Inventory Planning: Definition, Benefits, Challenges And Best Practices

Poor inventory planning can have severe repercussions for business operations, such as delays in shipping orders and subsequent stockouts.

However, good inventory planning helps reduce costs, avoid losses, save time, and streamline your business’s supply chain. It allows you to meet your customer’s expectations and consistently increase your revenue. Regardless of your current business development, inventory planning is critical to your business’s sustainability and success. 

In this article, you’ll learn about the ins and outs of inventory planning, the challenges you may face in managing your inventory, and how to overcome them. We’ll also walk you through the most effective inventory management technologies and planning methods you need to know to keep your business humming.

What Is Inventory Planning?

Inventory planning is a business’s strategy for determining the ideal amount of inventory it needs and the corresponding timing of supplier orders. It aims to meet consumer demand and minimize internal costs. Inventory planning directly impacts an organization’s cash flow and profit margins and contributes to supply chain efficiency. 

There are several benefits associated with inventory planning. Therefore, business owners must consider their inventory planning to create business forecasts that determine the number of goods to be ordered to meet market demand on time. 

What Are The Benefits of Inventory Planning?

The costs associated with poor inventory planning will certainly impact a company’s bottom line. Retailers miss out on nearly $1 trillion in annual sales because they don’t have what customers want to buy in their stores.

Roughly 20% of all out-of-stocks go unresolved for more than three days. This can result in significant revenue losses for retailers and other product-based businesses. Other benefits of effective inventory planning include the following: 

More transparency

Inventory planning gives a company better control over stored and sold products, thereby significantly reducing the risk of employee theft and other inventory loss issues. Accurate inventory planning and tracking procedures also improve warehouse transparency and pinpoint staff members’ responsibilities. 

Ensures better cash flow

The cost of holding and storing inventory is staggering for retail owners. It can make up about 20-30% of total inventory expenses. Better inventory planning helps you manage your inventory budget more wisely. 

For example, when you order the optimal quantity of a product to meet future customer needs, you avoid excess inventory, which prevents tying up too much capital in inventory. Finally, inventory planning makes inventory accounting easier during tax season and simplifies accurate inventory reporting.

Higher profits

Inventory planning can help a company increase its profitability. The cost of producing and purchasing inventory significantly impacts gross profit. 

Proper inventory planning will increase a company’s gross profits. It will also prevent businesses from wasting capital on ordering, storing, and managing excess inventory. 

It will reduce associated expenditures such as labor wages, warehouse rent, transportation costs, and security expenses, resulting in a higher profit margin and more consistent revenues.

Improved customer satisfaction

Unexpected product shortages can undermine your business’ reputation and erode consumer loyalty. Whether it’s a physical store or an eCommerce business, a lack of consistently popular items can result in lost sales due to missed opportunities and disappointed consumers who are more likely to switch to competing brands.

What Are The Inventory Planning Models And Strategies?

Several inventory planning methods are available, each with its own advantages and disadvantages. These planning models are used depending on the needs of different types of businesses. They mainly deal with raw materials, partially finished products, and finished goods. 

Economic order quantity (EOQ) Model 

The economic order quantity is a formula used to determine the ideal amount of items a company should order to minimize inventory costs such as holding costs, shortage costs, and ordering costs, and maximize business value in the replenishment and ordering process. 

The EOQ formula is particularly well suited to situations where demand, ordering, and carrying costs remain constant. 

The EOQ model also allows you to determine the size of the production batch and the amount of work-in-progress that will be available for the next production step or delivery to the customer. It can also indicate how many orders will be booked in a year.

For example, let’s assume a retail shoe store sells women’s shoes. Each year the store sells 3000 pairs of shoes, and it costs $5 per year to keep one pair of shoes in stock. The fixed cost for the company to place an order is $50. Here’s how to calculate the EOQ.

EOQ = square root of 2 X D X S divided by the carrying cost

Q=EOQ units

D= Annual demand in units (3000)

S=Order/ Carrying cost ($50)

H=Holding costs ($5)

The EOQ formula is the square root of (2 x 3000 pairs x $50 order cost) / ($5 holding cost) or around 110. The ideal order size to minimize costs and meet customer demand for this retail business is just over 244 pairs of shoes.

