Inventory management is the process of having the right products, in ideal quantities, at the right time to sell to customers. Accurately managing inventory can increase revenue by preventing stockouts, overstock, and unsold products. When learning how to organize inventory for small businesses, the easiest solution is to use a software program to automate the process.
The software we recommend for most small businesses is Lightspeed. Lightspeed automates the inventory management process, keeping records accurate and up-to-date. It cuts down time spent tracking products and offers data insights to improve your bottom line. Visit Lightspeed for a free trial.
If you’d rather manage inventory manually with a spreadsheet, download our free template and follow the steps below.
What Is Inventory Management?
Inventory management is a step in the retail supply chain. A supply chain is a system that coordinates moving a product from creation to the consumer. A basic retail supply chain consists of four parts: the product manufacturer, a wholesaler who distributes the products, retailers selling the products, and the shopper that purchases it.
There are many variations to the traditional retail supply chain such as dropshipping and direct-to-consumer products. In some cases, products will pass through several distributors or wholesalers before being purchased by the retailer. Online businesses also often have an additional order fulfillment step between the retail sale and the customer receiving their product.
Common Inventory Management Terms
When choosing the best inventory management software for your business, it can be helpful to learn the industry terminology for your specific type of inventory management.
- Anticipation/smoothing inventory: Anticipation inventory denotes excess products stored in anticipation of a future event such as a holiday, sale, or special event.
- Barcoding: Attaching a unique number contained in the barcode to an item so a barcode scanner can identify it.
- Bill of Materials (BoM): A list of materials needed to make a product.
- Buffer inventory/safety stock: Represents the products you keep on hand beyond your usual sales volume. To determine how much safety stock you need, multiple your maximum daily usage by maximum (daily) lead time. Then, multiply your average daily usage by your average lead time and subtract it from the first number.
- Bundles: A group of items that can be sold as a single product.
- Cycle counting: Counting a portion of your inventory on a regular basis. More valuable or active items get counted more often.
- Cost Of Goods Sold (COGS): The direct cost resulting in the production of any goods or services. It excludes indirect expenses like distribution and sales force costs.
- Dead stock: Items that are not selling well. Keep a minimum unless you discontinue the item and watch for expiration dates.
- Decoupling inventory: This term applies to manufacturing and refers to the parts, supplies, and products waiting to be used by the next machine in a chain. It keeps the process running smoothly even if a machine breaks down or runs more slowly.
- Economic Order Quantity (EOQ): The amount of stock you should reorder based on examining product demand and warehousing costs.
- Fast stock: The opposite of deadstock, these sell quickly. Consider setting multiple alerts, so you can keep up with demand.
- Finished goods: Products ready to be sold.
- First-In-First-Out (FIFO): Rotating inventory by selling the oldest items first. Also used for inventory costing.
- Holding costs: How much it costs to store an item in your warehouse before it’s sold.
- Just-in-time inventory: Inventory you receive just in time to deliver to the customer, as opposed to having products stored. This can save on warehouse expenses.
- Last-In-First-Out (LIFO): Rotating inventory by selling the newest items first; also used for inventory costing.
- Landed costs: The costs associated with purchasing, shipping, and storing inventory.
- Lot size: How many of a specific item is manufactured in a single run or ordered for delivery on a specific date.
- Maintenance, repair, and operating supplies (MRO): The items needed to keep manufacturing moving, such as shipping pallets, vehicles, or other vital tools. When creating inventory, these, too, can be labeled so managers can track their status.
- Multichannel: Selling a product in different channels such as ecommerce, brick-and-mortar, and Amazon.
- Omnichannel: Streamlining the channels so that the branding is consistent no matter where the item is sold.
- Pipeline inventory: Items in the various stages of the supply chain that are not at their final destination.
- Raw materials: Items needed to make a finished good, from gears for a bike and leather for a jacket to spices for a recipe.
- Reorder point: The level of inventory at which point you should reorder. Reorder point = (average daily use X average lead time in days) + safety stock.
- Stock keeping unit (SKU): A series of letters and numbers assigned to an item to identify it by product type and attributes. They are highly customizable and can vary from warehouse to warehouse.
