How to Organize Inventory for Small Businesses in 9 Steps
Meaghan has provided content and guidance for indie retailers as the editor for a number of retail publications and a speaker at trade shows. She is Fit Small Business’s authority on retail and ecommerce.
Brigitte is a retail specialist and staff writer with brick and mortar management experience. She is versed in retail sales analysis, merchandising, and buying with an emphasis in retail sales and marketing across platforms. She has a BA in writing from Washington University, St. Louis.
This article is part of a larger series on Retail Management.
Inventory management is the process of having the right products, in the right quantities, at the right time to sell to customers. Accurately managing inventory can increase revenue by preventing stockouts, excess inventory, and unsold products.
While it can be done manually, the easiest solution is to use a software program to automate your inventory management process. Our recommended inventory management solution for most retailers is Lightspeed.
If you’d rather manage inventory manually, download our free inventory management workbook.
Step 1: Choose an Inventory Management Method
Before you begin working with your stock, you need to choose an inventory management method. As we mentioned earlier, the method you choose should be one that best allows you to maintain the right products, in the right quantities, at the right time to sell to your customers.
You will typically combine a few inventory management methods to help you to achieve this goal, and the ones you choose will depend on a few factors, including:
- Quantity
- Product value
- Cost of goods sold (COGS)
- Turnover ratio
- Perishable vs non-perishable
- Turnover rate
- Carrying costs
Once you have chosen an inventory management method, you can implement it by programming an ordering cadence, automations, and alerts on your inventory management software or point-of-sale (POS) system. Or, if you are managing your inventory manually, you will need to monitor your books and item quantities to ensure implementation.
Below, you can click through the different inventory management methods at your disposal.
First-in, first-out inventory management, also known as FIFO, is one method to assign costs to ending inventory. FIFO assumes that the first items that are purchased will be sold first to assign a cost to the inventory remaining at the end of the year.
The last-in, first-out inventory method, or LIFO, assumes the most recently purchased inventory (“last in”) as the cost of goods sold (COGS). In other words, recently purchased goods are expected to be expensed first or transferred to the COGS.
This method is popular in the US because it’s allowed for tax purposes, and many proponents believe it most closely matches the replacement cost of inventory.
The average cost method, or AVCO, is another method used to determine the cost of inventory at the end of the year and the COGS during the year. Under AVCO, the cost of inventory is based on the weighted average cost of inventory purchases during the year. Because it uses an average cost of goods in inventory rather than tracking individual units, it is typically simpler to use than FIFO or LIFO.
A perpetual inventory system calculates your COGS after each sale, as opposed to periodically. This is also called live sales tracking in a POS system and simply means that your inventory information will update as transactions happen. You will also want to be sure that this includes all your sales channels, including online and additional locations.
A periodic inventory system calculates your COGS periodically when you perform physical inventory counts. This is a more common practice for businesses managing their inventory manually but is also used less frequently in conjunction with automated perpetual inventory management systems.
The specific identification inventory method identifies each individual unit of inventory and assigns its actual cost. This inventory management method doesn’t use assumptions like the FIFO, LIFO, or AVCO methods. The COGS and ending inventory are determined by the actual cost assigned to each physical unit of inventory and what is actually sold and unsold.
Step 2: Organize Product & 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 POS system that will keep searchable vendor and product directories.
There are lots of POS systems to choose from, and they all have unique inventory systems. Read our guide to learn more about the best POS inventory systems for your business.
To organize your products, you’ll first need to record information about each item and file it on a product page. Product-specific information should include:
- Product name
- Quantity
- Your internal product stock-keeping unit (SKU) number
- 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, cost, dispatch time, etc.
- Picture or product image
Keep track of your product information so you can reference it over time and reorder easily. (Source: Lightspeed)
In addition to creating a log of your products and their information, you will need to file your vendors’ information into your inventory system. That information should include:
- Vendor name
- Vendor contact name
- Vendor billing information
- Vendor phone
- Vendor email
- Vendor website
- Order volume
- Payment terms
- Line rep or showroom contact
- Fulfillment and shipping times
- Top products from vendor
Not ready to invest in a POS system with inventory management capabilities? No worries. There are also several free inventory management software available.
Tip: 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 purchase order, having a good relationship with your supplier can 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, meeting suppliers in person at trade shows, and, perhaps most importantly, paying invoices on time.
As sustainability is becoming more critical to consumers and as they demand greater environmental efforts from businesses, 53% of businesses plan to increase their focus on sustainable sourcing in 2023.
