How To Keep Track of Inventory: A Beginner’s Guide

Unforeseen changes in customer demand, supply chain snags, and miscategorized products can all make inventory management difficult. But to run and grow your business successfully, you need to know what is and isn't selling, when to reorder, and what you have sitting in your warehouse. That means you must learn how to keep track of inventory.

This beginner's guide covers the basics of inventory tracking and management, from the time a new product enters your warehouse all the way through to order fulfillment. You'll also learn the best way to track inventory for your specific type of business, along with the key metrics to track.

Inventory tracking is the process of monitoring physical resources through all steps of an organization's supply chain, from acquisition to fulfillment. Most businesses use some type of inventory management software to assist with this process, though businesses with very light inventory needs may be able to track inventory without technology.

There are three main ways to track inventory—manually, visually, and with software.

Manually

If your business maintains very small amounts of stock, the easiest way to track inventory is manually. You simply count your inventory on a periodic schedule, such as every two weeks. Compare the numbers you come up with against sales figures, then adjust inventory levels accordingly.

Visually

A different form of manual inventory tracking is to assess your stock visually. You can take photos of your warehouse or storeroom shelves to compare stock levels over time.

With software

The manual and visual approaches typically only work for businesses with extremely small inventory levels. Most companies need a more detailed and accurate inventory management process, and software can help with this.

Inventory management applications can be set up to automatically update inventory levels when orders are received from multiple sources, whether online or in-person.

This type of system also enables businesses to use perpetual inventory management, which is essential for companies that move a lot of inventory.

Some of the most common inventory management software features that can help with inventory tracking:

• Product categorization and custom tagging: Rather than manually categorizing your inventory in a spreadsheet prone to inconsistencies and labeling errors, this feature lets users use drop-down menus or custom tags to organize products by various attributes. You can then create reports to show every type of item purchased by a customer over the previous year, for example.

• Inventory reporting: A key element of inventory tracking is visibility and transparency. After all, how can you track what you can't see? While you could email your inventory tracking spreadsheet to relevant stakeholders, how do you ensure that they all have the latest version, or how do you present it in an easily understandable way? Inventory reporting can handle all of this for you.

• Barcoding/RFID: Keeping a digital record of your inventory is great, but it's only half of the battle. A barcoding or RFID (radio frequency identification) system allows businesses to physically scan everything coming into and leaving their facility, automatically tracking location and updating inventory levels.

As you develop a process for how to keep track of inventory, you should perform regularly scheduled counts. The frequency with which you conduct inventory counts depends on the nature of your business and how much stock you generally maintain.

Many businesses choose to conduct inventory counts quarterly. This ensures that you always have reasonably updated data to work with. However, depending on the nature of your business, inventory counts may require closing your warehouse and temporarily halting shipments.

For these and other reasons, some businesses only perform annual counts, typically at the end of a fiscal year. The downside to a yearly count is you may be working with outdated information for much of the year.

Some organizations employ cycle counting to help make periodic inventory counts less disruptive. This approach divides all inventory items into categories based on specific criteria (such as value, turnover rate, or demand level) and counts each category at different times throughout the year.

A newer approach is perpetual counting, which is a way to track inventory in real time. However, software and other technology are typically required to make perpetual counting feasible. RFID tags, barcodes, and scanners help make real-time counting a reality, but this technology also requires a significant investment.

The precise way you track your inventory will vary based on the size of your business, the products you carry, your budget, and many other factors. But here are some high-level steps that any business can use to begin tracking inventory:

1. Designate someone to be responsible for your inventory management

If your business handles a lot of inventory with many different products (mainly if this includes perishable items), consider hiring a full-time inventory manager. If physical inventory is a smaller part of your business, you might assign a manager inventory tracking in addition to their other responsibilities.

"We employ an inventory clerk as a full-time position to track shipments and manage orders," says Dan Gray, general manager of Kotn Supply [1], a Toronto-based custom apparel manufacturer. "They sign off on shipments, count the number of available products, and place orders for more inventory according to demand."

2. Select an inventory management system

Depending on the size and complexity of your inventory, you can manage inventory with a spreadsheet (or even a notepad in some limited situations). However, inventory management software will save businesses time and money in most scenarios and yield more accurate inventory tracking results.

Still, if you have limited needs, choose the spreadsheet route as you figure things out. If and when you do decide to invest in an inventory tracking system, our buyer's guide and list of inventory management category leaders can help you get started in your search. "These tools allow you to efficiently track inventory in multiple locations, determine reorder points, manage stock, cycle counts, and forecasting," says Gray.

3. Determine how often you need to run inventory

If you're using inventory management software, it will handle much of the daily and weekly inventory monitoring, updated via dashboards. Inventory managers can review these dashboards daily and whenever necessary to ensure that everything is in order and create reports to share with other stakeholders.

"We use cloud-based inventory management software to optimize operations and increase overall efficiency, significantly helping reduce the burden of physically counting inventory and freeing our clerks to spend more time on other critical tasks," says Gray. "That said, we adjust and monitor inventory accordingly every other day to keep shrink to a minimum."

If you're managing inventory without software, you'll want to check inventory levels weekly or at least monthly to get ahead of shortages, oversupplies, and expiring products. You'll also need to stay on top of when new inventory comes in and when inventory goes out to manually update stock levels on your spreadsheet (more on this below).

"Having periodic stock counts and wall-to-wall counts will always make you identify your actual stock levels and highlight any process deficiencies or areas for improvement," says Mike Nemeroff, CEO and co-founder of Rush Order Tees [2], a Philadelphia-based custom tee-shirt company.

