Better inventory management made simple: A guide for small businesses

Published Monday 27 October 2025

Table of contents

• What is inventory management?
• Inventory is money
• Understand the inventory types your business has
• How inventory management works
• Choose the right inventory management method
• Improve your forecasts
• Track your inventory effectively
• Essential features of inventory management systems
• Use the best tools
• Build your efficient inventory management system
• FAQs on inventory management

Key takeaways

• Implement demand forecasting by analyzing your sales patterns to identify seasonal trends, cyclical demand, and product popularity changes, which can reduce inventory costs by 10-25% while improving customer satisfaction.

• Choose inventory management software with real-time tracking, automated reordering alerts, and integration with your accounting system rather than relying on spreadsheets that create collaboration conflicts and data errors.

• Apply the appropriate inventory method for your business type, such as FIFO for perishable goods, JIT to reduce storage costs, or ABC analysis to prioritize your most valuable stock based on sales frequency and value.

• Avoid both overstocking and understocking by maintaining balanced inventory levels, as overstocking ties up capital in storage costs and depreciation risks while understocking leads to missed sales and customer dissatisfaction.

What is inventory management?

Inventory management is how you track and control your business's stock. It covers everything from ordering and storing to using and selling your inventory. Done right, it helps you know exactly what you have, where it is, and when you need to reorder.

A good system helps you meet customer demand without tying up too much cash in slow-moving items. Getting this balance right keeps your cash flow healthy and supports your business growth.

Inventory is money

Poor inventory management creates two costly problems that directly impact your bottom line.

Overstocking costs you money through:

• lost revenue from unsold items
• higher storage expenses
• missed opportunities to use space and capital elsewhere
• risk of depreciation, obsolescence, or damage

Understocking loses sales and customers through:

• missed opportunities to fulfill orders
• customer dissatisfaction and lost loyalty
• falling behind competitors

Both scenarios can limit your cash flow. Efficient inventory management helps you avoid these issues.

Understand the inventory types your business has

Inventory types fall into three main categories that require different management approaches.

Raw materials: Basic components used to create your final products

• Management focus: Ensure steady supply without overstocking
• Common challenge: Balancing bulk purchasing discounts with storage costs

Work in progress (WIP): Partially completed goods moving through production

• Management focus: Track location and completion status throughout manufacturing
• Common challenge: Preventing bottlenecks that tie up working capital

Finished goods: Products ready for customer delivery

• Management focus: Match stock levels with demand forecasts
• Common challenge: Avoiding obsolescence while preventing stockouts

Each category has different storage needs, and they all depend on each other. When you have enough raw materials, you can keep production moving. If demand for finished goods changes, you can adjust your raw material orders to match.

How inventory management works

The inventory management process is a cycle that keeps your business running smoothly. It starts when you purchase stock, continues as you store and use it, and completes when you sell the final product. Along the way, you'll track levels and reorder as needed to keep the cycle going.

This process helps you fulfill orders quickly and keep storage costs low. With a clear system, you always know where your stock is—from your warehouse to your customer.

Choose the right inventory management method

Different businesses need different strategies for managing stock. There are several popular methods, and the right one for you depends on your industry and the types of products you sell.

Common techniques include:

• First-In, First-Out (FIFO): Assumes the first items you purchase are the first ones you sell. It's great for businesses with perishable goods.
• Last-In, First-Out (LIFO): Assumes the newest items are sold first. This can be useful for products with no shelf life, and business owners should note that certain accounting rule updates do not apply to inventory measured with the LIFO method.
• Just-in-Time (JIT): Aims to receive goods only as they are needed in the production process, reducing storage costs.
• ABC Analysis: Categorizes inventory into three groups based on value and sales frequency, so you can prioritize your most important stock.

Understanding these methods can help you choose a system that fits your business goals and keeps your inventory moving.

Improve your forecasts

Demand forecasting uses historical data to predict future inventory needs, reducing both overstocking and stockouts.

