Inventory Policy: 38 Types of Inventory Management Policy & Procedure 2024

Inventory policy is like an essential guideline or ‘must follow’ protocol that help businesses use, store and manage their product stock efficiently. These will help you determine how much inventory you need to order, when to reorder, and how to track your stock levels, to make sure that your company meets customer demand without overstocking or even understocking.

Nike lost $100 million in sales in the early 2000s as a result of a breakdown in their new demand planning software, which led to overproduction of certain products and shortages of others. Back then this showed businesses just how important it is to accurately estimate demand and work with a good inventory policy.

One great tip is to always remember that effective inventory management lowers costs, prevents stockouts, and improves cash flow. By regularly updating key parameters like lead time, safety stock, and minimum order quantities, your business can also grow and adapt to your customer’s changing demands. These strategies will ensure smooth operations, happy line of customers, and overall profitability in sales. This blog will explore the 38 types of inventory policies, their benefits, and the steps to create an effective inventory policies.

Table of Content

• Importance of Inventory Management

Importance of Inventory Management

Types of Inventory Policies

1.  Disposal of Excess Inventory Policy
2. FIFO
3. LIFO
4. Seasonal Inventory Policy
5. Stock Review Policy
6. Stock Rotation Policy
7. Surplus Inventory Policy
8. Temperature Control Policy
9. Economic Order Quantity Policy
10. Batch Tracking Policy
11. Obsolete Inventory Policy
12. Theft Reduction Control Policy
13. Barcode and Tagging Policy
14. Two Bin Inventory Policy
15. Vendor Managed Inventory Policy
16. Consignment Inventory Policy
17. Just in Time Policy
18. Write Off Policy
19. ABC Classification Policy
20. Expiry Management Policy
21. Inventory Turnover Policy
22. Safety Stock Policy
23. Returns and Damaged Goods Policy
24. Minimum Order Quantity Policy
25. Reorder Point Policy
26. Bulk Purchase Policy
27. Order Quantity Policy
28. Lean Inventory Policy
29. Inventory Turnover Policy
30. Inventory Accuracy Policy
31. Inventory Reuse Policy
32. Inventory Relocation Policy
33. Cycle Counting Policy
34. Inventory Reconciliation Policy
35. Inventory Loan Policy
36. Inventory Cost Management Policy
37. Drop Shipping Policy
38. Demand Forecasting Policy

1. Disposal of Excess Inventory Policy

This policy outlines procedures for disposing of excess inventory to free up storage space and reduce holding costs. Donations, deep discount sales, liquidation, recycling, and, if possible, sending products back to suppliers are all examples of efficient disposal techniques. Reducing the cost of storing unsold inventory and making room for new, more profitable commodities are the main objectives.

Example: A clothing retailer donates unsold seasonal stock to charity or sells it at a significant discount.

2. FIFO (First-In, First-Out) Policy

In order to avoid waste and obsolescence, this policy makes sure that the oldest inventory is used or sold first. When talking about perishable items, it is extremely important.

Example:  A store handles its dairy items using FIFO. In order to keep products fresh and lower the chance of spoiling, older stock is sold before newer supplies are arranged on shelves. This helps to preserve customer happiness and cut down on waste.

3. LIFO (Last-In, First-Out) Policy

Although it’s less prevalent in physical inventory management, this policy promotes the inventory that was received most recently. It can be useful for some accounting tactics.

Example: A supplier of building supplies use LIFO for its gravel and sand inventory. Although this strategy might be less effective for goods that are perishable, they can better control cost fluctuations and accounting by using the newest stock first.

Formula: 

LIFO Cost of Goods Sold (COGS)=∑(Cost of Newest Inventory × Quantity Sold)

4. Seasonal Inventory Policy

Based on variations in seasonal demand, this policy adjusts inventory levels. During peak seasons, it guarantees an adequate stock, while during off-peak times, it minimizes excess.

