How much inventory you should have on hand is a question you will stumble on early in your eCommerce journey – and one that you will constantly be revisiting as you realize how much cash it sucks up.
There is no one answer, but there are plenty of ideas you should think about to develop your own inventory targets.
I have put together a article highlighting my own personal opinions, as well as some other well known experts in the field.
It all depends on your profit margins, how much cash you have available, your shipping lead times, manufacturing delays, and how bad it is if you run out of stock.
So, let’s begin.
Table of Contents
- 1 Inventory Rules of Thumb
- 2 How Much Inventory Do I Need?
- 3 How Much Inventory Do I Have?
- 4 How to Manage Your Inventory
- 5 How Much Inventory Do I Need to Launch?
- 6 Inventory Optimization Tips
- 7 Inventory Management from the Experts
- 8 Inventory Management Infographic
- 9 Conclusion
Inventory Rules of Thumb
Let’s start off with some simple rules of thumb – these are a great starting point. If you are just starting out then take this as your first best guess. You can always adjust it later as your inventory value increases and becomes more of a burden.
I feel it is always better to make a decision and set up your processes than to never make a decision and leave it until it is too late.
I have done this before and it sucks.
Turnover your Inventory Five Times per Year
This is a simple idea – take your annual cost of goods, let’s use $100,000 as an example. Then divide it by 5, so $20,000. This means that you will turnover your $20,000 worth of inventory five times in one annual year.
Very simple, fairly effective. Obviously this doesn’t include details like manufacturing delays, shipping delays, seasonality, etc.
But for beginners to eCommerce who are not sure where to start, this is a good starting point.
It also means that for every $5 in annual goods sold you should increase your inventory by $1. This can get real expensive, real fast.
How Much Inventory Do I Need?
Rules of thumb are one option, but let’s dive into some more satisfying mathematics.
- Take your monthly revenue – say $50,000 per month.
- Calculate your monthly cost of goods – maybe at a 50% profit margin this is $25,000 per month.
- Determine the amount of time it takes between when you place an order and when you receive it – let’s use 2 months
- Multiply your monthly COGS by the time it takes to receive new product – $25,000 x 2 = $50,000 in inventory required
The next step is build in some contingency. If there is anything Covid has taught us it is that disruptions to your supply chain can destroy your business – so make sure you have enough stock on hand.
You can do this by assuming that each order has a 2 week delay due to customs, or that your next month’s revenue will be 10% higher than the previous. You can even build in an extra $X to avoid missing any sales and disappointing your customers.
Then, depending on how complex your product options are, you may want to do this exercise for each product, or at least each supplier.
How Much Inventory Do I Have?
Another key input into this system is ‘How much inventory do I actually own?’ Sounds simple – and it should be, but only if you have set up the systems to allow it to happen.
Simply go into your Shopify dashboard -> Reports -> Inventory -> Month-end Inventory Snapshot.
This is a good starting point, but for it to really be effective you should be checking this report against your stock on hand. There will also be errors between reality and the data. There are dozens of reasons for this:
- Wrongly shipped items
- Returns not documented correctly
- Lost items
- Theft and stolen products
- Damaged items
- Shipping of goods wrongly accounted for in Cost of Goods (COGS)
You should be adjusting your inventory value on a regular basis – normally monthly or quarterly depending on how trustworthy and variable and complex your data is.
Build this into your processes early, before you actually need it. It is much easier to have a process setup then to discover you are missing thousands of dollars worth of products that have not been accounted for correctly.
How to Manage Your Inventory
Now that you have set your inventory target, you have to build a process for managing it. When you are starting out this is probably just a pen and paper, which will evolve into a spreadsheet, which will evolve into inventory management software.
The process itself is relatively simple:
- Conduct a monthly stock take so you know how much inventory you have
- Determine a forecast of your upcoming revenue
- Calculate your required cost of goods and inventory requirements for the upcoming few months
- Place your orders
I would certainly recommend building this process in on a specific day each month. If you leave it ad hoc then you will certainly either order too many or too little.
Having a warehouse full of products sounds like a dream come true. But it can have severely negative consequences to your cash flow situation.
Overstocking means that you have more inventory than you want. This locks up a huge amount of cash that you could otherwise be using more effectively.
A good example of overstocking was during the fidget spinner fad. Everyone put in orders for thousands of units of the weird toy and by the time it arrived the fad had passed and they were stuck with all of their money locked up in goods that they could not sell – even by dropping their prices to or below cost price.
