Inventory Management: How it Works and Tools (2025)

Inventory management is the process of organizing stock on its way through a supply chain.

The goal of inventory management is to minimize the cost of holding inventory while maintaining consistent stock levels and getting products into customers' hands faster.

Are you unsure where to start with inventory management? From avoiding paying for extra storage because you've overstocked, or losing sales (and customers) due to complete stockouts, this walkthrough contains proven techniques from inventory management experts to optimize your operations and keep your customers happy.

What is inventory management?

Inventory management is overseeing and controlling the flow of goods within a business. It involves tracking the movement of goods and materials, monitoring inventory turnover, and optimizing replenishment to ensure your products are always available and your space is used efficiently.

Inventory management aims to minimize the cost of holding inventory by helping you know when it's time to replenish products or buy more materials to manufacture them.

What counts as inventory?

• Raw goods: Materials or substances used in the production or manufacturing of products. Raw materials include wood, metals, plastics, or fabrics used to create finished goods. They come from one or more suppliers and producers.
• Work in progress (WIP): A partially finished product awaiting completion. WIP represents production costs such as labor and machinery. Costs are transferred to the finished goods account and attributed to the cost of sales.
• Finished goods: This refers to the number of products in stock available for customers to buy. Once a WIP is complete, it becomes part of the inventory of finished goods.
• Maintenance, repair, and operations goods (MRO): Materials and equipment used in the production process but not as part of the final product. These include machinery used in assembly and production, personal protective equipment, cleaning supplies, office supplies, and tech equipment.

How does inventory management work?

In today's world, inventory management is virtually synonymous with software called inventory management systems (IMSs).

Most inventory management systems are cloud-hosted. They work across devices and users to ensure that everybody interacting with the supply chain is on the same page.

While traditional approaches require connecting multiple systems, modern solutions take a different approach. The most effective platforms handle inventory as part of a single retail operating system, where all data naturally flows between online and in-store operations.

This unified commerce strategy eliminates the complexity of maintaining separate systems for different sales channels. Stock levels update automatically whenever a sale happens, whether online or in-store, preventing overselling and improving operational efficiency.

A good IMS follows your product from your warehouse to your retail store, all the way to the end consumer—or in the case of returns, back to the store or the warehouse for restocking. This important data is readily available to members of your team so they can help ensure the flow of goods is efficient and cost-effective.

Using unified inventory management can save significant time, as shown by apparel and lifestyle brand Oak + Fort, which freed up 50 hours of labor per week by simplifying their order management process.

"We go through constant inventory fluctuations and shifting demands," explains Guillaume Jaillet, chief omnichannel officer. "It was hard to reliably and accurately represent which stores had certain items in stock to our digital customers when they wanted to try something on." After unifying their retail operations, they reduced operating costs by 47% while improving the efficiency of how they handled orders and managed the flow of their products.

Benefits of inventory management

Whether you're a small business or a large company using enterprise resource planning (ERP), inventory management is important for several reasons:

Improve efficiency

Keep only the inventory you need to cut storage costs, and never have employees sitting idle because you've run out of your bestselling products or the materials you use to make them. Track how products move from purchase to sale to find and fix inefficiencies. Use methods like just-in-time (JIT) delivery and first in, first out (FIFO) to keep products moving smoothly. Manage returns and easily incorporate sellable returned items to your inventory.

Improve financial reporting

Good inventory records help predict what customers will buy. You can make smarter purchasing decisions and spot trends early by tracking sales patterns.

Inventory directly affects sales (by dictating how much you can sell) and expenses (by dictating what you need to buy). Both of these elements factor heavily into your business's current assets—how much cash you have on hand. This improves financial reports and helps manage cash flow. These factors all make a difference in how effectively and confidently you can grow your business.

Mitigate risk

Good inventory planning protects your business from supply chain problems. You can set up your system to track sales and stock levels so you can reorder before running out.