Step 3: Create & Submit Accurate Purchase Orders
A purchase order (PO) is a buyer-created record of an order that is submitted to the vendor and serves as a legal contract for the sale of goods. Typically, you will use your POs to cross-reference actual goods and invoices received to those ordered and paid for. If there is a discrepancy between your PO and the goods received, you can use your PO to return to the vendor and settle up.
Purchase orders record what you ordered from your vendors and act as a receipt that you can compare to the goods you actually receive.
POs are typically submitted to vendors electronically through email or the vendor’s online ordering portal. Some POS systems, like Lightspeed, have features that let you manage POs more efficiently—including directory features to manage vendor contact information, the capability to send POs directly from the interface, and low-stock alerts that tell you when you need to place a new PO and prevent stockouts.
In the news:
As the economy continues to dip and consumer habits become more conservative, the inventory-to-sales ratio is rising, hitting 1.24 in November of 2022 on an upward trajectory. This means that for every one sale, retailers have an average of 1.24 pieces of inventory. To account for this new economic environment, retailers should slow their purchasing rates to match slowing sales rates.
Step 4: Receive Orders Accurately
Once you have submitted your purchase order for the right amount of stock, you want to be sure that you receive that stock accurately. Supplier errors happen fairly often, and if you aren’t being systematic about receiving your inventory, you might get shorted or overcount or underestimate your inventory levels—which can lead to shrinkage and a decrease in your margins.
To receive inventory correctly, companies should:
- Unpack the shipment and organize items by product.
- Count/scan products.
- Compare the count to your PO.
- If the counts and products match, file as received.
- If you find errors like wrong, shorted, or missing items, note these on your PO and contact your supplier immediately to resolve them.
- Shelve or store all correctly received stock (tag or label first if needed for your system).
- Enter your invoice into your accounting system.
Many inventory management systems have accompanying hardware or apps that allow you to scan products rather than count and log them manually.
Accurately counting and receiving stock is important for preventing shrinkage and ensuring the accuracy of your orders. (Source: Pinterest)
In the news
A study from Ivalua finds that the majority of procurement leaders foresee supply chain issues persisting through 2023, with 97% foreseeing significant disruption in the direct materials supply chain.
Step 5: Tag & Label Inventory
Once your products are counted and physically on hand, you will need to tag and label your inventory, so it is ready for the sales floor and organized internally. To cover these two bases, your tags should include two main things:
- Price: The selling price of your item. All your inventory will need this before it can go out on the floor and be customer-facing.
- Product Labels: You should have some sort of labeling system for your inventory so you can easily organize and track it internally. We recommend using both a barcode label—so you can easily scan items in your inventory system and at checkout—and a descriptive written label, like “red shirt” or “child’s leggings,” that corresponds with where the item goes in your store and in storage.
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 should be fixed directly to the product. Some inventory might even arrive prelabeled with the manufacturer’s barcodes, description, and price. If you aren’t using an internal labeling system, this makes your job easy. You can just start organizing.
Use our guide on how to create barcodes (plus a barcode generator) and check out our picks for the best barcode label printers to get started labeling your products.
Step 6: Organize Your Stockroom or Warehouse
Having an organized stockroom will not only make things easier to find but will allow you to fit more merchandise and keep better tabs on your inventory.
In retail stores, tall storage shelves or double-tier hanging racks can maximize your wall space while allowing movement and easy access. Additionally, storage bins can be stacked and labeled on the ground to use floor space efficiently.
In larger warehouse settings, there is typically more room to store goods within aisles that have built-in shelving and hanging storage. The biggest thing you will want to ensure is that you choose storage devices that make sense for your merchandise and can change over time.
For example, we had a small storage room at my boutique, so we used lots of hanging racks and stacked bins to maximize the little space we had. The racks were easy to roll, and we could label them any way we needed with rack tags. Similarly, the bins were great for our heavier/knitted items that took up too much hanging space or couldn’t be hung, and were easy to label, depending on the inventory we had on hand.
Whatever your 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.
Utilize your wall space to fit as much product as possible in limited space. (Source: Pinterest)
Learn how to keep your warehouse operation efficient with our guide to warehouse layout design planning.
Step 7: Track Inventory in Real Time
Tracking your inventory levels in real time is key for keeping the right items on the shelves in the right quantities—i.e., good inventory management. Whether by hand or through your POS system, a sound inventory management system records every sale in detail and adjusts inventory levels as each item is sold.
There are some great inventory management software that you can use to help you stay on top of your inventory. Learn more about the top products on the market with our inventory management software guide.