- Turnover: How quickly a retailer is selling and replacing inventory.
- Universal product code (UPC): A numerical value used by everyone around the world to refer to that particular product.
- Work-in-progress/unfinished products: These include materials, parts, assemblies, and sub-assemblies devoted to a product under production. A WIP inventory account represents the value of materials, labor, and overhead issued to manufacturing that hasn’t yet resulted in a stockable item. It may include those awaiting final inspections.
How Inventory Management for Small Business Works
Inventory management’s ultimate goal is to keep stock levels optimized at all times so that you never have too much or too little product on hand. Small businesses achieve this by monitoring current stock levels continually, as well as inbound stock, and accurately placing purchase orders to suppliers.
For retailers, good inventory management involves having the proper systems in place to keep products organized and automating processes like stock tracking to maintain real-time data.
Retail inventory management also connects key financials, such as sales and cost of goods sold, to products so that retailers can cut losses though slow-selling or low-margin products, spot theft and inefficiencies, and place product orders based on metrics. Effective inventory management for small businesses can increase profits and save time.
Here’s how to organize inventory for small businesses in eight steps:
1. Organize Product and Vendor Information
The first step in organizing your inventory is to set up your stock and supplier information in a reliable and accessible system. Some businesses use manual tracking methods, such as spreadsheets. However, the best option for retailers is to use a point-of-sale (POS) system. Ecommerce businesses can use an order management system.
Whether you’re using a POS system or spreadsheets, you’ll need to record product-specific information and supplier details, including:
- Product name
- Your internal product stock keeping unit (SKU) number or code, if you use one
- Manufacturer’s Universal Product Code (UPC)/European Article Number (EAN) or other unique identifiers
- Short description
- Product category, class, or family
- Wholesale cost
- Regular retail price/MSRP
- Your selling price
- Colors or sizes
- Vendor, supplier, or manufacturer name
- Reorder quantities
- Shipping details: size, weight, box pack, if applicable
- Picture or product image
In addition to product-specific information, you also need to track your vendor or supplier information. Many POS inventory systems have vendor directory features to save contact information and let you tie products to a specific vendor or vendors.
The supplier information you need to track includes:
- Vendor name
- Vendor contact name
- Vendor billing information
- Vendor phone
- Payment terms
- Line rep or showroom contact
2. Create and Submit Accurate Purchase Orders
Purchase orders (POs) are the easiest way to manage your inventory purchases. They let you track every stock purchase efficiently, from placing the order to receiving the shipment and paying the bill. POs are financial transactions, so create them when you have time to review your cash flow and realistically forecast your stock needs.
Purchase orders are typically submitted to vendors electronically through email or the vendor’s online ordering portal. Most POS systems have directory features to manage vendor contact information. POS systems also have low-stock alerts that let you know when an inventory item reaches a designated minimum threshold. These low-stock alerts can often turn into a report that tells you what items need reordering.
3. Receive Inventory Orders Accurately
Even if you are purchasing stock accurately, not properly receiving shipments can leave your business open to loss due to error and theft. To receive inventory correctly, companies should receive and unpack all boxes in the same space, count each box, and check the items received against original purchase orders.
It’s especially important to ensure that you check all received items against your PO. Suppliers generally include a packing slip that lists the items and quantities in your shipment. It’s easy for stockroom and warehouse staff to check in a stock shipment with only the packing slip, but that’s a big mistake.
If the supplier made an error during order entry, their packing slip would match the shipment, but it won’t match your PO. If this isn’t caught by checking the received items against your PO, you’ll think you received stock that didn’t arrive. That leads to stock shortages, back orders and, ultimately, cash losses. Checking the packing slip and invoice against the original PO can also help catch any pricing errors or changes.
“Not having a system and process in place to accurately receive inventory is one of the most common small business inventory management mistakes, and the data backs that up. According to the National Retail Federation, 28% of inventory shrink is attributed to supplier mistakes that aren’t caught during the stock receiving process. A sound process that includes checking all stock receipts against purchase orders minimizes these losses.”