Analyze your sales patterns to identify:

• seasonal trends for each product
• cyclical demand throughout the year
• growth or decline in product popularity

• Seasonal trends: Which products sell more during specific months or seasons
• Cyclical demand: Regular patterns that repeat throughout the year
• Growth trajectories: Products with increasing or declining popularity

Use accounting software reports to:

• Track performance: Generate sales reports by product and time period
• Spot opportunities: Identify your most profitable items and peak selling periods
• Adjust inventory: Stock up before high-demand periods and reduce orders for declining products

Accurate forecasting can reduce inventory costs by 10 – 25% while improving customer satisfaction.

Track your inventory effectively

The next step is to find out what inventory you have and where it is. That might be easy if your business is small—which for tax purposes the IRS defines as having average annual gross receipts of $27 million or less for the three prior tax years—but it can quickly become complex as you scale up.

Essential features of inventory management systems

When you choose an inventory management system, look for features that make your work easier and give you more control. The best software fits seamlessly into your daily operations.

Key features to consider include:

• Real-time tracking: See stock levels update automatically as you buy and sell products.
• Barcode scanning: Quickly add, track, and manage inventory with a simple scan.
• Automated reordering: Set minimum stock levels to get automatic alerts when it's time to reorder.
• Reporting and analytics: Get insights into your best-selling products and sales trends to make smarter decisions.
• Integration: Connect your inventory system with your accounting software for a complete financial picture.

Use the best tools

Inventory management software provides real-time tracking and automated updates that spreadsheets cannot match.

Why spreadsheets fail for inventory management:

• Collaboration limits: Multiple users create version conflicts and data errors
• Error risks: Accidental deletions can destroy months of inventory records
• Manual maintenance: Constant backups and updates waste valuable time
• Functionality gaps: No automated reordering, barcode scanning, or demand forecasting

Purpose-built inventory software delivers:

• Real-time updates: Automatic stock level adjustments across all locations
• Integration capabilities: Direct connection with accounting systems for accurate financial reporting
• Automated features: Reorder alerts, demand forecasting, and supplier management
• Data security: Cloud-based backups and user permission controls

Choose software that integrates with your accounting platform—inventory directly impacts cash flow and financial reporting.

Build your efficient inventory management system

Efficient inventory management transforms your business operations and financial performance.

Key benefits you'll achieve:

• Reduced waste: Minimize obsolete stock and storage costs
• Faster turnover: Decrease time products spend in your warehouse
• Better forecasting: Predict demand patterns with historical data analysis
• Improved cash flow: Free up capital currently tied up in excess inventory

Cloud-based inventory systems provide:

• Real-time visibility: Track stock levels from anywhere, anytime
• Integrated reporting: Connect inventory data directly with financial records
• Automated processes: Reduce manual tasks and human errors
• Scalable solutions: Grow your system as your business expands

Even small efficiency improvements can have a big financial impact. If you reduce excess inventory by just 10%, you could free up thousands of dollars to grow your business.

Ready to optimize your inventory management? Xero cloud-based accounting software works with inventory tracking tools to give you a clear view of your stock and finances. Get one month free to see how better inventory management can improve your cash flow.

FAQs on inventory management

Here are some common questions small business owners might have about inventory management.

What are the 4 types of inventory?

The four main types of inventory are raw materials, work-in-progress (WIP), finished goods, and maintenance, repair, and operating (MRO) supplies. Each type represents a different stage in your production and sales cycle.

What is the 80/20 rule for inventory?

The 80/20 rule, or Pareto Principle, means that 80% of your sales come from 20% of your inventory. If you focus on that top 20%, you'll manage your inventory more effectively and boost profits.

What are the 5 stages of the inventory management process?

The five key stages are:

1. purchasing stock
2. storing it in your warehouse
3. using it for production or sales
4. tracking stock levels
5. reordering when supplies are low This cycle helps you always have what you need to meet demand.