Chapter 3

Inventory management

A complete overview of your inventory will help your business run smoothly and profitably, so where do you start?

What is inventory management?

Managing inventory consists of:

  • keeping track of goods – where they are and how long you’ve had them
  • knowing their value – what they cost and how much they’re selling for
  • forecasting demand – learning what sells and ordering accordingly

Why is inventory management important?

When you manage your inventory well, you can:

One of the main aims of inventory management is to hold inventory for less time. This reduces stock handling, lowers losses due to damage or spoilage, and reduces the risk of products becoming obsolete.

You’ll also find out which product lines are bringing in the most customers (highest sales), versus generating the most revenue, versus delivering the best margins. That’s all good to know.

How to start optimising inventory

You can see the value of your inventory and you want to manage it smartly. So what do you do?

Inventory optimisation is a big topic, and it can involve a lot of maths, but you don’t have to jump straight in the deep end. Here are three things you can do right now to get on the right track.

1. Begin with an ABC analysis

Financially speaking, not all inventory is equal. A small proportion of items often drive a lot of your sales and profits. This is often called the 80/20 rule. An ABC analysis involves sorting your inventory into three broad categories:

A. The select few items that bring in most of your income

B. The OK performers that contribute a decent amount of income

C. The bulk of items that don’t earn much (due to low sales and/or prices)

Pay particular attention to your A inventory, because mistakes in that category can cost a lot of money. The C items require less of your attention. This exercise gives you a framework for prioritising your focus and energy.

2. Understand demand and forecasting

Accurate estimates of what you will need are the backbone of good inventory management. It can seem like guesswork when first starting a business – but it doesn’t have to stay that way.

Use your sales records to figure out what’s hot and what’s not. As time goes by, break sales down into daily, monthly, and quarterly reports so you can spot patterns. Use that as a guideline for placing your orders. You can overlay considerations like promotions, economic conditions, holidays and so on – but use past experience as a basis.

3. Allow for lead times

You can't always pick up the phone and order more inventory for tomorrow. Find out how long it takes to replenish certain supplies and factor it into your inventory management. It’s a simple step but it can help stop you from making the same mistakes over and over again.

Ten ways to look after your inventory

You wouldn't leave a big pile of money in the middle of your shop floor, unattended and unprotected, right? Since inventory has financial value, it's important to look after it sensibly too.


Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided.

Guide to inventory

Inventory management is more than just knowing what’s been sold and what you’ve ordered. Find out what else is involved.

  1. What is inventory?

    Your inventory is one of the most important purchases you’ll make. It’s the reason you’re in business.

  2. Types of inventory

    Inventory comes in many forms. Understanding the types will help you identify it for valuation and management.

  3. Inventory management

    A complete overview of your inventory will help your business run smoothly and profitably, so where do you start?

  4. Inventory accounting

    Inventory can be a big expense, and a big earner, so it pays to stay on top of the numbers.

  5. Inventory management systems

    You know inventory is vital to a healthy business. So let’s look at some systems for efficient inventory management.

  6. Inventory management software

    Inventory management software may give you the extra time you need, or the ability to take things to the next level.

  7. Tools and guides for your business

    Now that you’re in business, you want to stay there. Xero’s got resources and solutions to help.

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