Keeping safety stock also helps handle:

• Unexpected spikes in demand
• Shipping delays
• Raw material shortages
• Supplier issues

A strong inventory system with built-in safeguards helps prevent supply chain management breakdowns and keeps customers happy. For example, the Stocky app for Shopify POS lets you configure minimum stock levels based on supplier lead times and anticipated demand. When quantities in your inventory management system fall below this threshold, Stocky can automatically generate a purchase order for the relevant supplier.

Build customer loyalty

Good inventory management means filling orders quickly and keeping popular items in stock.

Using data from your inventory analytics, you can adjust your procurement schedule so that bestselling items are always in stock. Reliable stocking practices also reduce delivery delays and back orders, so loyal customers trust their orders will be delivered on time, and first-time buyers are more likely to become repeat customers.

Maintain good supplier relationships

When you routinely monitor stock levels and use data-driven forecasting methods like economic order quantity (EOQ), you can communicate order needs to suppliers with precision and consistency. Clear, predictable ordering patterns strengthen supplier relationships because vendors appreciate reliable partners who place timely and accurate orders. On the flipside, if you notice that a particular vendor slows down your restocking by taking longer to deliver on more than one occasion, you can look into identifying a backup supplier to avoid future slowdowns.

Avoid spoilage

If you're selling products with expiration dates, every sale opportunity has a time limit. Managing inventory helps you avoid unnecessary spoilage by optimizing inventory control. Avoid buying more stock than you can sell on time, and move excess stock quickly by discounting products that are closer to expiration.

Prevent dead stock

Dead stock won't sell—not because it's expired, but because it may have gone out of season, out of style, or otherwise become irrelevant. By adopting a diligent strategy, you can address this mistake so you don't have to absorb the cost of storing items you're never going to sell.

At the opposite end of the spectrum, you should also monitor your inventory levels to reduce the risk of overselling or accounting mistakes based on phantom inventory.

15 inventory management techniques

1. Economic order quantity (EOQ)
2. Demand-planning
3. Inventory counts
4. LIFO vs. FIFO
5. RFID technology
6. Barcodes
7. ABC reporting
8. Inventory valuations
9. Minimum order quantities
10. Safety stock alerts
11. Inventory audits
12. Dropshipping
13. Supplier relationships
14. Outsource inventory management
15. Just-in-time

Regardless of the system you use, the following techniques will improve your inventory management and your cash flow:

1. Economic order quantity

Economic order quantity (EOQ) helps you determine the optimal amount of inventory to maintain from a cost-savings perspective, so you know exactly how much inventory to order each time. Order too much, and you waste money on storage and risk items going bad. Ordering too little will cause stockouts, unhappy customers and more spending on rush shipping.

EOQ finds the perfect balance by looking at how much you sell each year, what it costs to place an order, and how much it costs to store items. While many software systems can calculate this automatically, understanding EOQ will help you make smarter ordering decisions.

2. Demand-planning

A huge part of good inventory management comes down to accurately predicting demand. While countless variables are involved in projecting future sales, pay close attention to last year's sales during the same period, guaranteed sales from contracts and subscriptions, seasonality, and upcoming promotions. Some demand-forecasting tools also use machine learning algorithms to analyze large datasets and anticipate demand more accurately based on a broader range of factors.

3. Inventory counts

In most cases, you'll rely on inventory software and reports from your warehouse management system to know how much product you have in stock. However, it's important to make sure the facts match up. There's no better way to gain peace of mind than a physical inventory count or stock take.

Update inventory records in real time to ensure inventory reconciliation. If your stock take frequently comes up with less inventory than what your software indicates, you can take steps to identify the source of the shrinkage. If it's shoplifting, for example, you may need to beef up security or provide additional training for staff.

Access to fresh, correct inventory data is key to moving products quickly and efficiently.

4. LIFO vs. FIFO

Last in, first out (LIFO) inventory management is a method of measuring inventory costs that can yield tax savings for your business. LIFO assumes that the merchandise you acquired most recently is sold first. If prices rise over time, then the higher-cost inventory is recorded as sold, resulting in higher cost of goods sold (COGS), lower recorded profits, and therefore less taxable income.First in, first out (FIFO) assumes that the oldest inventory is sold first. This is useful for products with expiration dates.

