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Inventory Management Accounting: Ultimate Guide for eCommerce

Inventory Management Accounting is one of the most confusing parts to those who entered the eCommerce industry. In fact, 47% of the retailers dealt with the same problems with their inventories.

A good Inventory Management however, will bring your business to the highs and lesser lows. By developing a healthy practice in knowing your inventories, you can make sure that you can be at the top of your business. 

Recording this in your accounting books can also be a challenge. A good background on inventory will be your framework in reflecting correct numbers in your books.

What is a Merchandise Inventory?

Merchandise Inventory or Inventories are items you hold with the intent to sell. It may or may not be immediately sold but mainly, this is the heart of the business. Inventory Management Accounting focuses on the items that you sell.

Examples of Merchandise Inventories:

Shoes of a shoe selling business

Pet supplies of a pet shop

Medicines of a pharmacy

These may look very basic but you must need to know that having these in your record is not as easy as it seems especially when you have different product lines.

Let’s say, if you are in a shoe business, you must think about how many shoes you have in size 7, and how many size 7 shoes are in color brown. This not having mentioned that you still have not subdivided the shoes based on design.

With all these different categories of your products, you may find it difficult to keep this in record. Other considerations such as when to re-order your product may also be a problem that you have to deal with.

At the end of this article, you will gain more knowledge and understand inventory behaviours that can be applied to your eCommerce business. 

Photo by Artem Beliaikin from Pexels

First, I want you to learn the common terminologies being used in Inventory Management Accounting,

  1. Cost of Goods Sold

Cost of Goods sold is the cost to sell a product. It is oftentimes not just the item price, it also includes the cost of shipping the item to the warehouse.

  1. Lead Time

This is the ‘waiting time’ between the time you ordered your inventory from your supplier and the time it actually arrives.

Lead time is usually considered when your inventory starts to get low. You have to make sure that you still have products to sell while waiting for your order to arrive. A good inventory management is not letting your products go ‘out of stock’.

  1. Out of Stock (OOS)

Out of stock is when you do not have any product available to sell. This is what most businesses avoid to happen. 

Out of stock means you are not able to forecast the inventory that you need to keep in stock. Avoid OOS in your business to make sure you will not lose the opportunity to make a sale.

  1. Re-order Point (ROP)

This is your determined number of quantities (usually the lowest) when to place an order.

  1. Economic Order Quantity (EOQ)

EOQ or Optimal Order Quantity is the best number of quantities to order. This helps the business to lessen the annual inventory cost by not ordering a lot and burning money in storage / warehouse fees. 

EOQ has a formula developed by Ford W. Harris in 1913. It is an important cash flow tool but will need a deeper understanding or help by a professional accountant 

  1. Safety Stock

This is a stock you keep while intending to order to make sure that you will not go out of stock. Most businesses keep safety stock especially during peak season to take advantage of sales.

  1. ABC Analysis

This is categorizing your inventory into three parts to know your priorities when ordering. 

a.) High value products with low or slow-moving sales

b.) Average value products with average sales demand

c. ) Low value products with high sales demand. To make an impact, this type of inventory should really sell in high quantities.

  1. Dead Stock

This is a stock that is slow-moving or not moving at all. Some businesses sell this for auction to at least recover some of the cost that was spent to buy the inventory.

  1. Consignment

This is one of the strategies of holding items in stock but does not necessarily need to pay the entire inventory you are holding. As a consignee, you will only be paying the consignor for items you sold.

  1. Dropshipping

This is the modern type of consignment except that you don’t actually keep a product in your warehouse. Some eCom business displays and makes marketing efforts for the product and alerts the supplier when you make a sale. You don’t have to think about packaging and shipping costs anymore.

  1. Stock Keeping Unit or SKU

This is the identification code you assign to each of your inventory to identify and track the product.

  1. First In First Out or FIFO

Taking note of which inventories comes first in your warehouse should be the first one you send for sale. This is an effective method for food items or anything with expiration. This method also helps to make sure that out of trend products will be sold first before it becomes off-trend. 

  1. Holding Cost 

This is the cost of keeping the products in your warehouse. This should be considered to be conscious of keeping your quantities in your storage or warehouses in a manner that it is not too much. Remember that storage has costs. The space can be used for other more viable or saleable products that are deadstock. 

The longer you keep the product, the higher the cost.

  1. Just In Time Inventory

The point where the inventory arrives at your warehouse / storage just in time that it is needed or just in time before all your stocks are gone. However, this method creates potential out of stock and loss of customers.

  1. Inventory Management Control Systems

Aside from an actual knowledge of your inventories, there are a lot of developed softwares to manage inventories that will alert the business owner when to order. 

Inventory Accounting

One of the most tedious tasks in keeping an inventory is accounting it through counting. This way you will know how many items you still have on hand. Inventory Management Accounting is an effective tool in doing your count.

This also makes you aware of how many damaged items you are keeping in your warehouse that you should consider a loss. Again, the goal is to lessen the items in your storage / warehouses that will not add value to your business, otherwise, it will also incur more cost to keep them.

