Inventory Management: How It Works & 12 Core Techniques

Inventory management is the process of tracking and controlling inventory stock in a business.

One thing I learned from six years of working as an inventory manager is that poor inventory management is like a disease. Untreated, it diminishes profits, damages customer relationships, and derails productivity.

Effective inventory management helps you scale faster and meet consumer demand while avoiding lost capital caused by stockouts and overstocking. 

This guide covers what inventory management is, essential techniques for improving it, and how to select the right system for managing your inventory.

What is inventory management?

For businesses handling physical products, inventory management plays a crucial role in ensuring accounting ledgers are accurate and the business operates efficiently.

When stock is managed effectively, inventory costs go down and productivity goes up. This leads to higher profit margins, fewer stockouts, and an optimized inventory purchasing process.

7 benefits of inventory management

Inventory management is vital to sustainable business growth. Without it, customers won’t receive orders on time, the company’s reputation will take a hit, and you’ll likely run out of working capital to keep the business running.

An optimized inventory management process offers significant advantages for business owners.

Let’s dig a little deeper into how inventory management achieves these outcomes.

Stockouts happen when an item runs out of stock before it can be replenished. 

Overstocking is carrying excess inventory that impacts efficiency or limits cash flow. 

Both represent poor inventory planning and an imbalance of supply and customer demand. Proper inventory management establishes and maintains optimal stock levels to meet demand without hindering productivity.

When you manage inventory effectively, you reduce the time and money required to operate your business. The efficiency gains achieved through better stock management improve your bottom line, meaning your company also becomes more profitable.

Likewise, strong inventory management unlocks more working capital.

Excess inventory is one of the leading causes of cash flow problems, but optimized stock levels can mitigate the risk of overstocking.

The better your inventory management is, the more efficient your business will be.

When I managed inventory for an electronics distributor, there were no systems in place for tracking inventory. The business relied on paper records and insider knowledge to keep operations running smoothly.

After implementing a barcode inventory system and assigning locations to each product, we were able to reduce the time previously spent on manual processes—such as stocktaking and order fulfillment—by around 50%.

Another benefit of automating our inventory management with barcode scanners was the positive effect it had on our inventory accuracy.

When you remove the risk of human error, your stock counts are faster and more reliable. This makes it easier to spot inventory shrinkage in time to find its cause. It also ensures you reorder stock at the right time to meet demand and keep customers satisfied.

Effective inventory management makes it easier to find the products you need to fulfill customer orders. If you’re using digital tools, such as barcode scanners and RFID tags, you’ll also reduce the likelihood of sending customers the wrong items or quantities.

Good inventory management keeps customers happy. They receive exactly what they ordered in the time they were expecting it, without experiencing delays because of stockouts, disruptions, or fulfillment errors.

Inventory carrying costs are the costs associated with managing and storing inventory goods.

They include:

• Storage rental costs
• Overheads
• Insurance costs
• Property taxes
• Shrinkage costs
• Capital costs

When you have an effective inventory management system in place, the money you spend on holding stock goes a lot further—reducing your total inventory carrying costs per unit.

The role of an inventory manager

In a small team, it’s likely the inventory manager will be up to their neck in work—ensuring the business’s operations run smoothly and customers receive goods on time.

In larger organizations, the inventory manager may only be responsible for delegating these tasks to lower-level employees, such as warehouse workers and order pickers.

According to job platform Indeed, the average salary for an inventory manager in the United States in 2024 is $61,949 per year. However, salaries can range from $39,581–$96,959. This reflects how varied an inventory manager’s role can be across different sectors and organizations.

The role of an inventory manager can involve:

In my different roles as an inventory manager and warehouse manager for various organizations, I experienced a broad range of responsibilities and working environments. In some cases, I was in charge of all the tasks listed above. Other times, the title ‘inventory manager’ simply meant the person picking and packing customer orders.

How inventory management works

Inventory management is achieved by a series of interconnected workflows that support efficient and cost-effective operations.