5. RFID technology

Radio-frequency identification (RFID) technology certainly has a role to play in the future of inventory management. It can accurately update figures in your inventory management system without requiring a direct line of sight to the products.

Many companies already use RFID tags to search for stock, combat phantom inventory, and decrease excess inventory. For example, fashion retailer Rebecca Minkoff uses RFID tags to track inventory when it arrives at their store. Levels are automatically adjusted in their inventory management system with 99% accuracy.

6. Barcodes

Some retail stores use a barcode-scanning system to keep track of product stock levels. This involves scanning a barcode that identifies each product, sending that information back to your IMS so you can track each item.

Barcode inventory systems automate the tracking of products from the moment they enter your store to the moment they're sold. It provides accurate, real-time insights into your inventory, helping you make smarter decisions and keep your customers satisfied.

7. ABC analysis

An ABC analysis categorizes inventory based on the percentage of all items in your inventory it represents, alongside the percentage of your inventory's total value it represents:

• Your A items are stock that represents a small percentage of total items, but a large percentage (e.g., 80%) of your inventory's total value.
• Your B items are stock that represents a moderate percentage of total items, and a moderate percentage of total value (e.g., 15%).
• Your C items are stock that represents a large percentage of items, and a low percentage of value (e.g., 5%).

ABC analysis shows you which are your higher-priority items. Your A stock includes your most profitable and valuable products. You'll want to make sure you always have these products on hand so you don't miss out on future sales—and use tighter security measures to prevent loss. Conversely, C stock is lower-value. Discount these items to free up cash and shelf space.

8. Inventory valuation

Inventory valuation assesses the cost of unsold inventory at the end of a reporting period. Since inventory is often your largest asset, it's important to consistently measure its value. How you value inventory impacts your cost of goods sold, net income, and ending inventory—all factors that directly affect profitability. There are also tax implications associated with your inventory valuation method.

9. Minimum order quantities

Minimum order quantity (MOQ) is the smallest number of products that you can purchase in one order from a supplier. Suppliers set MOQs to avoid wasting resources on orders that deliver them little or no profit.

By strategically managing this metric, you can optimize inventory levels, reduce costs, and maintain a smooth supply chain, ultimately contributing to the success and profitability of your retail business.

Good relationships with vendors can also help you negotiate lower MOQs to provide you with greater flexibility.

10. Safety stock alerts

Safety stock is "extra" stock you keep on hand as a buffer to avoid stockouts. You know it's time to make an order when you dip into that buffer inventory. Set up your IMS to alert you immediately when safety stock begins to sell, so you can take steps to avoid a stockout.

11. Inventory audits

It's important to audit inventory regularly. Run monthly and annual audits to ensure accuracy between your stock quantity and financial records. Investigate discrepancies until you find and address the root cause.

12. Dropshipping

With dropshipping, you never touch the products you sell. When a customer buys from you, your supplier ships the item directly to them. This means you don't need to buy inventory upfront or find space to store it.

While this makes it easier to start selling, you'll need to pick good suppliers, since they're handling your products and shipping. Many stores use dropshipping to test out new products before stocking their own inventory.

13. Supplier relationships

Strong relationships with suppliers give you more leeway when unexpected problems arise. When you have an existing supplier relationship, minimum order quantities are often negotiable. To maintain your end of the relationship as a retailer, let your supplier know when you expect an increase in sales or a large number of purchase orders so they can adjust production and lead times.

It's also important to go over supplier performance. Identify where suppliers can improve or when to make a switch. And it's never a bad idea to identify backup suppliers for in case your regular supplies run into unexpected issues.

14. Outsource inventory management

Prefer not to handle the labor and logistics of inventory management? Outsource it to a third-party logistics (3PL) partner with the resources to store, fulfill, and ship orders on your behalf.