Example: A retailer of swimwear raises inventory throughout the spring and summer and lowers it during the fall and winter. In order to increase sales and reduce surplus inventory, they make sure that products are available when customers need them most by matching inventory to seasonal demand.

Formula: 

Seasonal Inventory Level=Base Demand + Seasonal Demand

8. Temperature Control Policy

To guarantee quality and compliance, this policy keeps sensitive inventory at the right storage temperature.

Example: To maintain the freshness of perishable items, a food distributor uses refrigerated storage.

9. Economic Order Quantity (EOQ) Policy

In order to reduce the whole cost of inventory, including ordering and holding expenses, this policy determines the ideal order quantity. It fulfills inventory requirements and guarantees cost effectiveness.

Example: A hardware business uses EOQ to figure out the ideal order size for screws and nails. They balance the costs of buying and keeping these things by figuring out the optimal order amount, which guarantees they always have enough stock to meet client demand without spending extra money.

Formula: 

EOQ = √2DS ÷H

This inventory policy is helpful for managing products with batch numbers and expiration dates since it tracks inventory by batches to provide traceability and quality control.

Example: Batch tracking is used by a pharmaceutical company to control the manufacturing of medications. In the event that a batch is discovered to be defective, the business can promptly identify and recall just the impacted batch, causing no disruption to the overall inventory.

Formula: 

Batch Tracking ID=Batch Number + Manufacturing Date

11. Obsolete Inventory Policy

This policy deals with the handling and getting rid of outdated inventory that isn’t useful or sellable anymore.

Example: An electronics manufacturer recycles obsolete, out-of-demand models.

Formula:
Obsolete Inventory Cost = Carrying Cost + Disposal Cost

13.Barcode and Tagging Policy

The proper use of barcodes and tags for inventory management and tracking is outlined in a barcode and tagging policy. For effective inventory control and accurate data, it guarantees that every item is correctly tagged and scanned.

Example: A retail electronics store applies the Barcode and Tagging Policy by giving each product a special barcode that combines the item’s unique identifier with the product category code. At the point of sale, this technology guarantees prompt product identification and effective inventory tracking.

14. Two-Bin Inventory Policy

16. Consignment Inventory Policy

Under a consignment inventory policy, even though the inventory is kept at the retailer’s location, the supplier is still the legal owner of the goods until the shop sells them. The retailer’s financial risk is greatly decreased because they only have to pay for the merchandise once it has been sold.

Example: A clothing manufacturer stocks different retail establishments with its merchandise. The producer keeps ownership of the clothing until it is sold, even though the stores display and sell the items. This way, both the manufacturer and the retailer can ensure that their products are always available to customers without requiring a significant initial investment. If any products don’t sell, the manufacturer can move the inventory to other locations or sales channels, and the retailer can return the unsold items to the manufacturer without incurring any losses.

Formula:

Consignment Inventory Value= Stock at Customer Location × Unit Cost

17. Just-in-Time (JIT) Policy

In order to reduce holding costs and increase efficiency, this method only orders inventory when it is required for production or sales.

Example: Using JIT, an automaker can only order automobile parts when they are actually needed for the assembly line. This guarantees that inventory levels match precisely with production needs, which helps to streamline operations and cut costs. It also lowers waste and storage costs.

Formula: 

JIT Inventory Level=Current Demand + Lead Time Demand

18. Write-Off Policy

The process of deleting or decreasing the value of inventory from accounting records that is worthless to businesses is known as an inventory write-off. Inventory can be written off for a number of reasons, including when it is no longer valuable and cannot be sold because of theft, damage, loss, or a drop in market value. Inventory can occasionally get out of date, deteriorate, sustain damage, or disappear. An organization is required to write off inventory when certain circumstances arise.

$$\text{Annual Consumption Value (ACV)}=\text{Annual Demand }\times \text{Unit Cost}$$

20. Expiry Management Policy

Inventory products with expiration dates are used or sold before they become unusable thanks to this policy.

