What Is Inventory Management Software?
Inventory management encompasses much more than simply keeping track of what you keep in your warehouse or retail storeroom. Inventory management also includes keeping track of what’s in your parts department, including individual parts and the combinations of those parts used to build other products and services. Inventory management also involves finding out what your supply partners or your best customers have in stock. For small to midsize businesses (SMBs), keeping track of all these items can get difficult quickly if you’re just using a spreadsheet to do so. Tying that inventory product information into all of the other data platforms your organization uses requires a dedicated software called inventory management software. Deciding on the right software package for your business can be difficult as you need to weigh required features against the best pricing. To help with this task, we have tested and compared nine inventory management software packages in this review roundup.
While “inventory management” sounds like it’s a simple tracking of what you have, inventory management software actually goes several levels deep. The software should integrate with at least one other back-end office system, namely, with either your accounting or enterprise resource planning (ERP) package. An inventory management system’s function is to track those warehouse items through acquisition, sales, or use processes; locate them across one or many warehouses, and price (cost) the inventory (sometimes in multiple currencies) so you know the value of items you have in inventory for accounting purposes.
In this way, inventory management software sometimes overlaps with typical asset management software. Core functionality definitely centers around your inventory levels, but this kind of software also tracks sales, purchase orders (POs), and deliveries. Aside from accounting, inventory management software is also often tied to point-of-sale (POS) software in many retail and storefront service operations. Very small operations can get away with fulfilling these functions with a simple spreadsheet. However, any business larger than that will want the asset identification, order tracking, and supply chain optimization capabilities that a good inventory management system delivers.
Inventory is considered a business asset. As such, it is accounted for in the Assets section of a company’s balance sheet. When assets are sold or used, those results are also recorded in the Cost of Goods Sold (COGS) or Cost of Goods Used section of the income statement. That figure is computed by using one or more pricing methods. Common inventory valuation methods used in the US include First In First Out (FIFO), Weighted Average Costing, Standard Costing, and Specific Costing (or Specific Identification). Last In First Out (LIFO) was popular for a while but has fallen out of favor and generally isn’t used anymore in most countries.
The acronyms LIFO and FIFO represent the order in which inventory is acquired and then sold or transferred. FIFO assumes that the oldest inventory is being sold or transferred first, while LIFO assumes that the newest inventory will be used first.
Weighted Average Costing is often used in situations where items are identical to each other and it’s impossible to assign a specific cost to an individual unit, or where the accounting system doesn’t have the ability to track inventory by using FIFO (which isn’t the case in any of the inventory systems we review here). The weighted average method divides the cost of goods available for sale by the number of units available for sale, which yields the weighted-average cost per unit.
Another frequent inventory valuation method is called Standard Costing. With Standard Costing, you substitute an expected cost for an actual cost in the accounting records, and then periodically record variances showing the difference between the expected and actual costs. This approach is often simpler than using FIFO in situations where there is a large amount of historical cost information. Standard Costing requires that you create estimated costs for inventory used in business; this method is used when it’s too time-consuming to track actual costs. But it also requires that the estimated Standard costs be periodically compared with the actual inventory costs, and a variance entry be made in the accounting records.
An additional common valuation method is called Specific Costing. This method assigns a cost to each individual item in inventory. Specific Costing is used when inventory items each have a readily available cost that’s different from other items in inventory. For example, a custom furniture manufacturer would be likely to use Specific Costing.
Finally, you should also consider the other end of this spectrum, namely figuring out the right price for your inventory. You’ll often see other suppliers offering price breaks based on order quantity: Save 10 percent on our widgets simply by ordering 20 percent more widgets! But figuring out the best choice here for your business can be complex depending on the kinds of carrying costs associated with your particular products. The larger your inventory of prodocts, for instance, the more you’re probably paying for storage and maybe even maintenance. This is where a system that can help calculate Economic Order Quantity (EOQ) can help. Typically, these come in the forms of customizable calculators you can configure to take into account the specific needs of your particular business.