—Jason Richelson, founder of ShopKeep, owner of Simply Wine
How to Accurately Receive Stock Shipments
- Ensure that you receive all boxes, containers, or other units in the shipment
- Unpack the shipment and organize items by product
- Check the items and counts against your PO.
- If the counts and products match, receive the PO in your POS, as shown below. You can also adjust the stock counts in your spreadsheet or manual inventory management system
- If you find errors like wrong, shorted, or missing items, note these on your PO and contact your supplier immediately to resolve
- Shelve or store all correctly received stock, tag, or label first if needed for your system
- Enter your bill into your accounting system
4. Tag and Label Inventory
Once your products are in your store or warehouse, we switch from inventory management, including product ordering, and forecasting, to inventory control, which consists of managing the products you physically have on hand.
Tagging and labeling stock are essential for inventory control for two reasons. First, price tags and product labels display an item’s selling price to shoppers. Second, product labels, particularly bar code labels, help you closely track your inventory and speed up the checkout process.
Bar code labels speed up both the checkout process and manual inventory counts because scanning the code will automatically link the product to the sale or count and adjust the on-hand stock levels and sales reports. Most POS systems support bar code software, including labeling and scanning.
Regardless of the type of labels you use, a good time to tag and label inventory is during the stock receipt process. That ensures the task isn’t overlooked and prevents the unlabeled stock from being shelved or displayed for sale.
Once printed, labels can be affixed directly to product packaging or attached to hang tags. Some inventory might even arrive prelabeled with manufacturer’s bar codes, which you can also track in your POS. In that case, your job is easy. You can just add a price label.
5. Track Inventory as It’s Sold
Tracking sales is a must for any business operation, and it involves more than just tallying up the totals at the end of the day. A sound inventory management system records every sale in detail, including items sold. A POS system dramatically streamlines this process over a manual spreadsheet system by adjusting your inventory records in real time with each transaction.
A POS also gives you up-to-the-minute sales totals. You don’t have to wait for an end of day closeout to know your daily sales since you can run reports anytime. As your inventory numbers click down with each sale, reorder alerts, or automatic POs will generate. This makes stock reordering quick, easy and, most importantly, bases your reorders on actual sales trends, not your best guess.
“In the early days of my online business, I accepted orders without having the product on hand but thought I had plenty based on my manual spreadsheet. Luckily, I was able to quickly restock and fill those orders. But what if I hadn’t been able to? It would have been a disaster. Now, my POS system ties inventory management to every sales task. It keeps up with how many units I sell order-by-order and alerts me when I’m running low. This gives me peace of mind. I never have to worry about selling a product that I don’t have in stock.”
—Zondra Wilson, President, Blu Skin Care
6. Take Regular Physical Inventory Counts
Physical inventory counts can be mundane and tedious. However, physical counts can reduce all types of inventory problems dramatically. Most small businesses do a full inventory count once each year for tax purposes, but it’s good to perform smaller partial inventory counts, even if you are using a POS system.
Annual Inventory Count
Annual inventory counts are a full inventory count done at the close of each fiscal year for income tax purposes. For some small businesses, it’s the only real inventory count they perform. If you only do inventory counts once each year, you’re likely to uncover shortages due to miscounts, misplaced stock, and receiving errors. By year’s end, it’s too late to fix most of these issues. To catch them before they become costly, you’ll want to conduct periodic counts, called cycle counts.
Cycle counts are periodic spot-counts that you can easily fit into your daily activities. With cycle counts, you just count a small portion of your stock on a rotating basis, such as a single category or product line each week. Done regularly, cycle counts uncover receiving errors, misplaced stock, and theft shortages quickly before they become costly, long-term problems.
The Inventory Count Process
You need to start every physical inventory count with the current quantity on hand (QOH) for every item you’re planning to count. This is the amount you should have in stock for each item you carry, according to whatever inventory management system you’re using.
