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One of the most important parts of running your small business is inventory management.
However, it’s something many businesses still struggle with, and it can affect their bottom lines — especially for stock-heavy businesses, such as fashion or cosmetics.
In this article, we discuss inventory management techniques, explore how inventory management software can make the process easier (and what to look for), and share some best practices for managing inventory while accounting for changes in supply and demand.
What is inventory management?
Inventory management is the process of controlling a business’s stock as it comes in and goes out, so you always have the right quantities of the right products available for sale at the right time. Good inventory management practices protect your cash flow and balance supply with customer demand while avoiding wastage.
Here’s a real-world example:
Imagine you own a small cafe that sells coffee, pastries and sandwiches to office workers.
Your system shows you just how many coffee beans, milk bottles and bread you have and tracks how quickly items sell, so you can predict when you’ll run low and reorder before the lunchtime crowd comes in. If croissants sell better than muffins, you can increase the number of croissants and reduce muffins the next time.
Inventory management helps you monitor what comes in and what goes out, minimise waste, prevent shortages during busy periods and keep costs under control.
How does inventory management work?
Inventory management works by using systems and processes to track stock levels in real time – from when products are ordered to the time they are sold.
Inventory management involves the following:
- Forecasting: Using historical sales data and seasonal trends to predict future demand and plan for optimum stock levels
- Purchasing: Ordering the right quantity of stock based on customer demand and supplier delivery timelines
- Tracking: Using a Point-of-Sale (POS) or inventory management software to monitor stock levels and sales in real-time
- Reordering: Replenishing low-running stock
- Reviewing: Analysing sales reports to identify stock movements and opportunities to optimise stock levels
Why is inventory management important?
Small business inventory management is important as it prevents overstocking or understocking, which affects revenue, profitability and customer goodwill.
Businesses use their working capital, which is money that’s available to run daily operations, to buy stock. Buying too much stock reduces working capital available for other business operations, like wages. Ordering too little stock creates shortages and affects customer satisfaction and retention: Research from the Commonwealth Bank of Australia shows 49% of consumers will avoid a business if they’ve experienced stock-related issues.
What to look for in inventory management software
The right inventory management software can transform how you order and track your stock. It gives you real-time visibility and helps you avoid expensive mistakes like overstocking.
Good inventory management software should:
- Reduce costs, improve cash flow and boost your business’s bottom line
- Track your inventory in real time
- Help you forecast demand
- Prevent product and production shortages
- Prevent excess stock and too many raw materials
- Allow for easy inventory analysis on any device
- Be accessible right from your retail point-of-sale (POS) system
- Optimise warehouse organisation and precious employee time
- Offer quick and painless bar code scanning to speed up intake
- Allow for multilocation management, tracking inventory across several locations or warehouses
Inventory management techniques and best practices for small businesses
Inventory management is especially important for small businesses because even minor mistakes, such as over-ordering certain items or running out of popular items, can impact cash flow and operations quickly.
Some techniques that small businesses can use to manage inventory are:
Fine-tuning your forecasting
Accurate forecasting is vital to effective small business inventory management. Your projected sales calculations should be based on factors such as: historical sales figures (if you sell with Square, look at your Square Dashboard for this information), market trends, predicted growth and the economy, promotions, marketing efforts, etc.
Using the First In, First Out approach (FIFO)
Goods should be sold in the same chronological order as they were purchased or created. FIFO is especially important for perishable products like food, flowers and makeup, but it also works for non-perishable goods since items sitting around for too long might become damaged or otherwise out of date and unsellable. Apply FIFO in a storeroom or warehouse by adding new items from the back so the older products are at the front.
Auditing your stock
You still need to carry out a stocktake (the process of counting and recording all inventory on hand so the physical stock matches the numbers in the system) even if you’re using good inventory management software to ensure your estimates match actual stock numbers. Businesses use different techniques, including an annual, year-end physical inventory count and ongoing spot-checking, which are useful for tracking fast-moving products or identifying stocking issues.
Using cloud-based inventory management software
Look for software with real-time sales analytics to gain visibility of your inventory across your business, especially if you have hundreds of products across multiple locations. Real-time analytics also helps small businesses make faster decisions during demand spikes and manage seasonal, promotional activities.
Tracking your stock levels at all times
Always keep an eye on your stock levels. A solid tracking system, especially for your high-priced items, helps you avoid errors and unexpected shortages. The right small business inventory management software can automate these tasks, saving you time and money, and providing inventory visibility at all times.
Remembering your ABCs
A simple way to strengthen your inventory control is to sort products into A, B, and C categories, allowing you to supervise your highest-value items. Category A products are your big-ticket items. You won’t have many of them, but they account for most of your inventory value, or ‘annual consumption value’, which is annual demand multiplied by an item’s cost. Category C products are the opposite; these are low-cost items that make up the bulk of your stock and have the lowest annual consumption value. Category B sits in the middle.
The chart below shows a typical ABC breakdown:
- A items: 10 – 20% of your stock, but 70 – 80% of your inventory value
- B items: About 30% of your stock and 15 – 25% of your inventory value
- C items: Around 50% of your stock, but only about 5% of your inventory value
Tips for businesses that make their own products
Some businesses make their own products and therefore own their whole supply chain – for example, a business that makes and sells handmade tote bags. Rather than sourcing finished products from a vendor, these businesses source raw materials from a supplier, make them into bags and sell them.