Another time when overstocking is likely is around the Christmas boom. If your revenue over this period wasn’t as high as you expected, then you might be stuck with high inventory for the next few months until you can sell it all.
The other side of the coin is understocking – this is when you don’t have as much inventory as you need and sell out early. This leaves your customers disappointed and finding other alternatives elsewhere.
It can also result in overspending of marketing unless you adjust down your ad spend in time.
Setting the correct inventory target and then building a management process is crucial for the future success of your eCommerce business.
How Much Inventory Do I Need to Launch?
Another common concept is how much inventory you should have when you launch your store? At this point you have no sales history and no data to base your decisions on.
A rule of thumb is to link your inventory value to your marketing budget. If you are going to spend $10,000 on marketing, then you might be able to earn $20,000 – $50,000 in revenue depending how amazing your product is and your marketing know-how.
Depending on your cost of goods/profit margin then you can get an idea about your starting inventory requirements.
If you run out of product, this can be an advantage. In a launch you can also collect email addresses to let potential customers know you have more products in stock. For a unique, revolutionary idea they will wait as they can’t just go to a competitor.
But if your launch isn’t successful then you are stuck with thousands of dollars in unsold/unsellable goods. This might hold you back from moving on to the next part of your entrepreneurial journey.
Another idea is to set up a pre-order or Kickstarter style campaign. This allows you to get an idea of how many sales you will get in advance so you can order/build the right number of units.
Inventory Optimization Tips
I hope this whole process isn’t too daunting. It can be both boring and important. I have wasted a lot of money by not managing my inventory optimally.
There are plenty of tips you can use to maximize the cash flow of your business. I have put together some of the more interesting ones that could help you out:
- Set a Minimum and Maximum of individual products based on their value, delivery time, and sales velocity. You can adjust this over time as you gain more data.
- Reducing the amount of time between placing an order and receiving the product can save you thousands of dollars in inventory value. This is one of the key advantages in working with local suppliers.
- Conduct regular stock takes, even if you don’t think you make mistakes in your cost of goods. I have found so many inconsistencies over the years that I still can’t explain. These sometimes result in customers ordering products that you don’t actually have in stock which can damage your reputation.
- Having multiple variations, sizes, and colors can make inventory management much more difficult.
- Upgrade your inventory management system before you need to. If your eCommerce store really takes off then you will be flat out dealing with customer service, marketing, new product design – the last thing you want to do is be forced to figure out a new inventory software in the middle of all of this work.
Inventory Management from the Experts
As with most aspects of eCommerce, there is no right answer. There are just different strategies for different aplications.
I can’t hope to go through all possibilities – what works with a single product store manufactured on site is very different to an apparel store with hundreds of SKU’s, all with a dozen sizes manufactured overseas.
To help show some other points of view have a read through these concepts by the best and brightest from around the internet:
Ste Minimal Stock Levels
If your eCommerce shop is already running, you should also take the time to set minimum viable stock levels for every product you sell. Remember: your goal is to determine the lowest possible inventory you can have in order to meet demand and avoid delays in fulfilment.William Harris from Sell Brite
Inventory Management Software Requirements
You will know when you need to start implementing a more robust system of tracking (i.e. software) once you are moving about 100 units or more per month. Until then, use your trusty spreadsheets and sales reports. Lastly, remember that inventory management is part of having a successful business. Getting familiar with it early on will save you headaches later.Syama Meagher from Makers Row
Inventory Management 101
Properly forecasting demand for your products is the foundation of a good inventory management plan. However, it’s easier said than done.
In order to accurately forecast your demand, you basically need some kind of past sales to go off of. If you don’t have that, it’s going to be a lot more guesswork, but it’s still possible.Bill from A Better Lemonade Stand
Inventory Management Infographic
We have put together this simple infographic to explain the key concepts of this post. Feel free to share this on your blog or social media but please reference this site.
That brings me to the end of this article. I have tried to make it as comprehensive as I can, but there are simply so many variables that you will need to build your own strategy and fine tune it going forwards.
Inventory management and cashflow management are tied together at the hip for any eCommerce business, but particularly one that is growing in revenue. Solving one effectively solves the other.
There is no correct answer for how much inventory your eCommerce store needs, but I hope this has helped you to build your own personal target.
I would love to hear what you have decided on for your own inventory targets, and what criteria you used to make this judgement.