Chapter 2. What Are the Concepts of Inventory Management?

Welcome to Chapter 2 of Sellercloud’s inventory management guide. In this chapter, we will introduce you to the basics of inventory management.

We’ll list many of the most important inventory management terms and abbreviations, how inventory management fits into the supply chain, and how to set up inventory storage areas.

As a reminder, this is the second chapter of the guide, and as we progress, we’ll begin to cover more advanced topics.

If you know most of this guide already, feel free to jump ahead to Chapter 3 or any of the more advanced chapters from the guide home page. Likewise, if it’s too complicated, head back to Chapter 1.

Inventory Management Terms and Abbreviations

Let’s start by running through some of the most important and commonly used inventory management terms and abbreviations.

Note that there’s no need to try to remember them all now. Most of them will pop up again in later chapters of the guide, where they will make more sense.

Plus, you can always return to this page to brush up on any terms or abbreviations you may have forgotten.

• ABC Analysis—A method to categorize items based on their importance, allowing efficient allocation of resources. ABC analysis is also known as ‘Pareto analysis.’
• Aggregate Plans—Long-term plans that determine production, inventory, and workforce levels to meet demand and minimize costs.
• Agile Strategy—An approach that emphasizes flexibility and adaptability in achieving goals, often used in fast-paced and uncertain environments.
• Andon—A visual signal used in manufacturing to indicate a problem or need for assistance, promoting prompt action and problem-solving.
• Automated Storage and Retrieval Systems—Automates warehouse storage and retrieval, improving efficiency and reducing manual labor. Also referred to as ‘ASRS.’
• B2B—Stands for ‘business-to-business.’ If you are a B2B merchant, you sell products to other businesses.
• B2C—Stands for ‘business-to-consumer.’ If you are a B2C merchant, you sell products primarily to consumers.
• Backorder—An order for a product that cannot be fulfilled immediately due to insufficient stock and is scheduled for future delivery.
• Barcode—A machine-readable code for identification, encoding information that can be scanned electronically.
• Barcode Inventory System—A system that uses barcodes to track and manage inventory, improving accuracy and efficiency.
• Batching Rule—A guideline used to determine the quantity or size of items grouped for processing or transportation.
• Bill of Materials—A detailed list of components, parts, and raw materials required to produce a finished product.
• Bins—Containers or storage compartments used to organize and store items or materials.
• Break Bulk—The process of unloading, sorting, and distributing goods from large shipments into smaller units for transportation.
• Business Strategy—A plan or approach developed by a company to achieve its long-term goals and gain a competitive advantage.
• Cabinet—Drawers or shelves used for storage and organization of items.
• Capacity—The maximum output or workload a system, machine, or person can handle in a timeframe.
• Carrier—A company or entity that transports goods or people from one place to another, such as a shipping company or airline.
• Casual Forecast—A forecasting method that identifies cause-and-effect relationships between variables to predict future outcomes.
• Closed Loop MRP—A manufacturing resource planning system that uses feedback to continuously update and adjust production plans. See Material Requirements Planning below for a definition of MRP.
• Co-managed Inventory—An inventory management approach where suppliers and customers collaborate to monitor and replenish stock levels.
• Consumables—Items or materials used up or depleted during production and need regular replenishment.
• Control System—A set of processes and mechanisms designed to regulate, manage, or manipulate the behavior of a system or process.
• Cost of Goods Sold—The direct expenses incurred in producing or acquiring goods sold by a company during a specific period. Also referred to as ‘COGS.’
• Cross-docking—A practice where incoming goods are directly transferred from inbound transportation to outbound transportation with minimal or no storage.
• Customer—An individual or organization that purchases goods from a business.
• Demand—The quantity of a product that customers can purchase within a specific period.
• Destock—The process of reducing or eliminating excess inventory by selling or disposing of products.
• Dynamic storage—A flexible storage method that efficiently allocates space based on changing inventory needs.
• Economic Order Quantity—The optimal order quantity that minimizes total inventory costs by balancing ordering and holding costs. Often shortened to ‘EOQ.’
• Electronic Data Interchange—The electronic exchange of business documents, such as orders and invoices, between trading partners in a standardized format. Often shorted to ‘EDI.’