4. Roll out your inventory tracking equipment

Whether you're using software or not, some inventory tracking equipment (barcode scanners, QR code scanners, RFID scanners, etc.) can help take a lot of the busy work out of inventory tracking. 

"We need mobile scanners to track our inventory," says Gray. "We scan items using a SKU barcode, and the information is instantly uploaded to our cloud-based system."

If you aren't using inventory management software, you can still use barcode scanners to make inventory tracking more efficient. Instead of syncing with your inventory software, the barcode scanner will send a string of data to whichever computer or mobile device the scanner is connected to, essentially turning your scanner into an input device. This method is less efficient than inventory management software that automatically recognizes scanned data and updates inventory information accordingly. Still, it is far more efficient and accurate than manually typing data strings into a spreadsheet.

5. Audit your inventory tracking on a regular basis

Unfortunately, inventory tracking isn't a "set it and forget it" enterprise. It's important to regularly (monthly or quarterly) shake down your inventory tracking system to weed out inefficiencies, double-check for accuracy, and find areas for improvement.

As you learn to track stock inventory, you'll soon discover that setting reorder points at the right time is critical. Failure to reorder at the right time can lead to stockouts (items are out of stock when customers want to buy them) or incur inventory holding costs (a liability on your business's balance sheet accounting for depreciation, storage rent, and other expenses).

To avoid these problems, strive to track inventory in the most accurate way possible. Updated and correct inventory data can guide you to find the reorder points appropriate for your business.

Analyze your inventory turnover rate, sales history data, and customer demand forecasts to gain insight into setting reorder points. Look for patterns in turnover and sales—such as peaks and dips in demand—to pinpoint a reorder cycle that avoids stockouts and holding costs.

Even if you're a small-business retailer, you need something to help you manage and track your physical inventory. But that solution is most likely not an inventory management system. Why? In almost every scenario, you'll be better served by a retail point-of-sale system with built-in inventory management and tracking.

A system like this will track and update your inventory in real time each time a customer purchases. (And if you exclusively sell your products online, look for an eCommerce solution with built-in inventory management and inventory tracking.)

If your current retail POS system or eCommerce tool is failing to meet your inventory management needs, you most likely need a more robust software system rather than adding a standalone inventory management system and trying to get it to work with your POS. This is why standalone inventory management software best suits distributors and parts suppliers.

Ultimately, the best way to track inventory will likely be industry-specific. To illustrate this point, here are inventory management strategies commonly used in different types of businesses:

Restaurant inventory management

The perishable nature of many stock items (food, liquor, other beverages, spices, dry goods, etc.) drives inventory management in the restaurant business. Then, there are non-food and beverage items such as cooking equipment, uniforms, and table linens. Given the differing storage requirements and turnover rates, most restaurants use a category-based approach to inventory management.

Track food and beverage items using additional criteria such as a unit of measurement, unit price, and total cost This detailed approach helps restaurant owners better calculate profit margins on specific items and determine how long each item can sit in inventory. Since some items will expire sooner than others, they may need different reorder points than others.

Online store inventory management

Online stores may maintain very little inventory depending on the products they sell. Instead, they might employ the just-in-time (JIT) inventory management technique. With the JIT approach, the business only stocks a product when a customer orders it. Therefore, inventory the number of orders for any given product impacts inventory levels.

The JIT method is prone to disruptions due to natural disasters, supply chain issues, labor strikes, and other unforeseen events. Therefore, some eCommerce retailers choose "first in, first out" (FIFO) inventory management instead. With FIFO, the first products the warehouse receives are the first shipped out to end users. This approach strikes a balance between the JIT philosophy and maintaining excessive amounts of stock.

Seasonal business inventory management

As you might expect, inventory tracking for a seasonal business is influenced by the time of the year. Owners can deploy multiple strategies, depending on the nature of the products and how long they can reasonably sit in inventory.

Seasonal businesses rely on accurate historical sales data to predict the inventory levels needed for each season more accurately. Accurate demand forecasting is important to avoid stock shortages or excess inventory.

No matter which type of business you operate, your industry, or your inventory management strategy, there are three key metrics you must track for effective inventory control:

Turnover rate

Inventory turnover is the rate at which stock is sold, used, and replenished. It's calculated by dividing your business's COGS (cost of goods sold) by the average value of the inventory. This ratio shows how often inventory is turned over in a given period.

Stockout rate

The stockout rate measures the percentage of times a customer wants to buy an out-of-stock product. To calculate your stockout rate, divide the number of stockout events by your total sales number and multiply by 100.

For example, if you had 10 stockouts in a period with 500 sales, you would divide 10 by 500, which is 0.02. Now multiply by 100 to arrive at a stockout rate of 2%. The lower the stockout rate, the better.

Holding costs

Holding costs are the expenses your business incurs to keep an item in inventory. As each business is different, calculating holding costs will depend on your inventory management strategy and related expenses.

However, you can start with a general holding costs formula. First, add your storage costs (rent, utilities, etc.), inventory depreciation, employee wages, and opportunity costs. Divide this number by the total value of your inventory on an annual basis. When converted to a percentage, the resulting figure is your holding costs. Again, a lower figure is better.

Every business must track inventory, analyze inventory turnover rates and other figures, and form a tailored strategy. What works for your business may not work for others. You may choose a manual approach or a sophisticated real-time system. However, key metrics like turnover rate, stockout rate, and holding costs are important, regardless of your particular strategy for keeping track of inventory.

Ultimately, the best way to track inventory is the one that helps your company avoid stockouts and excessive holding costs. Following the lessons and examples in this guide, you can now find the approach that enables you to master the art of inventory management.