Pros of EOQ

• Businesses can take advantage of supplier discounts when they know how much stock they will need to cover the year’s requirements. Buying wholesale can significantly reduce purchasing costs. 
• The economic order quantity reduces the cost of maintaining inventory with a specific recommendation for the annual order level.
• It balances inventory levels and provides a better understanding of how to manage and when to order inventory.

Cons of EOQ

• It is based on the assumption that the demand for a product is constant without considering economic and seasonal fluctuations.
• EOQ requires constant monitoring of inventory levels.
• The primary assumption is that the company is considered to be commercializing only one product since the formula does not consider the interactions between various products, such as complementary products.

Perpetual Inventory Model

The perpetual inventory model (also known as the continuous inventory system) is often used by companies dealing with partial or finished products. It continuously tracks inventory quantities, and replenishment orders are placed when the inventory reaches a certain threshold (the reorder point). 

The continuous inventory model works most effectively with a computer database called a point of sale (POS) system. The POS system provides better tracking of orders and inventory levels.

However, a key point to bear in mind is that while the stock levels in a perpetual inventory system are updated in real-time, you will still need to double-check your numbers through an occasional manual audit. The perpetual inventory method rules out theft, missing or damaged products, etc.

Perpetual Inventory System Pros

• It provides better replenishment decision-making with real-time knowledge of your inventory levels – you’ll know when you’ve reached your reorder points.
• Real-time sales data lets you know which products or items are selling well and which are not.
• Thanks to continuous updates, employees can quickly check if a product is in stock – an essential piece of information for same-day orders. The perpetual inventory system also facilitates a much simpler integration with an inventory optimizer or a price optimizer.
• The centralized system makes it easy to track inventory across multiple locations.

Perpetual Inventory System Cons

• If the recorded inventory does not match the actual inventory levels, the entire system is compromised.
• Human errors can occur if you enter information incorrectly.  

See the full list of differences in our full guide on perpetual inventory vs periodic inventory systems.

The Just-In-Time (JIT) Inventory Model 

A just-in-time inventory system keeps inventory low by producing only specific customer orders. The direct impact of this method is a significant reduction in inventory investment and scrap costs, even though a high level of coordination is required. 

The JIT inventory model differs from the common practice of switching to production or placing orders based on customer needs. With this inventory planning model, raw material and work-in-process demands are significantly reduced, while finished goods inventories should be close to non-existent.  

Just-In-Time Inventory Pros

The advantages of the just-in-time inventory method are as follows:

• Inventory should have low obsolescence, as the high inventory turnover rate prevents items from remaining in stock and becoming outdated.
• It is easier to cease production of a particular type of product due to very short production runs and switch to another product to meet changes in customer demand.
• Low holding costs due to very low inventory levels. 
• A low rate of excess inventory or damage to inventory within the company is not held long enough for problems to arise.

Just-in-time inventory cons

• A company may not be able to fulfill the need or requirement of a large and unexpected order immediately because it does not have enough inventory. 
• A business can be out of stock for days if the supplier does not deliver the items on time and in the right quantities. The direct impact would be a large loss of profit.  

Periodic Inventory System

This physical counting method measures inventory levels and the cost of goods sold (COGS). Inventory levels and cost of goods sold are refreshed at the end of a specific period (monthly or annually). The inventory quantity to be ordered is established based on what is on-hand and the expected demand.

The following is the cost of sales calculation for a periodic inventory system

Initial inventory balance + cost of inventory purchased ending cost of inventory = COGS.

Pros of Periodic Inventory

• Suitable for small business models
• Can be performed without complicated preparation
• Set the schedule according to business needs

Cons of Periodic Inventory

• Less accurate than the perpetual system, since the period of counting levels is longer, instead of in real-time
• When multiple accounts track sales, orders, holding, etc., periodic counting can be complex

What Are The Challenges of Inventory Planning?

Inventory planning can become increasingly challenging when a retail business or organization has multiple channels with multiple warehouses. Fluctuating demand and seasonality must also be considered. The main inventory planning challenge you will encounter is making sure your store has enough products in stock but not too many.

Inaccurate inventory tracking

Small businesses often start their inventory management with a manual tracking system. The small volume of inventory may make them think an automated system is unnecessary.

However, many owners don’t realize that manual inventory planning or the use of spreadsheets and paper are inefficient, time-consuming, and prone to human error. In addition, due to limited visibility in warehouses, identifying or locating your inventory can be challenging.