• Extended Storage—Additional storage space utilized when regular storage capacity is insufficient to accommodate inventory or goods.
• Fast moving—Refers to products with a high sales and turnover rate, often requiring frequent restocking or replenishment.
• Fulfilled By Amazon—A service offered by Amazon where the company handles order fulfillment, storage, and shipping on behalf of third-party sellers. Usually shortened to ‘FBA.’
• Fulfilled By Merchant—A fulfillment method where sellers handle the entire order fulfillment process, including storage, packaging, and shipping. Usually shortened to ‘FBM.’
• First-In-First-Out—An inventory management method where the items received or produced first are the first to be used or sold, minimizing inventory obsolescence. Usually shortened to ‘FIFO.’
• Forecast—A prediction or estimation of future events, such as sales, demand, or market trends.
• Forecast Value—The accuracy or usefulness of a forecast in guiding decision-making and planning.
• Forklift—An industrial vehicle for lifting and moving heavy materials and pallets within warehouses or distribution centers.
• Holding Cost—The expenses of storing and maintaining inventory, including warehousing, handling, insurance, and obsolescence.
• Information System—A system that collects, processes, stores, and disseminates information to support decision-making and business operations.
• Inventory Control System—A system that manages and regulates inventory levels, ensuring optimal stock levels and minimizing stockouts.
• Inventory Management Software/System—Tools used to track, control, manage, and optimize inventory levels and stock movement.
• Inventory Tracking System—A system that monitors and records the movement and location of inventory items in real-time.
• Inventory Turnover Ratio—A measure of how efficiently inventory is managed, calculated as the ratio of cost of goods sold to average inventory value.
• Item—A distinct unit or product managed, tracked, or sold individually within an inventory or supply chain context.
• Item Coding—The process of assigning unique codes or identifiers to items for efficient identification, tracking, and management.
• Judgmental Forecasting—Forecasting that relies on opinions or qualitative analysis and is best used when you lack any historical data to analyze. Also known as ‘qualitative forecasting.’
• Kitting—Assembling and packaging separate items or components as a single unit or kit.
• Lead Time—The duration between placing an order and receiving the goods, encompassing processing, production, and transportation time.
• Last-In-First-Out—An inventory management method where the items received or produced most recently are the first to be used or sold, often used for cost accounting purposes. Usually shortened to ‘LIFO,’ it is the opposite of FIFO.
• Lost Sales—The sales or revenue that could not be generated due to the unavailability of a product or failure to fulfill customer demand.
• Lot Sizing—Determining the number of items or materials to be produced or ordered in each production or procurement batch.
• Mass Customization—The ability to produce customized products at a large scale by leveraging flexible manufacturing processes and technologies.
• Master Schedule—A detailed plan that specifies the production schedule and quantities of each item to be manufactured within a specific timeframe.
• Material—Any physical substance or component used in the production or assembly of goods.
• Material Requirements Planning—A system that calculates the quantities and timing of materials needed for production based on demand and inventory levels. Often shortened to ‘MRP.’
• Mean Error—The average difference between forecasted and actual values, indicating forecasting accuracy.
• Order—A request or instruction to purchase goods or services.
• Out of Stock—When a product is temporarily unavailable or depleted in inventory, preventing immediate fulfillment of customer orders. You may also see this term shortened to ‘OOO.’
• Outsourcing—Contracting or delegating specific business functions or processes to external third-party vendors or service providers.
• Packaging—The materials and design used to wrap, protect, and present products for storage, transportation, and sale.
• Pallet Racking—Storage systems composed of racks or shelves designed to hold palletized goods, enabling efficient use of vertical space in warehouses or distribution centers.
• Parts List—A detailed inventory of all the components and parts required to assemble or manufacture a product.
• Periodic Inventory System—An inventory system that involves physically counting and reconciling inventory regularly.
• Perpetual Inventory System—A system that continuously tracks and updates inventory levels in real-time for accurate stock control.
• Picking—The process of selecting and gathering items from inventory to fulfill customer orders or replenish stock.
• Pipeline Stock—Inventory in transit between different locations or stages of the supply chain.