Some Common Inventory Terms
As is true with many financial systems, the inventory subsystem has its own set of terms. While it’s beyond the scope of this introduction to provide a comprehensive list of the terms you might run into, here are some of the more common ones.
One frequent acronym you’ll run across is called BOM or BOMP. This stands for “Bill of Materials” or “Bill of Material Processing,” and you’ll find it used most often in production inventory systems. A BOM is used when an inventory item is made up of sub-items; the list of these sub-items is the BOM. A similar term is “kitting,” which is a bundling of parts or items that make up a finished item (which may then be used as an item in the BOM). You can have both kitting and a BOM in a single inventory item, depending on the item’s complexity and how granular your need to maintain inventory pricing.
Sometimes you will run across the term “Just-in-Time (JIT)” inventory. This is a logistics term used in supply chain management (SCM) operations to time the receipt of inventory so that it arrives just before or precisely when it’s needed. This inventory strategy reduces the time that inventory is actually stored, which can save costs. But this strategy requires some advanced and well-tested SCM capabilities. Also tied into process management and SCM is something called “Work in Process.” This tracks any inventory released to manufacturing and then tracks the inventory as it’s used on the production shop or factory floor. In many cases, you’ll find these two terms when examining production inventory systems aimed at everything from small production shops, such as your neighborhood motorcycle repair shop, all the way up to a large-scale auto factory.
Inventory Software: Things to Consider
Because of all the complexity involved in how inventory works in any particular organization, there will always be aspects of it that closely tie in with other parts of your accounting system. For example, both sales and purchasing are integral aspects of inventory since you can’t sell or use inventory if you haven’t purchased it—and you can’t sell it if you don’t have it available. The exception to this is drop shipping, which lets you accept a sales order and then have it shipped directly to the customer from your supplier’s warehouse. In essence, if your inventory software has drop-ship capability (and your supplier is willing), then you’re using your inventory supplier as a warehouse. Depending on how your accounting system is set up, drop shipments are often not recorded as inventory but, rather, are frequently posted directly to the “Cost of Goods Sold” portion of your accounting system.
Often sold as a separate module, SCM refers to the logistics of obtaining materials needed for production and/or items needed for resale inventory. It involves purchasing, shipping, receiving, and storing, and as such, is tightly integrated with inventory. One aspect of SCM is called “Reorder Point,” a feature you will often also find in inventory management systems. This can be a manual level entered by whatever inventory manager the system uses to generate an alert, or even a PO that brings the number of a stock item below a specific level. Some more sophisticated inventory systems use a technique called the Economic Order Quantity (EOQ). EOQ is a method used to calculate the optimum amount and times to order (or reorder) inventory to minimize holding or storage costs. Essentially, when using EOQ, you want the inventory to go as low as possible without resulting in a stock-out (i.e., no inventory to sell or use).
Retail inventory has some terms and procedures of its own. One important characteristic of a retail inventory is that it integrates closely with a POS system, meaning your cash register. The POS system provides a checkout device (including not just a cash register but also things such as bar code readers) that looks into the inventory database, identifies the specific item being sold, and deducts it from inventory in stock. Depending on the type of product or item being sold, individual items may be identified with bar codes or Radio-Frequency Identification (RFID) tags. These are assigned when items are checked into inventory and then checked out of inventory when they’re sold. Some POS systems even identify the location of the item, perhaps in a specific warehouse or possibly even where it’s sitting on the store floor. This is common in apparel, consumer goods, and electronic goods operations. Bar coding, item location, and bin identification are also functions you’ll find in many inventory systems.
One thing to keep in mind is that inventory software is almost never used all by itself. Rather, it’s often a part of a modular accounting system. Even if that’s not the case, it will always need to talk to or integrate with other back-end business systems, especially with what you’re using for accounting. Some businesses will prefer to get all of their accounting modules, including inventory management, from a single vendor. But, if you’re willing to implement some integration, then you can tie together apps from different vendors. This can provide not only cost savings in terms of licensing, but will also let you leverage exactly the kinds of features you need, even if they come from different software vendors. All of the inventory systems we reviewed have the ability to export data, at least to a spreadsheet, so it can be imported into a third-party accounting system.