Key steps in the inventory management process include:

If you’re unfamiliar with these terms, don’t fret—I’ll explain how each step helps a company stay on top of its inventory.

Demand forecasting

When you’re able to accurately forecast future sales, you’ll have a better idea of how much inventory you need to keep on hand throughout the year.

Inventory planning

Inventory planning is the next step in preparing your business for upcoming sales.

Once you’ve forecasted demand for a specific period, you can effectively plan how much inventory you’ll need—and when you’ll need it—by analyzing historical data such as average lead times and order cycle time.

Purchase order management

Inventory is acquired by businesses through a process called purchase order management.

Once the order has been shipped to the customer, an inventory manager or warehouse receiver will check the goods against the purchase order.

Receiving

Receiving involves opening deliveries and checking them against the original purchase order—or against a packing slip attached to the shipment.

Receiving can also involve:

The person responsible for receiving may be required to operate a forklift, pallet jack, or overhead crane depending on the nature of the goods received.

Putaway

In some cases, it also involves moving existing stock around to make space for new products.

Inventory tracking

These records help businesses understand the locations, quantities, and value of on-hand inventory.

Order fulfillment

Technology is often used to streamline order fulfillment and improve order accuracy. Common tools include barcode scanners, pick-to-light systems, and warehouse robotics.

Stocktaking

Stocktaking, or stock counting, is how a business ensures its recorded inventory levels match the actual levels. Because of inventory shrinkage events such as theft, miscounting, and damages, even an automated inventory system can be wrong from time to time.

This process helps you avoid stockouts, maintain accurate stock records, and meet your end-of-year financial reporting obligations.

Inventory reporting

Inventory reporting allows you to identify areas for improvement and measure how efficiently your business is performing.

Stakeholders in some organizations will require inventory reports from inventory managers. 

Upper management uses these to assess employee performance, procurement managers use them to inform purchasing decisions, and production managers can use inventory reports to find bottlenecks in the manufacturing process.

Inventory optimization

The goal of inventory optimization is to maintain the perfect amount of stock on hand to meet customer demand without compromising cash flow.

Inventory accounting

Inventory accounting involves the periodic financial reporting of inventory valuations, alongside managing a company’s Accounts Payable, Accounts Receivable, and Cost of Goods Sold (COGS) accounts.

4 challenges of managing inventory effectively

Without proper inventory management, it doesn’t take long for your company to reach a state of crisis.

When I started my own ecommerce business, all my years of managing inventory for someone else still didn’t prepare me for how challenging it can be. Once Bucket Hats NZ was up and running, I was treading water trying to match purchasing with demand.

In a new business, you’re stretched thin. Most firms begin with one or two employees wearing multiple hats, struggling to stay on top of all the levers you need to pull to operate efficiently.

Some of the biggest inventory management challenges include:

• Inventory optimization.
  One of the hardest challenges in inventory management is balancing stock levels to meet demand without exhausting your working capital.
• Effective stock control.
  An inventory manager must maintain accurate records of inventory locations and quantities for every item.
• Inventory shrinkage.
  Without a good inventory system, it can be difficult to determine the root cause of shrinkage caused by theft, damage, or administrative errors.
• Forecasting demand.
  Good inventory management relies on accurately predicting customer demand based on historical data, seasonality, and consumer trends.

Thankfully, there are a few handy methods and techniques you can implement to overcome these common challenges.

Inventory management techniques

Inventory management techniques are methods used to improve inventory management efficiency and performance.

No two businesses are exactly alike, so consider which of the following strategies is most suitable to your unique situation.

12 techniques for improving inventory management:

So, how do they work?

Safety stock is a buffer of inventory that helps prevent stockouts by acting as your last line of defense against supply chain disruptions and unexpected spikes in demand.

The optimal level of safety stock is determined by consumption rate and average lead times, meaning it will be different for each inventory item. 

Demand planning is a supply chain management process that involves forecasting future sales demand and optimizing inventory levels and ways of working to meet that demand. Effective demand planning will help you increase profitability, cash flow, and customer satisfaction.

