What Are The 4 Types Of Inventory Management Systems?

An inventory management system is a tool used to effectively monitor, regulate, and oversee various types of inventory in a business or organization, either through software or procedural methods.

The number of inventory systems is not limited and the categorization varies across sources. There are two main groups of inventory management systems: manual and automated. Manual systems rely on human input and observation while automated systems use software or technology to manage warehouse stock in real-time with minimum effort and errors.

Good retail inventory management software helps streamline the handling and control of these various types of inventory. It typically involves activities such as inventory tracking, stock replenishment, order management, demand forecasting, and inventory valuation.

This article presents the four types of inventory management systems, explains what is inventory, and provides guidelines for choosing the optimal type of system for your unique situation.

What is inventory?

In the context of automated inventory management systems, inventory refers to the accounting of items, component parts, and raw materials that a company either uses in production or sells.

Automation in inventory management is defined as utilizing certain software or technology to manage warehouse stock in real time with minimum effort and errors. An automated inventory management system can significantly improve business digitalization by increasing accuracy, real-time tracking, problem detection, and efficiency.

Benefits of automated inventory systems

Automated inventory management systems provide a lot of benefits to retailers.

Here are some key advantages:

1. Increased accuracy:

Automated systems reduce human errors that can occur in manual inventory management processes. By relying on barcode scanning, RFID technology, or other automated identification methods, inventory data is captured and recorded more accurately, reducing discrepancies between actual inventory and recorded quantities.

2. Real-time visibility:

Automated inventory systems provide real-time visibility into stock levels, allowing retailers to have an up-to-date view of their inventory across multiple locations or channels. This visibility enables timely decision-making, such as reordering products, identifying stockouts, or reallocating inventory to meet demand.

3. Improved efficiency:

Automation streamlines inventory management processes, reducing the time and effort required for tasks such as stock counting, data entry, and order fulfillment. With automated systems, retailers can optimize workflows, minimize manual labor, and allocate resources more efficiently.

4. Inventory optimization:

Automated systems help retailers optimize their inventory levels by providing data-driven insights. By analyzing historical sales data, demand patterns, and other relevant factors, retailers can make informed decisions regarding stock replenishment, identifying slow-moving items, and avoiding excess inventory or stockouts.

5. Cost savings:

Effective inventory management systems can result in cost savings for retailers. By minimizing stockouts, overstock situations, and excess inventory, retailers can reduce holding costs, obsolescence costs, and lost sales due to stock unavailability. Additionally, automation reduces labor costs associated with manual inventory management processes.

6. Enhanced customer satisfaction:

With automated systems, retailers can provide accurate and reliable information to customers regarding product availability, estimated delivery times, and order status. Meeting customer expectations by avoiding stockouts, fulfilling orders promptly, and minimizing errors can lead to improved customer satisfaction and loyalty.

7. Streamlined supply chain management:

Automated inventory systems can integrate with suppliers and other stakeholders in the supply chain, facilitating seamless communication and collaboration. This integration enables retailers to optimize procurement, track shipments, manage vendor relationships, and improve overall supply chain efficiency.

8. Data-driven insights:

Automated inventory management systems generate comprehensive data and analytics that can be used for strategic decision-making. Retailers can analyze sales trends, identify top-selling products, assess the performance of suppliers, and forecast future demand. These insights can drive better inventory planning, purchasing decisions, and overall business strategies.

Automating your inventory management system is an impactful and easy choice that would return the investment in time and cost. It will allow the business to grow and scale up without complications that can be avoided with clear and orderly inventory management.

The Four Inventory management systems

The Perpetual Inventory System is a computerized system used by large companies with constantly rotating inventory and multiple locations. It keeps track of the quantity of inventory on hand and updates the records as goods are purchased. It requires point-of-sale terminals, barcode scanners, and software to deduct every piece of inventory.

The Periodic Inventory System, on the other hand, does not keep a continuous record of inventory. Instead, it requires a physical count of inventory at the end of a certain period, like a week or a month. It is suitable for small businesses with low-volume inventory and no need for real-time data.

The Just-in-Time (JIT) Inventory System is a technique designed to minimize waste and increase efficiency by receiving inventory only when needed. It aims to reduce inventory holding costs and eliminate the need for storage space. It requires a reliable supply chain and accurate demand forecasting, making it suitable for companies with consistent demand and reliable suppliers.