• Price—The amount of money or value assigned to a product or service in exchange for its purchase or use.
• Projective Forecast—A forecast based on future expectations and assumptions, often used for long-term planning and decision-making.
• Purchase Order—A document issued by a buyer to a supplier indicating the items, quantities, and terms agreed upon for purchase.
• Quick Response—A strategy aimed at rapidly fulfilling customer demands by reducing lead times and improving responsiveness in the supply chain.
• Replenishment—Resupplying or restocking inventory to maintain desired stock levels.
• Replenishment Rate—The speed or frequency at which inventory is replenished, often measured by the number of replenishment cycles within a given period.
• Return—When a customer sends a purchased item back to the seller or retailer for various reasons, such as defects, dissatisfaction, or exchange.
• Return Merchandise Authorization—An authorization or approval issued by a seller to a customer, allowing the return of merchandise and initiating the return process. Often shortened to ‘RMA.’ Other similar phrases include Return Authorization (RA) and Return Goods Authorization (RGA).
• Safety Stock—Extra inventory held as a buffer to protect against uncertainties in demand, supply, or lead times.
• Scientific Inventory Control—Using data analysis and statistical methods to optimize inventory management and control.
• Seasonal Stock—Inventory specifically acquired or held to meet increased demand during certain periods or seasons.
• Serial Number—A unique identifier assigned to an individual item or product for identification, tracking, and traceability.
• Shelving Units—Structures or systems with shelves for storing and organizing items or materials.
• Shortage—A situation where the quantity of a product or inventory falls below the desired or required level.
• Slow moving—Refers to products with low sales velocity or demand, resulting in longer inventory holding periods.
• Static Storage—Fixed or permanent storage space for inventory, where items are stored in predetermined locations.
• Stock Inventory Management—Effectively controlling and overseeing stock levels to meet customer demand and minimize costs.
• Stock Keeping Unit—A unique code or identifier assigned to a specific product or item for inventory tracking and management. More commonly referred to as an ‘SKU.’
• Stockout—A situation where a requested product or item is unavailable in inventory, resulting in unfulfilled customer demand.
• Stocktaking—The process of physically counting and verifying the number of items in inventory to ensure accuracy.
• Supplier—A company or entity that provides goods or services to another company or organization.
• Supply Chain—The activities involved in producing, distributing, and delivering goods to customers.
• Target Stock Level—The desired or optimal quantity of inventory to be maintained to meet customer demand while minimizing costs.
• Time Series—A collection of data points recorded over time, used for analyzing patterns, trends, and forecasting.
• Trolley—A mobile cart or platform with wheels for transporting items or materials within a facility.
• Two-bin System—An inventory control method where items are stored in two bins, one bin in use and the other replenished.
• Unit—A single, individual item or entity treated as a distinct and separate entity within the inventory or supply chain.
• Unitization—The process of consolidating individual items into larger units or groups for more efficient handling, storage, and transportation.
• Universal Product Code—A standardized barcode for product identification and inventory tracking in retail and supply chain operations. Often shortened to ‘UPC.’
• Vendor—A supplier, manufacturer, or distributor from whom goods or services are procured or obtained.
• Vendor-managed Inventory—An inventory management approach where the supplier monitors and replenishes inventory levels at the customer’s location. Shortened to ‘VMI.’
• Warehouse—A facility or building for storing, handling, and distributing goods or materials.
• Warehouse Inventory Management—The process of efficiently organizing, storing, and tracking inventory within a warehouse facility.
• Warehouse Inventory Management Software/System—Software and/or technology that helps automate and optimize the storage and tracking of goods in a warehouse, including inventory tracking, picking, and shipping. Shortened to ‘WMS.’
• Walmart Fulfillment Services—A service offered by Walmart that provides order fulfillment and logistics support to third-party sellers on the Walmart marketplace. Shortened to ‘WFS.’
• Work in Process/Progress—Inventory or goods that are currently in the production or manufacturing process but are not yet completed. Can be shortened to ‘WIP.’
• 80/20 Rule—A principle that approximately 80% of the effects come from 20% of the causes, often applied to prioritize efforts and resources based on impact.