When you track inventory across multiple channels, you have sophisticated inventory management software to view the data in real-time. Knowing how much inventory you have on hand at any time of the year is necessary to keep budgets down and stay profitable.

The human factor

Technology is not the be-all and end-all, no matter if you use the best inventory management software. For companies with giant warehouses, inventory planning is controlled by an inventory planner. When this person is replaced by a new inventory planner, there is a lot of historical knowledge that must be passed on to the new person in charge. 

The new planner will not initially have the internal knowledge of the outgoing planner and may have difficulty grasping the historical reasoning underlying the current inventory management system. 

In addition, you need to make sure that your staff is appropriately trained to use the software. Poor staff training will negatively impact management and lead to calculation errors. In addition, poor communication between procurement, production, and quality control managers will ultimately affect your company’s performance. 

Poor inventory control

Excess inventory is just as damaging as a lack of stock in your store. Overstocking increases not only the cost of storage but also the space. If you are performing inventory reporting for a convenience store, the likelihood is high that you sell perishable items such as food, making it even more important to control your inventory effectively. 

Conversely, if your inventory levels are low, overselling and out-of-stock problems hurt customer satisfaction. Not knowing your exact inventory levels at any given time makes it difficult to plan how much inventory your business needs.

Facing fluctuations in demand

As a retailer, you must constantly deal with fluctuations in demand throughout the year. Increased customer orders are usually seen around the holidays, especially when you run promotions like Christmas marketing campaigns. Poor ordering strategies will impact your ability to meet these changing demands and even result in stock-outs. 

With a demand forecasting tool, retailers can project inventory management software into the future. These functions integrate with your accounting and sales data to help you anticipate demand and place orders based on changing customer needs, seasonal fluctuations, or product availability.

Inventory Planning Best Practices: How to Develop a Plan

Knowing the best practices and procedures is an essential part of inventory planning. This involves a mix of good human expertise, appropriate inventory management software, and good strategies. Here are some questions to ask yourself when establishing an inventory management plan.

Estimating product volume

When answering this question, review your historical data to determine seasonality, as well as trend data from tools like your inventory planning software or Google Trends. Make sure you do this before you plan any orders. 

You’ll be able to calculate your inventory requirements for regular off-peak sales and account for anticipated demand spikes. Figuring out your economic order quantity will help you pinpoint the optimal amount of inventory to hold at any given time and help you minimize total ordering and holding costs in the process.  

Evaluating factors affecting inventory

A key consideration is to stay ahead of any internal or external drivers that may influence consumer demand in the future. Keep in mind variables such as forthcoming advertising campaigns, sales promotions, target market, seasonal demand peaks, and current consumer trends. 

Elaborating the right key performance indicators

Ask yourself if you have been using metrics and key performance indicators (KPIs) optimally. These critical data sets in retail help organizations benchmark the success of their inventory planning to date. Check to ensure that your inventory plan takes into account the key factors and variables below:

• Inventory turnover
• Forecast accuracy 
• Daily sales
• Customer satisfaction 
• Storage capacity usage 
• Carrying cost of sales  
• Orders delayed by stockouts 
• Movement of inventory 

Put efficiency first

Efficiency is the cornerstone of inventory planning. You should ask yourself if your warehouse and ordering process is set for optimal performance. If not, what can you do to make it so? 

Consider well-organized storage spaces for convenient picking and retrieving, sufficient space for additional inventory (but not too much, so you don’t lose money), ideal warehouse locations for faster deliveries, and streamlined communications between inventory and order management teams. 

Introducing KORONA POS: The Best Retail Inventory Management Software

The choice of your retail inventory management system is critical to the success of your business. KORONA POS has an inventory management software system specifically tailored to the needs of retail businesses. It is constantly updated with new features, integrated according to the needs and issues encountered by retail businesses. 

Some of the features you can find with KORONA POS include:

• Inventory tracking and optimization
• Orders and invoicing
• Customer relationship management
• Reporting tools
• Shipment tracking
• Bar code
• Price lists
• Demand forecasting

KORONA POS inventory tracking software automatically detects and notifies you of any inventory issues and helps you prioritize products that are out of stock or selling less frequently. 

In our rapidly changing retail ecosystem, you need to be armed with a system that can enhance your operational agility and allow you to quickly adapt to any sudden market changes, stay competitive, and retain your customers in changing and turbulent markets. 

Frequently Asked Question: Inventory Planning