Inventory Optimization for Small Business

When analyzing a balance sheet, pay careful attention to the inventory figures. What accounting method is used to track the inventory? How does inventory compare to competitors? Are there are significant changes in the relative percentage of assets made up by inventory over recent years?
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As the marketplace expands and goods become available from every corner of the globe, inventory management is becoming increasingly complex. Managers are required to manage and track goods coming in from diverse locations via different transport methods. Without a strategy that includes structured methodology and ongoing data analysis, it’s a nearly impossible task.

What Is Inventory Optimization?

In the simplest terms, inventory optimization is a collection of strategies designed to deliver the right amount of product at the right time for the lowest possible cost; delivering the optimal balance between supply and demand. Businesses operating without an inventory optimization plan are at risk of overspending and underperforming.

The goal of an inventory optimization strategy is to maintain a steady flow of inventory, eliminate out-of-stock situations, mitigate loss and risk, while boosting profits via improved efficiency and lower inventory costs.

How Inventory Optimization Cuts Business Costs

Both overstock and understock items are an issue in any business. For manufacturers and construction, for example, delays in raw material delivery can result in huge losses, as projects are delayed and work crews sit on their hands while waiting for materials to work with. Meanwhile, other materials that arrived on time can’t be used and you wind up paying for storage space.

In the past, businesses with a healthy bottom line typically overstocked critical items, and some of them went to waste as a result. For a small business, any wasted money or time is unacceptable.

Strategies for Inventory Optimization

  1. Plan Just-in-Time delivery. JIT delivery is part of a purchasing strategy that requires extensive knowledge of your needs and your suppliers. The trick is to have supplies delivered exactly when you need them, cutting down on warehousing and mitigating loss.
  2. Consider alternative warehousing. Some small businesses have turned to cost-effective warehousing solutions, such as shared warehouses where their inventory space is leased on demand from a vendor as needed.
  3. Have a supply chain disruption strategy. Supply chain disruptions are increasingly common, and at some point, every business will have to deal with the loss of product due to storms or other natural disasters, geopolitical issues, or tragedies, like that time a shipment of 28,800 rubber duckies fell off a container ship.
  4. Know your vendors. Thoroughly vet vendors to assess their reliability, charges, shipping methods, and capabilities. Use something the big businesses can’t: the human touch. With online ordering, vendor relationships have become increasingly impersonal. While it’s efficient to order online, friendly personal relationships still have perks. Friendly contacts will keep you in the loop about what’s going on, alert you to bargains, and bend over backward when you need extra help.
  5. Incentivize your staff. Ideas can come from anywhere. Offer incentives for staffers to find new ways to help you save money.
  6. Monitor your inventory and P&L frequently. Annual reviews are not sufficient. If your business is struggling, you need to know now, and today’s tools make monitoring inventory, sales, and trends a snap. If you can run a report in seconds, why wouldn’t you?
  7. Base decisions on business intelligence. Use predictive data analysis to inform decisions. Business intelligence software can show buying habits, trends, inefficiencies in your supply chain, and other areas where you can improve processes, cut costs, and spot problems.
  8. Use the FIFO approach (first in, first out). To prevent loss from aging and damage, goods should be used or sold in the order they arrived. This is especially important for perishable and trendy items, like food and seasonal goods. FIFO cuts costs by reducing spoilage and dead stock.
  9. Implement inventory management software. Modern inventory software comes with real-time sales analytics recorded in real time. With a good inventory system, you can know exactly what you have in stock at all times, and track sales trends as they happen.
  10. Use the ABC method. By classifying goods into A, B, and C categories, you can better allocate resources:
  11. A-category items are big-ticket items. They usually makeup about 10% to 20% of your total inventory and have the highest ROI.
  12. B-category items are mid-priced items that make up about 30% of the inventory and move at a steady pace.
  13. C-category items are the least expensive items that move the fastest, like candy bars at the grocery store cash register. These items makeup 50% of your inventory and have the lowest markup.

Does My Business Need Inventory Optimization?

The simple truth is that inventory optimization works for all but the simplest supply chains. Here are a few questions to help you determine whether the outcome is worth the effort:

  • Would reducing total inventory by 10% or more make a difference?
  • Would you like to provide better service without increasing inventory costs?
  • Do you run out of popular products and have to put old items on sale?
  • Would you like to launch new products more frequently or cost effectively?
  • Would you save money by sourcing raw materials or finished goods from overseas?
  • Should you update inventory targets more frequently than once a year?
  • Do you order goods and services from a variety of suppliers?
  • Do you have a plan in place if your supply chain fails?

If you answered yes to any of these questions, your business will most likely benefit from an inventory optimization strategy.

Article Sources

  1. Kanban Logistics. "The Role of the JIT Delivery System in Manufacturing Logistics," Accessed Oct. 10, 2019.


  2. NPR. "'Moby-Duck': When 28,800 Bath Toys Are Lost at Sea," Accessed Oct. 10, 2019.


  3. Lokad Quantitative Supply Chain. "ABC Analysis (Inventory)," Accessed Oct. 10, 2019.