Shopify Fulfillment Network connects you with trusted 3PL partners like Flexport, Amazon Multi-Channel Fulfillment, Bigblue, DHL Fulfillment Network, GoBolt, ShipBob, Shipfusion, and ShipMonk—all integrated into your Shopify admin. Compare capabilities, find a partner that fits your business, and monitor performance without switching systems. Shopify Fulfillment Network is free to install, and you pay your chosen 3PL partner directly for fulfillment services.

15. Just-in-time

Just-in-time or JIT inventory management is about keeping the lowest inventory levels possible to meet demand, replenishing just before a product goes out of stock. It requires careful planning and forecasting, but works well for rapidly growing brands with scheduled launches and product line extensions. This method can help reduce costs associated with inventory storage.

How to manage inventory

1. Assess your current inventory needs

Take stock of what you carry and what you sell. Pull sales reports from the past 6 to 12 months to identify trends such as:

• Fast-moving products: Those that fly off the shelves every week
• Seasonal products: Products that sell more during a predictable window, such as holiday gift items or swimsuits for summer
• Slow-moving SKUs: Products that haven't moved in 90 days

You can then forecast your inventory needs with this information. Check warehouse space and shelving costs against the projected movement of items in each category.

For example, say a craft beer subscription box sees fridge space maxed out every August. If they reslot slow movers into ambient storage and order fast movers on a weekly basis, they can free up 15% of their cold-storage capacity.

2. Choose the right inventory management method

Once you know how your products move, you can match them with proper inventory methods. For example:

• FIFO is a good fit for products that expire or go out of style quickly.
• LIFO is good for when raw material costs are rising.
• JIT is best for when demand is steady and suppliers are fast.
• EOQ is ideal when each purchase order carries a high fixed cost.

Retailers often blend methods to optimize their operations. You might use FIFO for food items, JIT for accessories, and EOQ for high-volume consumables—all managed in the same Shopify back office.

3. Analyze suppliers

Finding good suppliers is key to fulfilling orders on time. Before you commit to one, check:

• Speed and reliability: Order three test shipments and track promised versus actual arrival dates.
• Reputation: Scan trade show reviews, request two client references, and note email response time.

Share your plans with vendors about when you'll need more products. This helps them prepare and avoid delays.

Work with a mix of local and international suppliers to reduce inventory risks like slow delivery and dealing with customs. It's also smart to have backup suppliers for your most important items, just in case something goes wrong with your main supplier.

For example, say a vegan-snack company splits protein-bar production: 60% with a plant in Mexico for quick replenishment, 40% with a lower-cost facility in Thailand. When customs issues delay the shipment from Thailand, the plant in Mexico can bump up output for two weeks and prevent any stockouts.

💡 Tip: Create a supplier scorecard that ranks each vendor on lead time, reliability, service quality, and backup viability. Invite only the highest-scoring ones to quote and negotiate contracts.

4. Categorize inventory

Classify your products by their value and demand frequency. High-value items (A) need tight control procedures and frequent checks, while low-value items (C) can be managed in larger quantities.

You should also store similar products together, keep perishable items in a FIFO sequence, and label everything clearly. Then, use SKUs to identify and locate products in your system and physical storage.

5. Track inventory levels

If you want to compete with other online retailers, selling on multiple channels is no longer a question. Customers expect products to be in stock wherever and however they choose to shop. Having a single source of truth for all product data across multiple channels reduces errors and prevents stockouts.

Monitor real-time inventory updates for each product, including quantities that are available, incoming, committed, or located in multiple store locations. This unified view helps you optimize stock levels across all channels—online, offline, or otherwise. When you sell something in your store, Shopify POS immediately updates your online store. This means you'll always know exactly what you have in stock, both online and in your shop, which helps avoid selling items you don't actually have.

When Allbirds adopted Shopify POS and Shopify Plus, they took advantage of all the business tools that came included, including inventory management. This allowed the retailer to optimize store stock levels, keeping less in-store inventory and requiring less retail space to operate.

"With Shopify Plus, we have our point-of-sale and ecommerce systems under one umbrella, which serves our ultimate purpose of being an omnichannel retailer and viewing the customer as one customer—no matter where they shop with us," says Travis Boyce, head of global retail operations.

