Small business inventory management: A comprehensive guide

4 types of inventory costing methods for small businesses

First in, first out (FIFO)

The FIFO method is an inventory management strategy where the older items are sold or used first, ensuring they move out before expiring or losing quality. This is especially relevant for businesses that handle time-sensitive goods, like pharma and cosmetics.

This method also supports accurate cost tracking, as it aligns inventory costs with current market prices, making it easier for businesses to manage profit margins and inventory value accurately.

• Best For: Businesses managing perishable goods or products with expiration dates.

Last in, first out (LIFO)

The Last In, First Out method is an approach where the most recently acquired stock is sold or used first. This method is often chosen by businesses that deal with durable goods that don't face expiration concerns, such as hardware stores, and furniture shops, that want to account for rising costs, as it records the cost of the latest, usually higher-priced inventory on the books. LIFO can provide a tax advantage in inflationary times because it leads to a higher cost of goods sold (COGS), which may reduce taxable income.

These businesses benefit from LIFO's ability to match current inventory costs with sales revenue, helping them manage profits and cost flow in an environment where prices for raw materials or products frequently change. However, it's worth noting that LIFO isn't accepted under IFRS (International Financial Reporting Standards), so businesses with international operations may need to consider this.

• Best For: Businesses in markets with frequent price increases looking to lower taxable income.

Just-in-time (JIT) inventory

The Just-in-time method is a way for businesses to keep inventory costs down by only ordering stock as it's needed. Instead of keeping large amounts of inventory on hand, they bring in materials or products just before they're required for production or sales.

This helps avoid the costs of storing extra items and frees up cash that would otherwise be tied up in unsold stock. However, the red underline is that JIT depends heavily on reliable suppliers and accurate demand predictions because any delay or miscalculation can lead to shortages that disrupt operations.

• Best For: Businesses with limited storage that can predict demand accurately.

Economic order quantity (EOQ)

Economic order quantity (EOQ) is a formula that helps businesses determine the optimal order size to minimize both ordering and holding costs.

EOQ calculates the most cost-effective quantity to order by balancing the cost of ordering products with the cost of holding them, helping small businesses with consistent demand and reliable sales patterns, like wholesalers and office supply shops, find that “sweet spot” where they save money on storage without risking stock shortages.

• Best For: Small businesses with steady demand and predictable sales cycles.

Inventory management best practices for small businesses

With these strategies, small businesses can sidestep common issues, maintain the right stock levels, and stay prepared to meet customer demand- without unnecessary waste or overstocking.

Use inventory management software

An inventory management software, like the one offered by Priority enables small businesses to precisely and efficiently control inventory and provides tools for tracking sales trends, setting reorder points, and managing supplier relationships, making it easier to align inventory with actual business needs.

Instead of manually updating spreadsheets or paper logs, an inventory management software helps small businesses automate tasks like stock tracking, reporting, and forecasting, and reduces the chance for human errors, ensuring that stock levels are accurate and up-to-date. This technology gives small businesses access to real time data and rapidly gains the insights for accurate demand forecasting, procurement planning, and storage optimization.

The seemingly high initial investment in the software might deter small businesses with limited resources, but rest assured – The cost savings realized over time far outweigh the upfront costs.

Choose the right inventory management method

To choose an inventory management method, small businesses should look at factors like the nature of products, demand fluctuations, storage space, and their financial goals and monitor them over time to make sure the chosen method continues to meet the changing needs of the business.

For perishable items, FIFO is ideal to ensure older stock is sold first, reducing waste, while LIFO can benefit non-perishable goods in inflationary periods by lowering taxable income.
Understanding sales trends is also a prerequisite; stable demand can call for methods like Economic Order Quantity for optimal order sizes, whereas unpredictable demand may favor Just-In-Time practices to maintain lean inventory.

Small businesses must evaluate their financial objectives, as LIFO may offer tax advantages during high-cost periods, while FIFO or EOQ can enhance cash flow by optimizing turnover rates. Reliable supplier relationships also play a role; strong partnerships may allow for JIT efficiency, but less reliable sources might necessitate maintaining a buffer stock.

Set up a product identification system

Small businesses should implement a product identification system using SKUs or barcodes to stay organized and efficient, simplify stock tracking, and minimize the risk of errors in inventory counts to enable faster fulfillment processes.

Establish reorder points

Small businesses need to set reorder points based on factors like average demand, lead time from suppliers, and safety stock to keep the right amount of stock on hand by ensuring prompt restocking when inventory is low ( but high enough to meet demand until the new stock arrives.)

Integrate inventory system with other business functions

When selecting an inventory management system, small businesses should consider its ability to integrate with other core business functions and systems, like sales, accounting, and procurement, to create a centralized management hub that provides real-time visibility and seamless data flow across departments and enables quicker responses to fluctuations in demand.

How Priority Software can help

Good inventory management positions small businesses for resilience and growth. It means less stress, more control, and being ready for whatever comes next.

With Priority Software's Retail Management Solution, you get an all-in-one, omnichannel platform where inventory management is seamlessly integrated as a core feature, you can focus on what you do best – serving customers and growing your business – knowing your inventory is in check.