These businesses usually have three types of inventory categories:
- Raw materials from a supplier
- Work-in-progress pieces
- Finished products
Some inventory management tips for businesses making their own products:
- Create clear categories for materials you use and products you sell to avoid disruptions.
- Use a Bill of Materials (BOM) to list exactly what goes into each product so you don’t run out of essential components.
- Create a safety buffer for critical stock in case of delays.
- Monitor production lead times to track how long it takes to make each product.
- Batch production runs to maintain quality and avoid wasting time and materials.
- Use inventory management software that can handle raw materials, BOMs, variants and production runs, so you can manage production more efficiently.
Makers using these inventory management techniques avoid unnecessary costs, have enough stock on hand and ensure they can meet customer demand at all times.
Tips for retail inventory management
Good retail inventory management can help save money by ensuring the business only buys what it can realistically sell. While it can be tempting to buy merchandise in larger quantities to take advantage of vendor discounts and free shipping, having excess stock isn’t always good for your bottom line.
On the other hand, imagine customers go to your shop only to find out that their favourite product is out of stock. Understocking can lead to lost sales as customers abandon online carts and buy from competitors instead. Research from Grant Thornton reveals that 23% of Australian consumers’ purchasing decisions are influenced by product availability, while data from Australia Post shows long delivery times cause Australians to abandon online carts.
Some tips for managing retail inventory are:
- Forecast customer demand using historical data to plan future stock levels.
- Determine the minimum level of quantities for each item to avoid shortages.
- Review sales reports regularly to identify your best-selling products and slow-moving stock, and to avoid tying up capital in dead stock.
- Conduct routine stocktakes to avoid discrepancies between actual stock and estimates.
- Check deliveries against purchase orders quickly to maintain accurate inventory levels.
- Create a centralised inventory system for all sales channels to avoid overselling.
- Choose reliable suppliers with shorter lead times to avoid gaps on the shelves.
- Use automatic ordering to ensure stock is always available.
Your inventory management system should ensure you have enough stock on hand, and it can be shipped out on time to avoid lost sales.
Square makes managing inventory easier
Square for Retail offers free inventory management software that updates in real time and allows sellers to manage their inventory from anywhere. Our system is suitable for omnichannel retail and syncs with your brick-and-mortar point of sale and online store.
It’s quick to set up and simple to use. You can download inventory reports and receive daily stock alerts with items that are running low or out, so you always know what needs to be reordered.
Square for Retail also integrates seamlessly with third-party solutions like Stitch Labs, Shopventory and DEAR to manage inventory across multiple channels, or you can work with a developer to build a custom solution using the Square Inventory API.
Learn more about getting started with Square for Retail for free.
FAQs about inventory management for small businesses
Why is inventory management important for small businesses?
Inventory management is important for small businesses because it helps them avoid two costly problems:
- Ordering too much stock (overstocking) or
- Not having enough stock (stockouts)
Managing inventory effectively helps you track your popular items, ensure you always have stock available, reduce holding and storage costs, and prevent disruptions during promotional campaigns.
Businesses gain better visibility into which items are selling and which aren’t, which helps them manage their cash flow. Effective inventory management also reduces the staff hours needed for stocktakes and lowers costs, helping businesses maintain long-term profitability.
What tools do I need to track inventory effectively?
Some examples of tools that can manage inventory are:
- Inventory management software integrated with a point of sale that adjusts inventory levels automatically when an item sells.
- Cloud dashboard with mobile device access to help you view inventory wherever you are, using a tablet or phone.
- Barcode or QR code scanner to allow you to scan incoming and outgoing stock quickly.
- Low stock or reorder alerts with reporting tools that automatically inform you when products are running low or need to be reordered.
Any software or system you choose should be fully integrated with your other tools and operations so you can see what’s happening across all parts of your business in real-time.
Aren’t spreadsheets a good way to manage inventory?
Tracking inventory manually using spreadsheets and physical counting can quickly become overwhelming for small business owners and lead to errors. Spreadsheets aren’t an effective inventory management tool because they have to be updated manually, which is time-consuming. It also means the data is almost always out of date and useless for future planning.
Spreadsheets also can’t scale with your business or communicate with your POS, which means you’ll never know how or which of your products are selling or not selling.
Do I really need software to manage my inventory?
Whether you need inventory management software depends on the size of your business. If you’re only selling a few items, a manual spreadsheet can work well to keep track of stock.
However, for most growing businesses, an inventory management software makes the process quicker and more accurate than time-consuming spreadsheets, which can have errors.
Small business inventory management software has the following benefits:
- Real-time updates whenever you sell, receive or adjust stock
- Automatic low-stock alerts so you don’t run out of bestsellers
- Accurate reporting to help you understand what products are selling and what’s not
- Fewer manual tasks, freeing up time for customer service and sales
- Better visibility across multiple channels, especially if you sell both online and in-store
Tools like Square Inventory Management are designed specifically for small businesses, making it easy to manage inventory without adding complex systems or extra admin.
Isn’t inventory management software expensive?
No, inventory management software isn’t necessarily expensive, and you don’t need to pay a lot of money to get inventory software that works for your small business. The cost of the software will depend on the size of your business, advanced integrations, extra features or the number of users.
Square Inventory Management is free and fast to set up. The system also sends daily stock alerts so you know what is running low and needs to be reordered. Easily edit your items from the Square Dashboard or directly from the Square Point of Sale App.