6. Set reorder points

Use past sales data and average lead times to calculate a safety margin. Get low-stock alerts and notifications when certain items reach their reorder point. This proactive approach helps you restock before running out.

If you're on an eligible plan, you can set up custom workflows in Shopify Flow that trigger solutions when an item reaches its reorder point. For instance, Flow can automatically:

• Send a Slack or email notification to your purchasing manager
• Tag products that need replenishing
• Create and send a purchase order to the supplier
• Hide products on your online store when they're out of stock

These automated workflows help you reorder stock as quickly as possible and so you won't run out of items and disappoint customers.

7. Conduct regular audits

Physical inventory checks (stocktaking) verify that your online records match your actual stock on hand. Inventory audits help identify theft, damage, or administrative errors early.

Set a schedule to:

1. Plan the audit date and who will conduct it.
2. Organize inventory in a clear, labeled way.
3. Count and verify each item carefully, investigating discrepancies.
4. Update your records in Shopify accordingly.

8. Forecast demand accurately

Use Shopify's analytics to spot trends in sales volume, seasonal demand, and bestselling products. If you know particular items sell out quickly during peak seasons (like holiday gifting), place larger orders or order earlier than usual to avoid last-minute scrambling or stockouts.

If you're planning seasonal marketing campaigns—for example, a Black Friday sale—make sure your inventory levels can support a sudden surge in demand. You might also create bundles or special holiday packaging that need their own stock considerations.

Even with careful forecasting, seasonal spikes can exceed expectations. Keep a safety buffer for high-demand items, especially if supplier lead times increase during busy periods.

9. Review and optimize your process

Inventory management is an ongoing cycle of refinement and improvement. Once you have a clear system for managing online and offline data, review your processes to see how effectively they meet customer expectations and support growth. Here's what that might look like:

• Track inventory turnover, days of supply, and carrying costs.
• Explore techniques like JIT or EOQ to see which suits your business model best.
• Adjust your reorder points, supplier list, and categorization strategies as your product offerings grow or your customer base changes.
• Regular reviews keep your processes agile and effective.

Common inventory management challenges and solutions

Preventing overstocking and understocking

Too much stock ties up cash and raises carrying costs. Too little stock means back orders and lost sales. Many retailers struggle to find the balance. Some practical fixes include:

• Forecast routinely. Refresh demand forecasts monthly using historical sales, planned promotions, and external signals (e.g., weather, social buzz).
• Set reorder points. Recompute reorder points by multiplying lead time by a safety factor so thresholds rise during peak season and fall in slower months.
• Build safety stock selectively. Hold a 10%–15% safety buffer only on high-velocity or high-margin SKUs. Low-value C items can run leaner.
• Automate alerts. Use Shopify Flow to ping purchasing when available and incoming units drop below days-of-cover targets.

Managing returns and damaged goods

In the US in 2024, 16.9% of all retail goods sold were returned, meaning roughly $890 billion in merchandise was sent back. Unsorted returns and damaged items also distort on-hand counts and hide sellable inventory that could be put back on the shelf.

Some ways to fix this include:

• Create a dedicated returns zone. Physically separate returns within 24 hours so they never mix with sellable stock.
• Standardize triage. Label each returned item "Resell," "Rework," or "Write-off" at intake and update Shopify immediately to keep counts accurate.
• Track root causes. Tag return reasons (fit, defect, shipping damage) to spot systemic issues and reduce future returns.
• Recover value. Route "Resell" items to secondary marketplaces and liquidators within 48 hours to recoup 30%–50% of original cost and clear space fast.

Dealing with seasonal fluctuations

Peak season demand can spike sales volume by 200%–300%. Data shows that holiday sales, which take place in November and December, make up about 19% of a retailer's annual sales.

Too often, demand spikes can lead to stockouts and rush-freight costs, while offseason lulls leave warehouses stuffed with unsold inventory.