You can also check out Sellercloud’s 53 essential e-commerce acronyms if you want to master every term related to e-commerce. (But remember to come back and finish the guide.)

How Is Inventory Management Important to the Supply Chain?

To fully grasp how important inventory management is, you must understand how it fits within the supply chain and impacts processes before and after stock sits in your warehouse.

First and foremost, what do we mean when we say ‘supply chain’? The supply chain is the journey the product takes from where it’s made to where it is sold.

Most products will follow a similar supply chain: Supplier (Manufacturer or Vendor) → Seller → Carriers and Logistics → Customer.

Inventory management is between both ends of the chain—the supplier before and logistics and carriers after, leading to the customer at the other end.

Poor inventory management on the seller’s end can disrupt the flow of the entire supply chain, while optimizing inventory management will make operations significantly smoother.

Let’s look at how a seller’s inventory management skills impact different areas of the supply chain.

The Supplier

For the manufacturer or vendor—whom you buy your products from—if you have a poor handle on your inventory, it can make it difficult for them to forecast how much they need to produce.

They can easily end up with insufficient stock, which means they’re missing out on sales, or far too much stock, which is costly to store. Suppliers must know how much to produce to optimize their resources and manage costs.

Furthermore, disorganized sellers may send erratic and vastly different orders to suppliers (or last-minute changes), leading to cash flow problems.

A seller’s poor inventory management skills can lead to stockouts or excess inventory, resulting in late payments to suppliers, which is risky for their business.

If these problems persist and frustrate your supplier, they may raise their prices or not give preferential treatment, impacting your bottom line.

And if worst comes to worst, they may no longer want to work with the seller. The seller will then need to find another supplier, and word may spread that your company is difficult to work with.

The Carrier and Logistical Solutions

For the carrier who delivers the products you sell to the customer, poor inventory management can mean a wide range of costly inefficiencies, which can sour your partnership.

What may seem like a small and innocent mistake can become a much larger issue further down the line. 

Unexpected changes to orders and incorrect information, such as quantity, size, and weight, can impact the transport carriers have available.

Suppose carriers unexpectedly have to hold your stock at their fulfillment centers.

In that case, it can cost them in storage space, and handling your company’s returns/reverse shipments because of a mistake is also costly.

Again, if the problems persist, carriers may want to alter their relationship with the seller, which could mean higher premiums or end their relationships with the seller.

The Customer

Lastly and perhaps most importantly (as it’s where the money comes from), let’s look at how poor inventory management affects customers.

If your products are always out of stock, customers will simply shop elsewhere, and over time, they may develop a habit of shopping with other sellers.

More often than not, bad inventory management means sending the wrong product to customers.

Sometimes the order can be entirely wrong. Other times, sellers may send the wrong variation or miss one or two items in orders of multiple products.

In more frustrating situations, you could sell a reserved product to someone else.

Or, if you are not dedicating space for returned items, you may even accidentally send a product that needs to be repaired to a different customer.

If there are issues with locating an order within your inventory, it can take longer for a product to reach the customer.

All of the above can infuriate customers, who will stop shopping with you, leave negative reviews, and advise others to avoid you. Again, harming your bottom line.

So, now that we’ve seen how proper inventory management impacts a merchant’s relationship with other supply chain components, let’s look at how beginners should take their first steps.

What Is the First Step of Inventory Management?

Tricky question because it depends on if this is the first time you or your company has had to manage inventory before.

You might already be taking orders and unsure if you’re doing everything right, or maybe the company is new, and you’ve just got hold of storage space, or you’re relocating from one warehouse to another.

The point is you might already know a few things, and some things might already be in place to manage your inventory.

Your degree of readiness can differ in different areas, which changes what steps you should take next.

Many inventory management pros will argue that the first thing you must do, no matter what stage you are at, is implement inventory management software so you can track your inventory.

It can be a massive mistake not to have a tool like this early on, as it can help mitigate many of the supply chain issues outlined above.

(Though we will say that these systems can be rather complex and very different depending on your needs. We will dig deeper into them later in the guide.)

A great example of an inventory management system is us—Sellercloud—we utilize hundreds of integrations to help sellers manage inventory-related tasks all from one interface.

If you’re not very experienced in inventory management, it might be too early to start managing your inventory with such software.

You might be a very small business, perhaps working from your bedroom or garage, and purchasing such software may feel out of the question at this point.

If you don’t use a system (yet), for your first steps into inventory management, you can still do an ‘audit’ or ‘stocktake’ to see what you have.

Record all your products, their state and varieties, SKU (Stock Keeping Unit), description, location, unit cost, and whatever else might be important to shipping the product.

You can then compare this information with what you already have recorded to ensure that everything is correct.

Next, you can use this information to decide whether to replenish some stock or solve stock-related issues.

That aside, it’s also important to understand early on that the larger your operations become, the more complex they become.

This is often why companies need to use multiple solutions to reduce the workload of their operations before they become overwhelmed.

The basics can be rather simple, but the larger you get, the more technical they can become.

So, while small businesses may be able to get away with not using a software solution now, further down the road, they will struggle to succeed without one.

How to Set Up Inventory Storage Areas?

One of the more practical steps you may or may not have taken is setting up your storage areas.

Though it may seem obvious, there’s a lot to consider to make storage areas practical for inventory management and, on a pragmatic level, comes before adopting any software.

The first thing you need to know is how much inventory space you have, both in floor space and volume.

This will inform you of any size limitations to consider, which is particularly important when starting in a new warehouse.

It is also helpful to know the dimensions of the products you will be selling, as you can then calculate the amount you can store.

Remember to account for space between products too. Fitting products tightly together as if they were bricks is called ‘overutilizing,’ and it can be dangerous and impractical.