Stock counts are tracked as a running tally, so figuring your QOH for each item follows this basic formula:
Previous QOH + Received Inventory – Sold Inventory = Quantity on Hand (QOH)
Counting Inventory Using a POS System
With a POS system, you can quickly print an inventory list for physical counts. This list includes the name of each product to be counted, SKU, bar code, and the quantity of each product that you should have on-hand. This is termed your expected or starting QOH for purposes of your inventory count. Your POS does the math for you by tracking your received items and subtracting the sold items to give you an expected QOH for each item you carry.
Using your printed inventory sheet, you’ll count your stock physically and record that quantity next to your expected QOH for easy comparison. If the counted quantities match your expected QOH, your inventory is accurate. If they don’t, you have an error in your process and need to do some digging to uncover the reason for the shortage.
Counting Inventory Using a Manual System
If you don’t use a POS, you must tally up the starting QOH totals yourself manually or using your spreadsheet’s inventory records. Then, you’ll need to create inventory count sheets to record your physical counts. Using an inventory template for your count sheet can make the process easier.
Taking a physical inventory count requires a lot more steps if you are not using a POS. First, you will need to take the QOH you recorded for each item after your last inventory count. Then, add the inventory you received from purchase orders since that last count. Next, subtract inventory items you have sold to customers. Finally, you have your expected QOH and can begin tallying what is on your shelves and in your warehouse. A POS system automatically keeps track of inventory as it is sold and received, so you do not have to do any math to get your expected QOH to perform an inventory count.
7. Reconcile Inventory Differences
Ideally, after performing your physical inventory count, all of the expected QOH numbers will match your actual QOH numbers. However, that is not always the case. If you have more or less of a product than anticipated, you will need to investigate the problem and reconcile the difference.
The first step is researching the count discrepancy. There are many reasons inventory goes missing―physically and figuratively. It can be an actual loss, like employee theft, damaged goods not reported, or stock recorded as received but that never actually arrived. Other times, the stock is there, it’s just in the wrong place or incorrectly labeled.
If you can’t locate the stock, then you need to adjust the QOH for that item in your system to what you have on hand. This is as simple as just changing that number in your POS, spreadsheet, or written inventory record.
After that, you need to adjust your inventory value for that item in your accounting system to track the dollar value of the loss. This loss is referred to as inventory shrink. Accuracy with inventory shrinkage is especially critical since you need to supply inventory valuation for insurance policies, investors, or if you’re applying for a Small Business Administration (SBA ) loan.
Monitor for Theft
Inventory shrink can sometimes be a result of human error. Other times, inventory shrink is a result of customer or employee theft. According to the National Retail Federation’s 2020 National Retail Security Survey, 95.7% of retailers use burglar alarms to prevent theft, and 88.4% use digital video recorders.
Using a security system such as SimpliSafe can help prevent inventory shrink through theft with professional 24/7 live monitoring and recording. Businesses can get started with SimpliSafe for less than $300, with low monthly fees, no contract, and a 60-day money-back guarantee. Visit SimpliSafe to get started.
8. Organize Your Stockroom and Warehouse
Whether you have a retail store with a small stockroom in the back or an expansive warehouse for your ecommerce business, organizing your inventory is key to smart management. Even if you operate in a tiny space, it’s good to have organized overstock space so you can take advantage of discounts and deals on bulk wholesale orders.
In retail stores, tall storage shelves or double-tier hanging racks can maximize storage space along walls yet allow movement through the space to access stored goods. In ecommerce fulfillment warehouse settings, you generally have more room to store goods on aisles built using light-duty metal shelving or heavier-duty shelving, depending on your needs.
Whatever your inventory storage method, your stored inventory needs to be well-organized, clearly labeled, and accessible for pulling and inventory counts. This can be done using the boxes goods come in, stacking bins, or even hanging separators for hung apparel. Periodic cycle counts of overstock also help keep track of extra inventory and ensure it’s not lost or misplaced over time.
Best Practices for How to Organize Inventory
Understanding the basics of how to organize inventory for small businesses is the first step. However, there are still plenty of additional tips and techniques you can use to streamline your inventory management. The best inventory management practices will go even further in reducing overstock or missed opportunities.
Use Forecasting to Stock Accurately
If you are using a POS system to manage your inventory, you can already place purchase orders easily based on real-time stock counts and low-stock alerts to keep your shelves full. However, the next step is to use your POS to look at historical sales numbers, industry trends, marketing campaigns, and predicted growth to identify opportunities where you can sell more and order accordingly.