You can account for these problems a few different ways:

• Layered forecasting: Combine year-over-year sales, marketing calendar, and wholesale preorders for a composite view of seasonal demand.
• Flexible supplier terms: Negotiate MOQs that shrink in the offseason and allow surge orders in peak periods.
• Timed markdowns: Preschedule end-of-season discounts before demand drops to keep cash flowing.
• Temporary capacity: Line up 3PL overflow space ahead of peak season instead of leasing year-round square footage.

Optimizing warehouse space

Average peak warehouse space utilization slipped to 73.2% in 2024, down from 78.5% the prior year, according to the Modern Materials Handling 2024 Warehouse/DC Operations Survey, indicating that businesses are using their valuable space less efficiently and effectively. Poor layout and wasted space lead to slow picking and higher labor costs.

You can optimize your warehouse with the following tactics:

• Slot by velocity. Place high-turn SKUs in the "golden zone" (waist-to-shoulder height near packing); push slow movers to upper or lower racks.
• Go vertical. Add pallet racking or mezzanines to capture cubic capacity before renting more floor space.
• Use clear labeling and SKUs. Large, scannable labels and logical SKU prefixes speed up picks and reduce mispicks.
• Leverage tech: Deploy barcodes or RFID with a location map so staff travel fewer steps and inventory accuracy stays high.

Inventory management tools

Inventory management software comes as a standalone program or is built into an ecommerce platform such as Shopify. If you run your business with Shopify, inventory management is already built in.

You can set up inventory tracking, view your inventory, and adjust your inventory levels in the Inventory area of your Shopify admin. You can also view the history of inventory adjustments and transfers for variants tracked by Shopify.

Shopify also provides inventory reports that show you a month-end snapshot of your inventory. You can access various reports like:

• Average inventory sold per day
• Percent of inventory sold
• ABC analysis by product
• Product sell-through rate
• Days of inventory remaining

To find these reports:

1. From your Shopify admin, go to Analytics > Reports.
2. Click Categories.
3. Click Inventory to filter the reports to show only inventory reports.

Inventory management apps let you monitor the live status of your stockroom. These apps are handy for employees involved in running your business actively, allowing them to access information from a smartphone or tablet. Most offer features such as inventory quantity and location tracking, stock level alerts, and order monitoring.

If you're a Shopify merchant, try these popular inventory management apps for your store:

• Stocky: Powerful and detailed real-time inventory tracking
• Thrive by Shopventory: Connect multiple Shopify accounts and automate purchase orders.
• ShipHero: Demand forecasting, purchasing automation, and more
• Zoho: Integrates with Zoho CRM and Zoho Books

The future of inventory management

Technology continues to grow and develop at an incredible pace, and many of these new and emerging technologies have applications for inventory management:

Predictive analytics

Predictive analytics uses a combination of automation, data, and machine learning to deliver accurate forecasts and analyses. Based on algorithms, these analytics models can give retailers data-backed insights that can improve inventory allocation and replenishment. This technology only continues to improve over time—and the more data you give it, the better it will know your business.

Artificial intelligence

Artificial intelligence (AI) continues to develop and gain new applications within inventory management solutions. Self-correcting AI solutions can empower businesses to automate inventory decisions and react to customer demands in real time.

The Internet of Things

The Internet of Things (IoT) can reduce the time it takes associates to find inventory by providing real-time location data for connected items. This data can also help you make more informed and effective inventory management decisions by knowing exactly how much stock you have and where.

Blockchain for supply chain transparency

The blockchain is a tamper-proof, shared ledger that records every hand-off of a SKU, from supplier to storefront. Each transfer writes an encrypted "block" that can't be altered without the network consensus.

A 2024 Inspectorio survey found 47% of supply chain leaders now list blockchain as a crucial technology for visibility and automation. It helps provide complete traceability for brands.

For example, a single scan can show where (and when) a carton of baby formula was produced, how long it sat in each warehouse, and its current temperature reading, which is important for recalls and compliance.

Run an efficient inventory management process with Shopify

A solid inventory management system will reduce your holding costs and help you analyze sales patterns, predict future sales, and prepare for the unexpected. With proper inventory management, businesses have a better chance of profitability and growth.