Your scheme also needs to reserve space for certain tasks in the inventory management process—don’t consider all your available space a dumping ground for stock.

For example, you’ll need storage space preparing products for shipment and packaging items together, like kitting, which requires assembly tables and workbenches.

You also need to dedicate space for equipment. Consider if you’ll need the following:

• Trolleys.
• Forklifts.
• Pallet racking.
• Shelving units.
• Bins.
• Cabinets.
• Specialized storage systems such as mezzanines or ASRS.

On top of those, you may need a computer with software to help you manage your inventory.

Another thing to consider is seasonality—do you sell more products (or a certain product) more frequently during a certain time of the year?

For example, if you operate a ski shop, you’ll probably sell more products around winter than in summer.

This kind of storage is called ‘extended storage.’ You will have to reserve space for this kind of inventory, which you’ll move into rotation at a certain time of the year.

Ultimately, no two businesses have the same requirements when planning inventory storage, so account for your own needs.

Before you know it, what you think is a very large space is cut down into defined areas.

Creating a Floor Plan

After you’ve made a list of everything your plan needs to consider and made the appropriate measurements, you should create a simple floor plan.

It should focus on making your storage areas practical and easy to navigate with aisles, shelves, and racks, accounting for space to move between aisles.

A floor plan can help you outline zones for different product types and if they are fast or slow-moving (if they sell quickly or slowly).

Depending on your business, you may need to reserve areas for hazardous or fragile products or with specific storage requirements (such as temperature).

The size and sometimes the shape of products should also be considered as they affect accessibility to products.

If you’re lucky, you’ll have a conventional space to work with. If not, assigning practically sized zones can be a lot more challenging.

Further to that, you should have a space for newly received products to wait before they are processed and added to the rest of your stock.

If you have two entrances, you can dedicate one to receiving and the other to dispatching, preventing confusion and speeding up the flow of inventory.

You also need aisles to move people and things around and reach items ergonomically and quickly without risking an accident.

Be sure to check them yourself to be sure you are not creating difficult working conditions that could slow down your employees.

You also need to consider where products and equipment are in relation to each other and the flow of products through your warehouse, which can be determined by the shape of the space you have available.

Decide if you want to dedicate areas for the following:

• Receiving stock—It stays there until it can be processed and join the rest of the stock.
• Static and dynamic storage—Ideally, dynamic storage should take up more space and run between receiving and shipping areas.
• Dispatch—Items that have been picked, prepared, and must be shipped.

Last but not least, consider safety regulations! They’re in place for a reason, and you don’t want to fail an inspection!

Implementing a Classification System

Setting up inventory storage is pointless if you have not yet decided on a classification system that will work in collaboration.

This classification system should be something that works for you and your team and something you can consistently follow so it’s easy to figure out where products are stored.

If you fail to devise such a system, it will be easy to lose track of products and orders, and all sorts of issues can arise.

Firstly, you must consider what products should be stored next to each other.

You may decide on products of the same type, or it may also be practical to keep products often sold together next to each other for easier picking.

A common way to classify products is alphabetically by brand or product name. Again, though, it depends on what makes more sense for your business.

For example, let’s pretend we’re selling clothing.

Rack for the product category (shirts), shelf for a niche of the product category, products arranged alphabetically (by brand), then further by color.

A vital thing to consider when classifying products is the flow of inventory as it comes in and out of your warehouse.

Ideally, products that sell faster should be easier to pick, while slower products should be reserved to the sides so they don’t get in the way.

Organizing how your inventory is ordered makes it far easier for staff to pick and replenish products when you follow it consistently.

That means you’ll need to train employees on how your system works to keep it functioning, or it’ll fall apart.

Don’t be surprised if you soon learn your inventory could be better organized or more practical—you’ll learn this as you go on.

You can’t always be sure of your requirements until you start working with the system you’ve implemented, so be sure to accept feedback to continuously improve how your inventory is stored.

Key Points From Chapter 2

Here are the most important points to remember from Chapter 2.

• There are a wide variety of terms associated with inventory management. You will learn them all as you progress through this guide.
• Poor inventory management can impact a company’s partnerships with suppliers and carriers and customer experience.
• Your first steps into inventory management depend on your degree of readiness—you may have already taken a few steps and are aware of some basic principles.
• Creating a floor plan and setting up storage areas is an early practical step for inventory management, but there’s a lot to consider, such as equipment and how quickly products are sold.
• While utilizing software to streamline inventory management is important, you must focus on correctly classifying your inventory.