Overstocking and understocking are two problems that product-based businesses face. These problems can be especially challenging for new businesses who are just getting started and have not had time to gather much data, get to know their customer base, or go through many seasonal cycles yet. We’ve compiled a quick guide including valuable information about common inventory management pitfalls of overstocking and understocking and how to avoid them.

What is inventory overstocking?

In simplest terms, inventory overstocking is when a retail business purchases too much inventory.

Overstocking is a common issue for many small businesses, especially in the beginning stages of growth. A lack of proper planning and proper analytics can lead to overstocking.

It can be tempting to purchase large amounts of inventory in hopes of making more profit. Likewise, it is easy to accidentally purchase more inventory than you actually have a demand for, especially when you are still learning what your customers want and need. However, overstocking can hurt your company’s cash flow and profit margins and should be avoided.

What is inventory understocking?

On the other hand, inventory understocking is when a retail business fails to purchase enough inventory to keep up with demand. It is especially common in businesses with high seasonal fluctuations and new businesses who are still learning the demands of their customer base.

Understocking may be a company-wide issue, or it may apply only to a few best-selling products that just seem to keep flying off the shelves. While not a bad problem to have, you may be missing out on potential profits and hurting your company’s reputation if the products your customers want are routinely out of stock.

Key differences between overstocking and understocking

While both overstocking and understocking result from a failure to plan, there are some key differences in how they affect your company’s bottom line.

Overstocking can put a stress on your warehousing capabilities, leave you stuck with oversupply that must be sold off, and takes away funding from other areas of your business such as marketing or staffing.

On the other hand, understocking leaves money on the table in the form of missed sales, eating into your company’s revenue and profits. Even if you choose to fulfill those transactions as backorders, it can put a strain on your business.

The good news is that both of these common inventory issues can be addressed with proper planning, data, and inventory management.

Causes of overstocking and understocks

Here are the most common causes of inventory issues such as overstocking and understocking:

• Reliance on emotions over data: Although starting a new product-based business can be exciting, you must make your business decisions based on facts and not emotions. If the product you thought would be a best-seller turns out to be a dud, cut your losses and move on. Businesses make mistakes when they fail to account for the numbers.
  

• Failure to collect data: Of course, you can’t make business decisions based on data if you aren’t gathering any. Inventory analytics is key to understanding why your business performs the way it does. Likewise, it is equally important to identify your target audience and know what their product demands and expectations are. Lastly, all retail companies should stay up to date with current market conditions and industry trends.
  

• Failure to innovate: Not keeping up with technology can lead to gaps in inventory visibility and decrease the efficiency of your inventory management systems. For example, if you are still maintaining paper records, you are likely missing out on an opportunity to streamline your operations and save both time and money on your inventory management. The right technology can be especially helpful for eCommerce companies who often have to monitor inventory remotely across multiple locations.
  

• Failure to forecast: Likewise, demand forecasting software can help you make the right inventory calculations. This is especially helpful if your company is just starting out and doesn’t have much historical sales data to go by yet. While even the best forecasting is still a prediction of future demand, it is still far better than a random shot in the dark.
  

• Failure to account for seasonality: Seasonality can lead to some of the biggest gaps in inventory management if you don’t anticipate these drops or increases in demand. For example, if you own a sports & outdoor business, you probably won’t need to order as much camping gear in the winter or snowboarding gear in the spring. Keeping these seasonal fluctuations in mind can help your company avoid common inventory pitfalls.

Tips to minimizing inventory overstocks and understocks

With the proper inventory management system, businesses can avoid costly mistakes when it comes to ordering and maintaining the proper amount of product in stock.

• Ensuring you have the right systems in place: Whether you handle your company’s inventory in-house or through third-party fulfillment or logistics companies, it is important to maintain a cost effective inventory management system that accounts for shipping speed, customer service, staffing, efficiency, accuracy, and quality. If your current system isn’t quite cutting it – don’t be afraid to jump ship and find one that will.

• Performing inventory audits on a regular basis: Even the best performing business can always improve, and inventory audits can help ensure your company is operating at its highest potential. Undergoing regular inventory audits helps to ensure accurate data, identify areas of shrinkage, and give you a better understanding of inventory flow.

• Accurate data collection: Without data, your business is flying blind. We’ve compiled an article on the top inventory management KPIs your business should be tracking here.

• Inventory management software: Inventory management software helps increase your company’s visibility into your available inventory, especially if you are using third-party warehousing and order fulfillment services. With the right software, you can track your available inventory from anywhere in the world with just the click of a button.