Set up Low-Stock Alerts
Many businesses use a POS system to set minimum quantities for products, especially bestsellers. When a product nears that minimum quantity, the POS will notify the business owner or generate a report to reorder the products that are selling out. Some businesses also refer to this as periodic automatic replenishment levels (PARs) or low-stock alerts.
Sell Products in Proper Order
Many businesses, especially grocers, restaurants, cafes, and any food-related business, use the first-in, first-out (FIFO) method for using and selling inventory. However, selling products in chronological order is also crucial for retailers that sell cosmetics, supplements, or anything else with an expiration date.
You’ve likely noticed that when grocery shopping, items close to their expiration date are in front of the display, and fresher goods are in the back. Many retailers apply this concept to both their shelves and stock rooms to make sure goods are sold before they expire.
Consider Just-In-Time Purchasing
The ultimate goal of a streamlined small business inventory management operation is to bring in inventory just in time to be sold to customers while preventing stockouts and dead or excess inventory. As a solution, some businesses, especially ecommerce and online retailers, use dropshipping so that they do not even need to worry about submitting bulk wholesale orders or handling inventory in-house.
When a dropship order is placed, the retailer receives the order, but the information is also sent automatically to the supplier, who fulfills the order and sends it to the customer on behalf of the retailer. In most cases, customers do not know the difference. With dropshipping, retailers don’t need to worry about inventory ordering, storage, or order fulfillment.
Build Relationships With Product Suppliers
Even with the best inventory management plan, issues can still arise where you need products ASAP to fulfill an order. When this happens, retailers are at the mercy of their suppliers. If there is a quality control issue, or a discrepancy with a PO, having a good relationship with your supplier will help resolve these issues quickly.
Retail and ecommerce businesses can build strong relationships with product suppliers by sticking with the same suppliers over a period of time, meeting suppliers in-person at trade shows, and, perhaps most importantly, paying invoices on time.
Inventory Management Frequently Asked Questions (FAQs)
No matter the size of your business, managing inventory is a complex process. It also looks different for every type of business.
What is the best inventory management software for small businesses?
The best small business inventory management software depends on your individual business type, needs, and budget. For most retailers, the best inventory management software is one that is connected to your POS system. For online stores, the best inventory management software will be integrated with or built into your ecommerce platform.
There are several free inventory management software options, such as Square, that may work well for very small businesses. Traditional retailers will need a more robust system with built-in PO features and detailed analytics such as Lightspeed. Online or multichannel businesses can use an order management system like Orderhive.
How do restaurants organize inventory?
Restaurant inventory management has an additional level of complexity because they work with raw ingredients instead of finished products. A good restaurant inventory management system uses a POS to tie specific ingredient quantities to recipes and menu items to track inventory down to an individual ingredient or raw-good level.
How does inventory management help a business?
Inventory management can help a business become more profitable and efficient by organizing and streamlining inventory storage, tracking, ordering, and receiving. For most businesses, especially retailers, inventory is the source of revenue. Yet, buying and storing inventory ties up a lot of a business’ money. Managing inventory effectively helps maintain healthy cash flow.
Can I use spreadsheets to track inventory?
If you are a small business with less than 100 SKUs, yes, you can. It will just require a lot of time and energy to update continually. You’ll want to maintain a spreadsheet with all of your SKUs or products and update them daily to record sales, purchase orders, and shipments received. Using a POS automates most of this process, which saves a lot of time and helps prevent human errors.
Follow the techniques above, and your retail store or ecommerce business will soon be running an effective small business inventory management system. Whether you’re looking to learn the basics of how to organize inventory for small businesses or reinvigorate an existing system that has become disorganized, these basic principles will help you set up and streamline your operation.
For most businesses, the first step in organizing inventory is getting set up with a POS system. Lightspeed has some of the most robust retail inventory management features, including detailed analytics, purchase order management, and bar code generation, at a price that is accessible for small businesses. Visit Lightspeed for a free trial.