While you can use a spreadsheet for real-time inventory tracking, we recommend a POS system to streamline this process dramatically. POS systems track real-time inventory levels and adjust your counts with every sale. As your inventory numbers dip below your safety stock level, you can set up reorder alerts, stockout warnings, and automatic PO generation. A POS system will make tracking inventory levels and reordering your supplies quick and easy and, most importantly, will base your inventory on actual sales trends, not on your best guess.
Step 8: Conduct Regular Inventory Counts
Physical inventory counts can be mundane and tedious. However, physical counts can dramatically reduce all types of inventory problems. Most small businesses do a full inventory count once each year for tax purposes, but it’s good to perform smaller partial inventory counts, or cycle counts, even if you are using a POS system.
The basis of both annual and cycle inventory counts is your current Quantity on Hand (QOH) or the amount of inventory you should have in stock for every item you carry. The formula for QOH is as follows:
QOH = (Previous QOH + Received Inventory)-Sold Inventory
Your QOH is the number you will measure your annual and cycle counts against. So, for example, if I thought I should have 272 packs of gum based on my QOH calculation, I would be looking for 272 packs of gum in my cycle or annual count. If I found a discrepancy, say only 250 packs of gum, that would indicate an error or theft that I could then look into further.
Annual inventory counts are a complete inventory count, typically done at the close of each fiscal year for income tax purposes. These counts give you an overall picture of how much inventory you have on hand at the close of your year. They can also help businesses uncover inventory shortages due to miscounts, shrinkage issues, misplaced stock, and/or receiving errors.
While most retailers perform more frequent counts, some small businesses with limited staff or small inventories will only perform this type of inventory count each year. While annual inventory counts are a good practice regardless, by year’s end, it’s too late to fix most of the problems they reveal. To catch inventory issues before they become costly, you’ll also want to conduct periodic counts, called cycle counts.
Regular counts will also help you understand what stock is not moving and might need to go on sale to avoid incurring greater carrying costs (the expenses a small business must pay to hold and store unsold merchandise).
Cycle counts are periodic spot counts that take inventory of specific categories or subsets of products. For example, at my boutique, we would do a couple of cycle counts each week for different types of clothing—basics T-shirts one day, jeans another, earrings the next. Cycle counts helped us see how specific products were performing and determine whether it was time for a restock.
Typically, you perform cycle counts on a regular basis. So, you might decide to count shirts every other Wednesday and jeans every two months. As a best practice, you would cycle count all of your products daily to keep a good grasp on their levels. Without the right tech and staff, however, this is next to impossible. Schedule your cycle counts based on the speed with which you move through your inventory, with items that sell faster getting more frequent counts.
When it comes to how you count your inventory, you have two options. You can either do it manually or use a POS system to automate your processes. Here, we will look at both:
Step 9: Reconcile Discrepancies
Ideally, your physical inventory counts will match your projected QOHs. 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. In retail, having less product than expected is known as shrink.
Shrink: The difference between the number of products you thought you had and the number you actually have in your inventory.
There are two primary reasons for inventory shrinkage. Either there has been a clerical error or theft has occurred. Sometimes, clerical errors are not actual losses—an item could have been misplaced or a key mistyped. Other times, shrinkage indicates actual loss, and you should investigate where it happened so you can work on preventing it in the future.
If you determine that your missing merchandise is truly gone, you should adjust your QOH in your records. After that, you need to record the dollar value lost due to the shrinkage in your inventory.
Inventory Management System Quiz
Thinking you want to automate your inventory management and use software instead of a manual application?
Inventory Management Frequently Asked Questions (FAQs)
Click through the questions below to get answers to some of your most asked questions about inventory management.
Inventory management is the process (or all the processes) involved in keeping the right products, in the right quantity, in stock at the right times. In other words, inventory management is anything you do to avoid stockouts and to have in-demand products in stock for your customers to buy when they want them.
Overall, our top pick for inventory management systems for small businesses is Zoho Inventory. For retailers specifically, however, we recommend Lightspeed.
To do inventory management, you first need to organize your existing products and vendor info, place purchase orders, receive your orders, tag and label new inventory, organize it into your storage area, and then continually track and count inventory over time so you can monitor when it is time to place new orders or put items on sale.
There are nine steps in inventory management that you should follow to ensure accuracy.
- Choose an inventory management method
- Organize product and vendor information
- Create and submit accurate purchase orders
- Receive orders accurately
- Tag and label inventory
- Organize your stockroom
- Track inventory in real time
- Conduct regular counts
- Reconcile discrepancies
Bottom Line
A good inventory management system means that you always have an accurate picture of your stock so that you can avoid waste and provide the merchandise and experience that your customers expect. 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 steps will help you set up and streamline your operations.
