What does a high inventory turnover tell investors about a company?

    Inventory turnover is an important metric for evaluating how efficiently a firm turns its inventory into sales. Read Answer >>
  5. Which industries tend to have the most inventory turnover?

    Understand what inventory turnover measures and why it is good to have high inventory turnover. Learn what industries tend ... Read Answer >>
  6. How does inventory turnover affect the cash conversion cycle (CCC)?

    Learn how a company's inventory turnover affects its cash conversion cycle (CCC). Understand why a higher inventory turnover ... Read Answer >>
Trading Center