Just-in-time (JIT) inventory management is a technique used to minimize the amount of excess inventory held by a business at any given time. It involves working closely with suppliers to ensure goods arrive on time.

JIT requires accurate demand planning, effective supplier management, and a reliable inventory system. Done well, it can help you reduce inventory costs and maximize working capital.

Economic order quantity (EOQ) is an inventory management formula you can use to calculate the ideal number of units to purchase at a time for each of your inventory items.

This formula helps you avoid overstocking and stockouts by balancing purchasing with the cost of carrying inventory.

Here’s a calculator you can use if you don’t want to run the numbers manually:

Reorder points are the minimum stock levels that reflect the best time to replenish inventory. They’re informed by the economic order quantity and supplier lead times, and help you optimize your reordering process.

When an item’s on-hand stock levels reach the reorder point, this lets inventory managers know it's time to place an order for more stock.

Cross-docking is an inventory management technique that minimizes—or eliminates—the time inventory spends in storage. Using this method, goods that come in from your suppliers are loaded onto trucks for delivery to customers immediately after being received.

Cross-docking reduces inventory carrying costs, lowers the risk of products being damaged during storage, and can help you save on warehouse space and storage costs.

The first in, first out method, commonly referred to as ‘FIFO’, is an inventory management technique that can be applied to fulfillment and inventory accounting.

In fulfillment, FIFO ensures that the oldest goods are prioritized over newer goods. This helps companies minimize spoilage for perishable goods inventory.

In inventory accounting, FIFO assumes the oldest inventory goods are sold first when valuing inventory, calculating COGS, and fulfilling tax obligations.

LIFO, or ‘last in, first out’, is the opposite of FIFO. In inventory accounting, it assumes the last items to be purchased are the first to be sold. In fulfillment, it means the most recently purchased items are sent out to customers first.

Batch tracking, also known as lot tracking, is an inventory management method whereby items are grouped based on similar characteristics, such as expiry dates or production dates.

This technique is commonly used in the manufacturing industry. It helps manufacturers maintain quality control over batches of alike items, facilitating more efficient product recalls for defective or dangerous goods.

Barcode inventory management involves using barcode scanning systems to improve inventory traceability, automate order-picking processes, and increase stocktaking accuracy.

Unique barcodes are assigned to each item in a company’s inventory. These barcodes can be scanned by digital tools, such as scanners and mobile devices. 

If a barcode system is integrated with inventory management software, stock statuses can be updated in real time as soon as a product has been scanned.

Vendor-managed inventory (VMI) is a supplier-reliant method of managing a company’s stock levels and replenishment.

The supplier keeps track of inventory levels on behalf of the buyer. They’re typically responsible for ensuring the company doesn’t run out of stock by determining optimal order sizes and delivery windows.

Dropshipping is where goods are shipped directly from your supplier to your customer whenever an order is placed with your store. Rather than storing inventory on your own premises, you can minimize inventory carrying costs by having it sent straight from the source to the destination.

What is an inventory management system?

An inventory management system is a collection of processes and technology used to track inventory levels, record and update stock movements, and manage sales, purchase orders, and deliveries.

There are two types of inventory management systems: manual and automated.

When shopping for an automated inventory system, you’ll find a lot of tools that do more than is necessary for your business. You should begin your search with needs identification, and then map those needs to specific software features.

Key features to look for in an automated inventory management system include:

Save time managing inventory with Red Stag Fulfillment

Keeping track of inventory is a full-time job. In many cases, it's several full-time jobs.

That means more time spent hiring and training staff, conducting stocktakes, and worrying whether you’re ordering the right amount of inventory to balance consumer demand with working capital.

At Red Stag Fulfillment, we combine years of hands-on experience managing inventory and customer orders to provide a reliable service that helps companies like yours focus on growing the business—while we tackle the operational challenges.

If you’re interested in partnering with Red Stag Fulfillment, contact us today to learn how we can help your business flourish.