The ABC Analysis Inventory System provides essential information for inventory planning, determining pricing, and business margins. It categorizes inventory into three groups based on their contribution to the company’s overall revenue – A, B, and C. Items, which are responsible for the majority of revenue, are closely monitored, while C items, which contribute the least, are monitored less frequently. It is suitable for companies with a large variety of products and limited resources.

Let’s take a deeper look at each of the systems.

1. Perpetual Inventory System

Perpetual inventory management is a computerized system that tracks inventory levels in real time. It updates inventory records automatically every time an item is scanned or sold, providing a continuous estimate of the cost of goods sold and gross profit. This approach provides businesses with real-time data tracking, a more detailed paper trail, decreased management costs, immediate end-of-year inventory balance calculation, and more accurate demand forecasting.

Perpetual inventory systems are recommended for large companies with high inventory volumes and multiple locations. They work by continuously recording all transactions using point-of-sale terminals, scanners, and perpetual inventory software. However, these systems do not replace the need for periodic physical inventory checks.

One of the benefits of perpetual inventory management is that it allows businesses to use the economic order quantity method to purchase inventory. Also, the system provides a continuous estimate of COGS and gross profit, which can help companies make informed decisions about pricing and profitability.

FIFO and LIFO are two inventory management methods used to track inventory costs. FIFO assumes that the first items purchased are the first items sold, while LIFO assumes that the last items purchased are the first items sold.

In a period of rising prices, LIFO will result in higher cost of goods sold and lower net income compared to FIFO, because the most recently purchased, and therefore most expensive, items are being sold first. In contrast, in a period of falling prices, LIFO will result in a lower cost of goods sold and higher net income compared to FIFO, because the older, less expensive items are being sold first.

The choice between FIFO and LIFO depends on the specific needs and goals of the business.

The downside of perpetual inventory management is that it can be costly to implement and maintain. Additionally, it requires a high level of accuracy and attention to detail to ensure that inventory records remain accurate. Small businesses with low inventory volumes may not benefit from using this type of system.

2. Periodic Inventory System

The Periodic Inventory Management System is a manual inventory system that involves taking physical inventory counts periodically. This method is suitable for small businesses with low inventory levels and a limited number of products. In contrast, the Perpetual system is a computerized system that tracks inventory levels in real time, which is needed for more complex operations.

The periodic inventory management system provides businesses with almost real-time data tracking, a more detailed paper trail, decreased management costs, immediate end-of-year inventory balance calculation, and more accurate demand forecasting.

The benefits of using the Periodic Inventory System include reduced setup costs and minimal experience required to operate it. However, it disrupts business hours and has an increased risk of errors due to the manual process of calculating COGS. Determining COGS with a periodic system involves manually calculating beginning inventory, additional inventory, and ending inventory costs, which can be complicated and prone to errors.

Small businesses with low inventory volumes may benefit from using this type of system.

3. Just-in-Time (JIT) Inventory System

The Just-in-Time (JIT) inventory management system optimizes inventory levels by receiving goods and materials just in time for customer demand, balancing on the verge of understocking at all times. JIT aims to reduce inventory holding costs such as warehousing, insurance, and inventory depreciation. JIT can lead to cost savings, reduced waste, improved cash flow, increased efficiency, and enhanced quality control.

However, relying heavily on timely deliveries can make businesses more susceptible to disruptions in the supply chain. It’s important to note that JIT may not be suitable for all businesses, such as those with unpredictable demand or those in industries with long lead times.

Additionally, JIT requires close relationships with suppliers and a high level of trust to ensure timely deliveries. Businesses considering implementing JIT should assess their supply chain and consider the potential risks and benefits before making a decision. 

JIT requires precise planning and coordination, leaving little room for unexpected changes in demand or supplier availability. JIT inventory management can be challenging to implement effectively in the retail sector due to the unique characteristics and demands of the industry. However, certain aspects of JIT can be adapted and applied to retail operations.

Businesses that can benefit from JIT include manufacturing businesses, industries with stable and predictable demand, businesses focusing on cost reduction, and lean manufacturing practitioners. It’s important to evaluate the pros and cons of JIT inventory management before implementing it in a business.

4. ABC Analysis Inventory System

The ABC Analysis Inventory System is a method of classifying inventory into three categories based on their value and importance.

