Inventory management: track stock and improve cash flow

Published Monday 23 March 2026

Table of contents

• Why inventory management matters for your business
• Understand the inventory types your business has
• Improve your forecasts
• Track your inventory
• Choose the right tools for your inventory needs
• Streamline your inventory and improve cash flow
• FAQs on inventory management

Key takeaways

• Enable inventory tracking in your accounting software to automatically update stock levels and financial records as you buy and sell, eliminating manual data entry and keeping your books accurate in real-time.
• Understand the three main inventory types—raw materials, work in progress, and finished goods—as each has different storage requirements and tracking challenges that affect your overall stock management strategy.
• Use historical sales data to identify seasonal demand patterns and slow-moving stock, allowing you to adjust purchasing decisions before overstocking ties up cash or stockouts lose you sales.
• Avoid using spreadsheets for inventory management as they create version conflicts, allow easy mistakes, and lack the automated features that cloud-based inventory software provides for real-time tracking and financial integration.

Why inventory management matters for your business

Every item you hold ties up cash that could be used elsewhere in your business. Predicting demand is difficult, and getting it wrong affects your cash flow in two ways.

Too much stock creates problems:

• Unsold items generate no revenue.
• Warehousing and inventory accounting cost money.
• Stored items occupy space needed for other purposes.
• Stock may deteriorate or become obsolete.
• Items could be damaged or stolen, with one business case study showing that stock missing from the physical count represented 6.6% of the total cost of goods sold.

Too little stock creates different problems:

• You miss sales when demand spikes.
• You lose customers to competitors.
• You struggle to fill large orders.

Either way, you lose money. Managing inventory efficiently protects your cash flow and keeps your business competitive.

Understand the inventory types your business has

Inventory types are the categories of stock your business holds at different stages of production. Most businesses manage three main types:

Raw materials

Raw materials are the basic components from which your final product is made. Depending on your field of work, they can take up significant storage space.

Work in progress (WIP)

Work in progress refers to goods being manufactured but not yet complete. Examples include toys waiting to be painted or ceramics that haven't been fired.

Finished goods

Finished goods are products ready to sell to your customers. You may send them to distributors or sell directly to clients.

Each category has different storage requirements, but they're interdependent. Without enough raw materials, you can't make finished goods. If demand for finished goods drops, you end up with excess raw materials.

Improve your forecasts

Demand forecasting helps you predict how much stock you'll need based on historical patterns and seasonal trends. Understanding when demand rises and falls lets you adjust stock levels before problems occur.

Accounting software like Xero generates reports on past sales that reveal which products sell well at different times of year. Use these insights to:

• identify seasonal demand patterns
• spot slow-moving stock before it ties up cash, as a low turnover rate can be a major issue: one business found its rate was 33 per cent below its industry benchmark
• plan purchasing around predictable busy periods
• reduce both overstocking and stockouts

Track your inventory

Inventory tracking means knowing what stock you have and where it is at any time. This is straightforward for small businesses but becomes complex as you scale up.

Different inventory types present different tracking challenges:

• Raw materials: Generally stay in one location and are easier to track.
• Work in progress: Moves around during production and can be anywhere in your facility.
• Finished goods: Need tracking from warehouse to customer delivery.

When you use Xero, inventory updates automatically as you create purchase orders, receive stock, and invoice customers. For physical tracking, common methods include:

• Barcode scanning: The traditional approach, still widely used and reliable.
• RFID tags: Becoming more affordable, offering faster scanning and greater flexibility.

The best systems track products from raw materials through to customer delivery.

Choose the right tools for your inventory needs

Inventory management software connects your stock tracking directly to your accounting, giving you real-time visibility into both inventory levels and their financial impact. Whatever tracking system you use, make sure you have software that supports it.

Why spreadsheets fail for inventory management:

• Create version conflicts when multiple people edit simultaneously.
• Allow easy mistakes that delete entries or entire files.
• Require manual backups to prevent data loss.
• Lack the features designed specifically for stock management.

Cloud-based inventory software handles upgrades and backups automatically. It also lets you check and manage inventory from anywhere, at any time.

When your inventory software connects to your accounting, every stock movement automatically updates your financial records. An Australian Taxation Office (ATO) program found a 90 per cent correlation between small businesses calculating tax correctly and their use of both cash flow and accounting software.

Streamline your inventory and improve cash flow

Efficient inventory management directly improves your cash flow by reducing waste, speeding up stock turnover, and helping you predict future demand.

For businesses selling physical items, proper inventory management is essential. With money tied up in every item you hold, even small efficiencies make a meaningful difference to your bottom line.

When your inventory system connects to cloud-based accounting software, you get the best of both worlds:

• Real-time stock visibility: See exactly what you have and where.
• Automatic financial updates: Every stock movement reflects in your accounts.
• Remote access: Manage inventory from anywhere, at any time.
• Better forecasting: Use sales data to predict demand accurately.

The less money tied up in unproductive stock, the more you have to invest elsewhere. That means stronger cash flow, which helps your business succeed.

Ready to streamline your inventory? Get one month free and try Xero's inventory management features.

FAQs on inventory management

Here are answers to common questions about managing inventory in Xero.

How many inventory items can Xero handle?

Xero supports up to 4,000 tracked inventory items. Businesses managing more items or needing advanced features can connect specialised inventory apps through the Xero App Store.

Can Xero track inventory across multiple locations?

Xero's native inventory features track stock in a single location. For multi-location tracking, you'll need to connect a dedicated inventory app from the Xero App Store.

When should I use a third-party inventory app with Xero?

Consider a third-party app if you need multi-location tracking, batch or serial numbers, manufacturing support, or advanced reorder automation beyond Xero's native features.

How does Xero calculate cost of goods sold for inventory?

Xero uses the weighted average cost method to calculate cost of goods sold. When you invoice a customer for an inventory item, Xero automatically records the COGS based on the average purchase cost of that item.