As per various researches and studies, it has been discovered that most of the businesses, especially small businesses, are awfully under-prepared to manage their inventories.
Since small businesses don’t have an effective inventory management system, they have either fewer products in their stock or extra stock, both of which are bad for business. There should be a balance between these two: Neither there should be a deficit of the best selling products, nor there should be an excess of any item.
If such businesses, especially those in the manufacturing and wholesale, don’t manage inventory, they will lose their customers and incur losses.
There are effective inventory systems such as the Just In Time inventory system, which ensures that inventory position is always optimized based on the demand-supply ratio.
In this article, we will share some of the best practices for managing inventory, and explain What is LIFO and FIFO, and give a brief idea of FIFO method step by step.
At the end of the article, we will share how your small business can avail expert assistance for implementing inventory systems such as JIT system for optimized results.
Let’s begin our journey…
How To Manage Inventory: 3 Best Practices
Inventory management is a dynamic process that impacts your business’ bottom line and is directly responsible for revenues and profit. Small businesses should always focus on optimizing their inventory management and ensuring a balance between demand and supply.
Three best practices on how to manage inventory:
Prioritize & Categorize Your Inventory
Categorize your inventory based on the value of the products or demand, and then prioritize its availability and stocking. For example, categorize your inventory into A, B, and C groups, wherein A has items that are in high demand, B has more valuable items, and C has low-cost items sold out first. This will help you in prioritizing your inventory.
Track & Monitor All Inventory Items
Adopt and use an inventory management system, which helps you properly track and monitor your inventory items. You should be able to pinpoint every item as and when required.
Audit Your Inventory
There should be a mechanism to audit your inventory periodically. Auditing helps get a 360-degree view of the items in your inventory, giving you a better understanding of the entire inventory management process.
What Is Just In Time Inventory System?
First introduced by Toyota is 1978, the Just In Time inventory system or JIT system is considered the most productive inventory management system today.
In the JIT system, the inventory items are ordered from the supplier only when they are needed. Hence, there is significantly less requirement to over-stock any material or product. Just In Time inventory system is especially relevant in the manufacturing sector
It follows a lean-strategy to optimally manage inventory, reduce waste and expenses, and encourage local sourcing of products. Often, the suppliers are directly linked with the system to know when they need to ship raw materials and finished products to the inventory.
What Is LIFO and FIFO?
When it comes to methods to value your inventory, as part of the inventory management system, there is a great deal of debate on the effectiveness of two models: LIFO and FIFO.
LIFO is Last In, First Out
FIFO is First in, First Out
In the LIFO model of inventory valuation, the last item which comes into the inventory is shipped first, and in the FIFO model, the first item which comes in is sent out first.
Among these two, FIFO is the most popular and widely used inventory valuation method since the inventory costs are less, which means higher profits.
LIFO is a relatively new inventory valuation method, being introduced in the 1930s, and as soon as it came in, several businesses in the US and Europe started using it.
LIFO’s advantage is that inventory costs are high, which means lower profits and lower taxes. To save taxes, some businesses prefer the LIFO method,which is considered as controversial. With the FIFO accounting method for inventory, there is a higher profit reported, hence higher taxes.
For small and medium scale businesses, the FIFO model is recommended by experts, but again, it depends on the nature of the products, their valuation, and demand in the market.
In some nations, if you wish to change your inventory management protocol from LIFO to FIFO or vice versa, you will need to inform the tax authorities since the entire calculation of the inventory products and the shipments changes drastically.
Except the US, very few countries accept LIFO as a valid inventory valuation method.
Brief On FIFO Method Step By Step
Here is an example of the valuation of inventory, based on the FIFO model:
Assume your inventory is storing Bluetooth speakers.
In week 1, you order 100 speakers, costing Rs 1000 each.
In week 2, you order 400 speakers, costing Rs 1500 each, since the supplier has increased the cost.
At the end of week 2, you will have 500 speakers, whose total value is
Rs 100,000 + Rs 600,000 = Rs 700,000
In week 3, you sell 400 speakers, at Rs 2500 each, and have 100 speakers left.
Under the FIFO accounting method, you have sold those 400 speakers, at Rs 1000 each (First In)
And thus, at the end of week 3, you have 100 speakers left, whose per unit cost is Rs 1500, and thus, the total value of leftover speakers is:
Rs 1500 * 100 = Rs 150,000
Under LIFO method, you will sell the 400 speakers at the cost of Rs 1500 per unit (Last In), and thus, the cost of the remaining 100 speakers will be:
Rs 1000 * 100 = Rs 100,000 (Source)
Inventory management and Selective inventory control techniques are a vast subject, and you will need expert assistance in this regard.
This is where we at MSMEx can help you out.
Our micro-advisory platform provides you a direct link with some of the sharpest business minds and experts having decades of experience in the verticals such as inventory management, accounting, Govt loan schemes, venture capital, and more.
All you need to do is, book an appointment at MSMEx and get connected with the experts right now!