There are three types of inventory audit that you can implement in your business

Year-end inventory

This involves manual counting of your inventory in your warehouse to make sure that the actual inventory count matches the number in your records. 

Usually this is scheduled a few days after year-end. You must consider a day that the sales is slower or no incoming replenishment of your stocks when you want to get an actual number of your inventories.

Cycle counting

A periodical schedule of your inventories especially if you have a lot of items and product items. Let’s say you are selling kitchen supplies, you may start accounting for all the rice cookers for January and the pots in May.

Spot checks

If year-end inventory or cycle count does not suffice to trace missing stocks, you have to do a spot check. This means randomly choosing a product and starting counting how many of that product you have in stocks. Your most expensive products should be spot checked. 

When to Order?

Knowing when to order is the most important part of inventory management accounting especially in eCommerce. Now that you are doing mostly online, you have to make sure that even though most communications are done through calls and emails, you have confidence that your stocks are at bay. 

Below are the tips and tricks to know when to order your inventories:

  1. Get historical data

When you started your business, you know when your sales are at peak. You know when you need to stock more. If you are new in the business, you can get insights online or by experience on what season you do your shopping.

Thanksgiving, Christmas, New Year, Valentines, start of the summer season or beginning of the school year (for bookstores) are usually the peak season for most of the businesses.

  1. Set an Automatic Replenishment or Auto Order

So you’ve been running your business for some time now and you have identified your demand on a monthly or even weekly business which is good, now you may start scheduling your order quantity on a certain day.

For example, you are in a fried chicken business, you know how much sales you make on a per day basis, you may total that (if that gives you a consistent number) and get the average to determine the order quantity you will place at the end of the week to start your next week. 

This way, you will not have to buy a month’s worth of inventory and worry about the storage.

  1. Practice FIFO method

First-in-first out is a very common practice among inventory heavy businesses. Always sell the oldest stock in your warehouse to make sure that your stock is in good condition. Boxes of non-perishable goods can be worn out which may distort your products too. You may not be able to sell it at the best possible price.

Replace the oldest stock that you currently sold to make sure that all your stocks are in best condition.

  1. Just In Time Inventory Purchasing

It may help you lessen storage costs when you order to meet demands on a certain time. You will order enough based on your sure sales. This also applies to the pre-order method when you accept orders first then you only buy and dispatch on a certain date.

It is very unpredictable and does not have an allowance for mishandled stock. When there’s missing or damaged stock, you may have to deal with delay and low customer satisfaction.

Guide on Easy Inventory Management

  1. Make sure you have a good relationship with your suppliers

Who can tell if you will have problems in the future. Sometimes, you order less than you wish and have to place more orders just to meet your demand. While making adjustments seem to be easy, it is actually not especially for the logistics. 

It will be easier to return wrong items ordered when you are working in a good atmosphere with your supplier. Include them in making decisions if you must.

  1. Be open to dropshipping

Dropshipping has been really popular with most eCommerce businesses. It meant not holding a single inventory in your warehouse which eliminates the costs of it and need not to coordinate in shipping.

However, this practice may be tricky as you may miss doing quality control for each item being sent to your customer and may be at risk of bad reviews. Your dropshipping supplier will not be responsible after service, too. This may be later on costly when it comes to refunds as you may need to hire a point person to handle customer concerns. 

  1. Consider getting a Fulfillment Service

Fulfillment services take care of storage, quality control, packing and shipping of the inventories that you sell online. Although costly, you can make sure that there’s a uniformity in quality of your products.

Downside would be losing your brand identity. Amazon fulfillment centers have their brand on the boxes and not yours. 

  1. Keep a healthy stock, no over or under stocking

I already mentioned ways to determine when to order and how much to order. You have to pay attention to your stocks. Purchasing a lot than you could actually sell may lead to high storage cost. Purchasing less may put you at risk of being out of stock. 

You also need to consider your cash flow. Avoid losing cash and keeping it in inventories that is uncertain as to when it will be converted to cash. If you have immediate need of cash for other operating expenses such as salaries, rent, utilities, software, you need to plan how much you can use to purchase stocks that will not affect your other business activities.

Implement the use of software to help you determine if you are nearing out of stock and may suggest when you have to order based on the records of your past sales.

  1. Prepare your business on peak seasons

Observe the market when it makes a high demand on a yearly basis. Aside from focusing on your marketing strategy, make sure that your inventories are prepared and available in season to meet demands.

A lot of businesses may experience out of stock and you can have that opportunity to get random customers that are not in your list yet. Either letting the market be aware of your existence or introducing a better alternative through your product is a great chance to highlight your products.

Whatever your chosen Inventory Management Accounting Strategy, knowing your business is always the key to be able to apply it to garner more profit in the long run. 

Start small and avoid overwhelming yourself with a lot of products or online platforms to sell. You may do that later once you master the trend and practices around your business. 

Intelligently choose an eCommerce platform, manage a few product categories under your brand, master it and then slowly introduce new products to add in your records. Enjoy selling!

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