• Use the ABC method: ABC analysis classifies and prioritizes your inventory into 3 key categories: (A) high-value products with low sales volume, (B) moderate-value products with moderate sales volume, and (C) low-value products with a high sales volume. Taking the time to use this system will both boost efficiency and save you money. For example, using ABC analysis can help companies understand which products need to be ordered the most often, and which big-ticket items you should avoid overstocking.

How Kickfurther can help

Inventory challenges are real, and they go beyond just overstocking and understocking. Oftentimes, inventory levels are a direct result of funding. Small businesses may struggle to get the funding they need at a price they can afford. Determined to succeed, they know they must find a way. For entrepreneur Sean De Clerq, the way to succeed was to create Kickfurther.. Kickfurther is the world’s first online inventory financing platform that enables companies to access funds they were unable to acquire through traditional sources. 

So how does it work?

Kickfurther has companies start by creating a profile. Next, we connect brands to a community of eager buyers who help fund the inventory on consignment and give brands the flexibility to pay that back as they receive cash from their sales. Flexible repayment schedules alleviate cash flow challenges that are often made worse by traditional lenders. Small businesses can take advantage of flexible repayment schedules by allowing the brand to scale quickly without impeding your ability to maintain inventory. To qualify for funding through Kickfurther, brands must sell physical products or non-perishable consumables. In addition, brands must have revenue between $400k to $15mm over the last 12 months. Our average funding amount is $78,000, but businesses can fund up to $5MM to manufacture new inventory or get reimbursed for current stock.

Closing thoughts

No matter how your company chooses to maintain its inventory, business owners must keep in mind the various aspects of inventory management including how to avoid overstocks and understocks, how to account for seasonality, how to gather data about your inventory, and how often to order more inventory. Furthermore, they must ensure they have the funding to stock the appropriate amount of inventory without taking away from other parts of the business. By freeing up cash flow, hopefully you have more money to invest in other critical areas of operation. 

Interested in getting funded on Kickfurther? Create a free business account today to get started!

Inventory is at the core of success for every product-based business. It’s what generates revenue, but it’s also what ties up most free cash. For product-based businesses to operate efficiently and maximize potential, they must have accurate inventory management systems and track KPI’s. Determining what this exactly means for your company can be challenging, but with a little bit of research and education we’re confident that you can make significant improvements.

What are KPIs in business inventory management?

KPI stands for “key performance indicator” and is exactly what it sounds like – a metric or data point that is a key indicator of your company’s performance and success.

If you operate a product-based business, most of your KPIs are going to be related to inventory management and maintaining products in stock. By measuring key aspects of your company’s inventory in real-time, you can make informed business decisions that will increase profitability and improve your bottom line.

How is inventory management measured?

There are many different KPIs that can be used to measure the success or failure of your current inventory management systems. Companies often use specialized software or companies who provide analytics services to help them keep an eye on this key business data.

The benefits of measuring your inventory management performance includes the ability to see how efficiently your company is moving products off the shelves and how your actual product sales compare to sales forecasts. Utilizing this data helps your company anticipate future business needs and pivot when needed, which translates to increased revenue and profitability.

We’ll cover the most common and most helpful inventory management KPIs in more detail in the next section.

Top inventory management KPIs your business should be tracking

Proper analytics is key to your future business success, especially when it comes to inventory management. Knowing and understanding your company’s relevant data and trends will help your business increase profitability, reduce expenses, manage cash flow, evaluate the need for financing, avoid understocking or overstocking, and account for seasonality.

Here are the top KPIs your retail or product-based business should be tracking:

• Product Sales: You may also see this KPI called “sales revenue.” It’s the revenue gained from customer purchases minus any returns, discounts, and other losses. This metric is typically tracked on a monthly, quarterly, or yearly basis. To calculate product sales use the following formula: Gross sales revenue – sales returns – discounts.
• Cost Per Unit : This KPI measures how much it costs your company to produce or buy a single unit of a particular product. It’s important in calculating your profit margins and financial projections, placing orders, and knowing which products are the most cost-effective. To calculate cost per unit, use this formula: (fixed costs + variable costs) / # of units.
• Rate of Return: Rate of return (ROR), commonly known as return on investment (ROI) is calculated as a percentage and is used to show the profit or return made on the initial investment, usually expressed annually. This number is a key indicator of the strength of your business along with its potential for future growth. To calculate ROR, use this formula: [(final value – initial value) / initial value] x 100.
• Inventory Turnover Rate : Also known as the inventory turnover ratio, this KPI measures the number of times your business sells and replaces its product inventory in one year. This number indicates how fast your inventory is moving off the shelves, which helps you identify areas of overstock and measure the efficiency of your product sales. It also lets you know the current performance of your inventory management and marketing strategies. High turnover, while generally a good thing, can also be a red flag to areas of insufficient stock. On the other hand, low turnover can suggest issues with overstocking or simply be a result of sluggish product sales. The 2 most common ways to calculate turnover include: Cost of Goods Sold / Average Inventory OR Sales / Inventory.
• Days Sales of Inventory: This key metric helps calculate the amount of time it takes a company to turn its inventory into sales. DSI is typically expressed as an average number of days and uses the following formula: (Average Inventory / Cost of Goods Sold) X 365.
• Stock to Sales Ratio: Stock to sales is a ratio that measures the amount of inventory in storage vs the number of sales. This key metric is used in making inventory stocking decisions. Stock to sales ratio = $ inventory value / $ sales value.
• Stockouts: Usually expressed as a percentage, this number helps measure how many items are “out of stock” at the time of order. This KPI is an indicator of your ability to meet customer demand. Having too many stockouts results in a decrease in customer satisfaction as well as the potential loss of future business. Stock outs can be caused by seasonal increases in product demand, poor inventory management, production delays, or supply chain issues. There are a few different ways to measure stockouts including: Volume of unmet product orders as a percentage of total sales volumes, volume of unmet product orders as a percentage of total purchase orders, or number of products on stockout as a percentage of total product lines.
• Backorder Rate: Backorders not only cost your company time (and possibly money), but they also can hurt your reputation. When customers regularly find that your most popular items are out of stock, they begin to lose faith in your business. Backorder rate is the measurement of how many orders a company is failing to fulfill at the time of order. A low backorder rate indicates a well-managed inventory system, while a high backorder rate identifies a need for better forecasting to keep items in stock.  To calculate your backorder rate, use the following formula: (# delayed orders due to backorders / total # orders placed) x 100.
• Inventory Shrinkage: The inventory shrinkage rate helps companies determine the rate at which the value of their inventory has been reduced due to loss, theft, or errors in reporting. To calculate this important KPI, simply subtract the actual current value of your inventory from the expected value of your inventory, and then divide this number by the expected value. This KPI can be most accurately measured immediately following a physical inventory count (otherwise known as an audit). You will want to keep an eye on your shrinkage rate over time and use it to help identify and correct any pain points such as inaccurate record keeping, frequently damaged goods, or employee theft.
• Lead Time: Lead time is the amount of time it takes for a customer to receive their order after purchasing it. Lengthy lead times can be an indicator of issues with your supply chain or order fulfillment process, while short lead times are an indicator of healthy business operations. To calculate lead time, simply add your order processing time + production lead time + delivery lead time. The faster your lead time is, the higher your customer satisfaction will be (think Amazon Prime).

How Kickfurther can help

Once you know and understand key inventory management metrics, your business can take advantage of funding opportunities. Keep in mind that funding can be costly so make sure you’ve accounted for additional costs. Traditional financing or funding methods are often the most expensive and hard to qualify for, thus forcing business owners to flee for alternative methods. Here’s where Kickfurther comes in to help. Kickfurther is the world’s first online inventory financing platform that enables companies to access funds they were unable to acquire through traditional sources. Compared to other funding sources, Kickurther is up to 30% cheaper. 

So, how does it work?

Kickfurther has companies start by creating a profile. Next, we connect brands to a community of eager buyers who help fund the inventory on consignment and give brands the flexibility to pay that back as they receive cash from their sales. Flexible repayment schedules alleviate cash flow challenges that are often made worse by traditional lenders. Small businesses can take advantage of flexible repayment schedules by allowing the brand to scale quickly without impeding your ability to maintain inventory. To qualify for funding through Kickfurther, brands must sell physical products or non-perishable consumables. In addition, brands must have revenue between $150k to $15mm over the last 12 months. Our average funding amount is $78,000, but businesses can fund up to $1MM to manufacture new inventory or get reimbursed for current stock.

Closing thoughts

Whether you handle the collection of your key inventory management data points in-house or you outsource these calculations to a third-party company or software, knowing and tracking the top KPIs for inventory management are critical to future business success. With confidence in how much inventory you need to achieve sales goals, you can earn the confidence of backers to secure funding. Funding for inventory can resolve cash flow challenges that inventory may cause. 

Interested in getting funded on Kickfurther? Create a free business account today to get started!