Inventory planning is how a business can effectively manage the goods it sells. But what particular model works for small and medium enterprises, especially during this coronavirus pandemic?
Before we get to the nitty-gritty of managing your goods, what is inventory planning or management? The TLDR (too long, didn’t read) is that it is a systematic approach to sourcing, storing, and selling your inventory—both raw materials (components) and finished goods (products).
Inventory management means the right stock, at the right levels, in the right place, at the right time, and at the right cost — as well as price. But now, entrepreneurs, founders, and independent brands live in a world where SMEs compete against global conglomerates – and they’re all looking for an edge.
Therefore, online and traditional sellers alike must know how to handle their inventory properly – because this helps to reduce costs, optimize fulfillment, provide better customer service, and prevent loss from theft, spoilage, and returns, among other benefits.
COVID-19’s impact on the global supply chains is “a major disruption, along the lines of having an earthquake or a tsunami,” also says Morris Cohen, professor of operations, information, and decisions at Wharton Business School.
In a macro view, inventory planning also provides insights into your financial standing, customer behaviors and preferences, product and business opportunities, future trends, and more.
Motives to consider for inventory planning
So, what are the inventory planning models small businesses and startups should know? Before that, you need to consider three motives often used in planning your stocks:
1) Transaction Motive: This takes advantage of economies of scale — buying raw materials in larger quantities and holding that inventory is cheaper than buying in smaller lots. Large production volumes, meanwhile, bring down the per-unit cost. This also makes it possible for manufacturers to specialize in the products they create. The finished products can then be stored in a warehouse to fulfill customer orders.
2) Precautionary Motive: Inventory is used as protection against uncertainties when there’s a flux in demand, mainly to prevent stockouts. This also caters to cyclical, seasonal, and surges in demand. Sellers thus stock up on raw materials and hold inventory to increase production and rush supplies to the market to meet increased demand.
3) Speculative Motive: Here, business owners hedge on price increases in materials or labor, and look at the trade-off between inventory cost and benefits. Thus, inventory is used as a buffer in critical supply chain events.
Types of inventory planning models
With those motives in mind, you now have three planning models to consider:
1. EOQ (Economic Order Quantity) Model – This model focuses on the most economical number of items a business needs to order to reduce costs and maximize value in the restocking and ordering process.
With EOQ, businesses can take advantage of vendor deals when they are clear about how much inventory they will need for the year — ordering in bulk can save purchasing costs. It lowers the cost of carrying inventory with a specific recommendation for a time-bound (weekly, monthly, yearly) order level. EOQ balances stock levels and gives more clarity on how to manage and when to order inventory.
However, EOQ also assumes a steady demand for a product, not taking into account economic and seasonal fluctuations. It requires consistent monitoring of inventory levels and assumes that yours is a one-product business, as no interactions between products are accounted for in the formula.
2. Perpetual Inventory System – This method involves keeping constant track of inventory quantities. Businesses should monitor inventory counts, and when certain products reach their reorder points, it is then time to place an order for a predetermined quantity.
When a product is received or sold or even returned, the inventory level should automatically be updated. As this requires constant monitoring of stock fluctuations, businesses need to utilize inventory management software with barcoding capabilities to successfully implement this.
A perpetual inventory gives you clarity on real-time stock levels, more direct control of inventory for management, and ease of tracking stock across many different locations (if you have more than one). However, this system cannot be manually maintained – specific software needs to be used, and the staff to be trained in using the software. If the recorded inventory does not reflect actual inventory levels, the whole system is also affected.
3. Periodic Inventory System – This physical count method measures inventory levels and the cost of goods sold (COGS). Levels of inventory along with the COGS are updated at the end of a specific period (monthly or yearly). The amount of inventory determined to order is based on what is on hand along with the expected demand.
Calculating for COGS under a Periodic Inventory System goes like this: Start balance of inventory + cost of purchased inventory ending cost of inventory = COGS.
Periodic Inventory is most suited to small business models. It can be done without complex preparation, and a business can set the time frame based on their needs.
However, it is not as accurate as the perpetual system, since the period of counting the levels is longer, rather than in real-time. Also, when several accounts track sales, orders, holding, and other factors, it can be complex to periodically count.
What’s the right inventory planning model for your business?
The precise inventory management of your own business will vary based on the types of products you sell, and the channels you sell them through. Most SMEs often use Microsoft Excel, Google Sheets, or other manual tools to keep track of their inventory and make decisions about ordering.
But knowing when to reorder, how much to order, where to store stock, and other concerns can quickly become a complicated process. Many growing businesses thus graduate to an inventory management app, software, or system with capabilities beyond manual databases and formulas.
These advanced systems extend the procedures of inventory management beyond basic reordering and stock monitoring — to everything from end-to-end production and business management, to lead time and demand forecasting, to metrics, reports, and even accounting.
But what inventory planning method is right for your small business? We can’t tell you for sure, but knowing the motives above, here are some guidelines:
· When it comes to the pandemic, it’s essential to understand your supply chains. Where are your goods coming from? Are there any problems with supply? Are your suppliers closing shop because of COVID-19, and can you find new ones to replace them?
· To help your business prepare for sudden changes in supply, you must identify the potential risks. This doesn’t only help you understand your direct exposures — it helps find possible risks among your second-and third-tier suppliers and customers, and identifies the potential strengths and weaknesses among the relationships with and of your competitors.
· Good inventory planning requires the right mix of people, processes, and technology.
· You can use software that initiates orders to ensure you top off stock to the appropriate level and prevent overstocking.
· In a small business, you will likely be your own inventory planner – so analyze trends and provide forecasts in your field. Try to work with supplier managers, purchasing, and contract management leaders, supply chain financial analysts, and production and quality control people to get a clearer picture.
· Creating an inventory policy will help guide your planning activities and step-by-step inventory maintenance processes.
Finally, Richard Outcalt, a co-founder of The Retail Owners Institute, says: “If business owners don’t plan inventory ahead, they should get out of retailing. Not planning is a deal-breaker… In retail, there are precious few controllable aspects, and one that’s very controllable is inventory.”
So take control of your inventory, and see your business rise today!
