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What is Inventory Management?

Inventory management refers to the process of ordering, storing, and using an organization’s inventory. This includes the warehousing, processing, and overall management of raw materials, as well as work-in-progress (WIP) inventory and finished products.  

Why is it important?

Inventory management is especially important for employment social enterprises that depend on sales of a product for their revenue. For these organizations, inventory is not only essential to their market operations, but it may also be one of the organization’s largest assets. Inventory management helps these employment social enterprises to:

  • Identify when to order new inputs or raw materials: Fundamentally, inventory management is essential to helping identify when more inputs or raw materials are needed (and also to avoid spending unnecessarily on inventory when there are sufficient inputs or raw materials already).  
  • Monitor effectiveness of production processes: Monitoring the amount of raw materials, work-in-progress inventory, and finished products there are and comparing that to expectations can help the organization to determine if there are issues with the end-to-end production processes.
  • Stay aligned with the market and customer demand: Unexpectedly high amounts of unsold inventory may indicate that there are products or product lines that no longer meet customer needs or demand, or that are priced too high. This could indicate opportunities for promotions or discounts to clear inventory, and helps employment social enterprises to improve product planning. 
  • Remain aware of irregularities that may be a sign of bigger issues: A sudden or unexpected change in inventory could have a significant impact on operations and sales, and could signal other critical issues that need to be addressed (e.g., a leak in the warehouse roof that has resulted in damaged inventory or inadequate facility security, resulting in stolen inventory).  
  • Stay in compliance with tax regulations related to inventory: Closely and consistently tracking the value of inventory is important to calculating gross margin (and therefore taxable income), and in some instances, the value of inventory on hand at the end of the year could have tax implications as well.   

Self-assessment checklist

Your organization may be in need of increased focus on inventory management if it:
  • Currently sells a product or will soon be selling a product that it produces or keeps on hand in a warehouse or storage area
  • Needs to improve cash flow and holds a significant amount of inventory
  • Has inventory, but doesn’t have good records for how much, its location, or in what condition the inventory is
  • Wants to take advantage of the tax benefits of good inventory management

Best practices 

  • Getting started with the basics
    • Understand how you are currently storing and managing inventory: The first step to good inventory management is understanding how your organization is currently storing and managing inventory. Identify and list the locations where inventory is being held, and what kind of inventory is at each location (types of goods, whether they are perishable, and whether they are raw materials, work-in-progress inventory, or finished goods). Determine whether your organization has standard processes in place for receiving items and adding those items to inventory. Are items recorded as they are received? Is there a clear labeling and shelving process in place so that the inventory is organized while it is being stored? When inventory is removed for processing or sale, is it removed on a First In, First Out (FIFO) or Last In, First Out (LIFO) basis?
      • First In, First Out (FIFO): The most common inventory management method, in FIFO the inventory items that have been added to inventory first (first in through acquisition or production) are removed from inventory first (first out when they are sold, used, or disposed of). This is most common as it often aligns with the nature of inventory items’ lifecycle (the first items acquired or produced will be the first to expire, spoil, or be out of date in some way, so it makes sense to remove them from inventory first). It is also the most common because it is the most widely-accepted method from an inventory valuation and accounting perspective.
      • Last In, First Out (LIFO): A less common inventory management method is LIFO, where inventory items that have been added to inventory last (last in) are removed from inventory first (first out). This is less common because it does not often align with the nature of a company’s inventory and also requires more work from a valuation and accounting perspective.    
    • Evaluate the inventory your organization has on hand: Once the location and nature of inventory have been determined, counting and valuing the inventory is the next important step. Determine the best approach to counting inventory based on the resources you have on hand and the accuracy needed in the count and valuation:
      • Cycle count: The least resource-intensive approach that may not require specialized software, a cycle count takes a sample of inventory (a combination that may include a select set of items, a section of the warehouse, or a certain stage of inventory processing) and uses the result of that sample to estimate the inventory total. This is also the least accurate of all inventory counting methods, but it may be appropriate for certain types of organizations or times in the year.
      • Physical count: More resource intensive than cycle count but more accurate, a physical count requires counting every single item in inventory. This manual counting process can take a significant amount of time and labor, and may also require brief disruptions to operations. 
      • Electronic count: Facilitated by software and hardware such as tablets, an electronic count can also be highly accurate and require less labor to complete. However, conducting an electronic count requires investment in the appropriate suite of technologies to facilitate the counting process.
    • Establish a method to track inventory: Ensure that you have in place a method to track inventory (to include inventory level, inventory turnover, returned or damaged goods, etc.). This inventory tracking method should take into account best practices related to data management and may also be relevant to your organization’s key metrics. Common methods to track inventory include:
      • Manual tracking: Using a pen and paper may be a good method if your inventory levels, value, and turnover are relatively small.
      • Spreadsheets: If your organization is not yet ready to invest in specialized inventory management software, using spreadsheets may be an adequate method for tracking inventory. It will require, however, that team members responsible for making inputs be familiar with using spreadsheets.
      • Specialized Software: Specialized inventory management software may be a good option for organizations with significant inventory levels, value, or turnover. Software can take advantage of the use of Stock Keeping Units or SKUs, which are codes that enable more effective and efficient tracking of inventory. Use best practices in selecting software to determine the best fit for your needs.
  • Keeping momentum with high-performance practices
    • Understand how your inventory is tied to the nature of your product and market: Product-focused employment social enterprises that are undergoing growth or plan to grow in the future will need to understand how inventory relates to the nature of the product they sell and the market in which they operate. This gives the organization the advantage of optimizing the efficiency of operations related to inventory by optimizing use of warehouse space, cash, and staff time and reducing the amounts of excess inventory. Internal data on turnover rates as well as factors such as industry trends, seasonality, and competitor behavior can inform how an ESE adjusts its inventory management practices. 
    • Define roles & responsibilities and establish internal controls related to inventory: Establish and assign clear duties as it relates to inventory management. For very large organizations this may include having one or more inventory managers whose responsibilities are to oversee all processes and team members who order, track, count, and control inventory.  Internal controls related to inventory help to ensure the security and useability of the organization’s inventory. These controls are typically standard processes or procedures such as securing the locations where inventory is stored, controlling access to warehouses, inspecting and counting goods and items upon arrival before adding them to inventory, tagging/labeling and organizing all goods and items before adding them to inventory, and tracking inventory levels on a regular basis.

Additional Resources

About Emerging Market Enterprises

Emerging Market Enterprises (EME) is an advisory firm based in Washington, DC, that works with startups, scaleups, and intermediaries in the impact ecosystem. EME provides a variety of services to its clients and partners to include market strategy, operations improvement, and leadership coaching.