The main benefit of using ABC Analysis is that it allows businesses to prioritize their inventory control efforts and allocate resources more efficiently. By focusing on the most critical items, businesses can reduce stockouts and excess inventory, leading to cost savings.

However, ABC Analysis has some downsides. It requires accurate and timely data to be effective, which may be challenging to obtain for some businesses. Additionally, it may not account for seasonal demand fluctuations or changes in customer preferences.

While ABC Analysis is suitable for any business with a large and diverse inventory, it is important to note that it should not be the only method used for inventory management. Businesses should also consider other factors such as lead times, safety stock levels, and economic order quantities when determining optimal inventory levels. By taking a comprehensive approach to inventory management, businesses can improve their supply chain efficiency and reduce costs even further.

Overall, ABC Analysis Inventory System is an effective tool for inventory management that helps businesses prioritize their resources and reduce costs.

Metrics for inventory management system

Retailers can use several metrics to determine the effectiveness of their inventory management system.

Here are some key metrics to consider:

• Inventory turnover: This metric measures how quickly a retailer’s inventory is sold and replaced over a specific period. It is calculated by dividing the cost of goods sold (COGS) by the average inventory value. A high inventory turnover ratio indicates efficient inventory management.
• Gross margin return on investment (GMROI): GMROI measures the profitability of inventory investments by comparing the gross margin generated with the average inventory investment. It is calculated by dividing the gross margin by the average inventory cost. A higher GMROI indicates better inventory management.
• Stockout rate: This metric quantifies the frequency at which a retailer runs out of stock for specific items. It is measured by dividing the number of stockouts by the total number of opportunities to sell during a specific period. A low stockout rate indicates effective inventory management and helps prevent lost sales.
• Order fulfillment rate: This metric reflects the ability to fulfill customer orders accurately and on time. It measures the percentage of orders that are shipped complete and on schedule. A high order fulfillment rate indicates efficient inventory management and customer satisfaction.
• Carrying costs: Carrying costs represent the expenses associated with holding and managing inventory, including warehousing, insurance, obsolescence, and capital costs. Monitoring and reducing carrying costs can indicate effective inventory management and cost control.
• Cycle time: Cycle time measures the time it takes for a retailer to receive, process, and fulfill an order. It includes order processing, picking, packing, and shipping. A shorter cycle time indicates improved efficiency and faster order fulfillment.
• Backorder rate: The backorder rate measures the percentage of customer orders that cannot be fulfilled immediately due to stockouts. A high backorder rate may indicate inventory management issues or supply chain disruptions.
• Lead time: Lead time refers to the time it takes for an order to be fulfilled from the moment it is placed. Monitoring lead time helps retailers assess the efficiency of their supply chain and the accuracy of inventory forecasts.
• Accuracy of demand forecasting: This metric evaluates the accuracy of inventory demand forecasts. It measures the variance between forecasted demand and actual sales. Accurate demand forecasting enables better inventory planning and reduces stockouts or excess inventory.
• Customer satisfaction: While not a direct inventory metric, customer satisfaction is influenced by inventory management. Monitoring customer feedback, reviews, and repeat purchases can provide insights into how well the inventory management system is meeting customer expectations.

By analyzing these metrics, retailers can gain a thorough understanding of the effectiveness of their inventory management system. This allows them to make informed decisions to optimize inventory levels, reduce costs, and improve customer satisfaction.

The metrics outlined above are not exhaustive, and retailers may choose to track additional metrics depending on their specific needs and goals. However, by regularly monitoring and analyzing these key metrics, retailers can gain valuable insights into their inventory management system and identify areas for improvement. This can ultimately lead to increased profitability, improved customer satisfaction, and a more efficient operation.

Conclusion

Ultimately, choosing the right inventory management system depends on factors such as business size, inventory volume, complexity, and specific needs. By implementing an appropriate system, businesses can optimize stock levels, reduce costs, improve operational efficiency, enhance customer satisfaction, and achieve better financial performance.

It is essential to carefully evaluate the characteristics of each system and consider the unique requirements of the business to make an informed decision and effectively manage inventory.

The benefits of a good inventory management system include improved accuracy, reduced labor costs, and better forecasting. Some potential options for inventory management systems include barcoding, RFID, and cloud-based software. It is important to assess the needs of the business and evaluate the features of each system to determine the best fit.

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