Example: A pharmacy rotates its inventory to guarantee that older drugs are sold first and reduce waste.

Formula:
Expiry Cost Savings = Cost of Expired Goods − Cost of Rotation

21. Inventory Turnover Policy

Over time, this policy creates targets for the frequency of inventory replacement and sale. It saves holding expenses and improves efficiency.

Example: A  clothing store usually plans to swap out its stock every 3/4 months. They minimize the quantity of outdated inventory and guarantee that consumers always have access to the newest fashions by routinely upgrading stock to keep up with current trends. This increases sales and enhances inventory management.

Formula: 

Inventory Turnover Ratio=Average Inventory ÷ Cost of Goods Sold​

22. Safety Stock Policy

This policy describes excess inventory held as a safeguard against changes in supply or demand. It guarantees both client happiness and continuous servicing.

Example: A pharmaceutical company that keeps safety stock of essential drugs. This buffer helps to preserve consumer confidence and prevent shortages by guaranteeing that necessary medications are available even in the event of supply chain disruptions.

Formula: 

Safety Stock=Z×σ×$$\surd$$L

23. Returns and Damaged Goods Policy

Procedures for managing returned or damaged inventory are outlined in this policy. It lowers losses and keeps correct data.

Example: An electronics retailer has explicit guidelines about how to handle returns and damaged goods. They guarantee precise stock levels and limit losses by processing these effectively and updating inventory records, which contributes to the preservation of profitability.

Formula: 

Returns Rate=Total Units Sold ÷ Number of Returns​×100

24. Minimum Order Quantity (MOQ) Policy

This policy establishes the lowest quantity that a buyer must purchase from a supplier. It guarantees that production demands are met while helping in cost management.

Example: A manufacturer establishes a minimum order quantity (MOQ) for raw materials such as steel. This helps them optimize inventory levels and cut costs since they guarantee they always order enough to meet production demands without going over budget.

Formula: 

MOQ=Number of Orders per Period ÷ Total Demand

25. Reorder Point Policy

In order to avoid stockouts and unnecessary holding costs, this policy specifies when inventory should be reordered. It guarantees steady product availability.

Example: For popular drinks, a beverage distributor establishes reorder points. They guarantee that clients may always locate their favorite beverages, lowering the possibility of missed sales, by setting a threshold that initiates fresh orders prior to stock running out.

Formula: 

Reorder Point=Lead Time Demand + Safety Stock

26. Bulk Purchase Policy

Businesses can take advantage of discounts and lower per-unit expenses by purchasing merchandise in bulk thanks to this strategy.

Example: In order to reduce purchasing expenses, a chain of supermarkets purchases non-perishable commodities in bulk.

Formula:
Cost Savings = (Unit Cost Before Discount − Unit Cost After Discount) × Quantity Purchased

The major goals of this policy are to reduce waste and keep inventory levels at only what is required. It lowers expenses and increases efficiency.

Example: A tech business that uses lean inventory methods maintains very little inventory of components and orders new ones only when needed. This strategy helps the business be flexible and adaptable to changes in the market by cutting waste and making sure that resources are used effectively.

Formula: 

Lean Inventory Level=Demand During Lead Time + Safety Stock

30. Inventory Accuracy Policy

The policy at hand sets guidelines for conducting routine audits and checks in order to maintain correct inventory records. It guarantees accurate facts for making decisions.

Example: An electronics seller conducts quarterly inventory audits to make sure that system records and actual stock match. By locating and resolving disparities, this procedure guarantees that inventory data is reliable and suitable for use in making valid business decisions.

Formula: 

Inventory Accuracy Rate=Total Inventory Counts ÷ Correct Inventory Counts​×100

31. Inventory Reuse Policy

In order to cut expenses and waste, this policy encourages the reuse of inventory goods that may be repaired or reconditioned.

Example: A furniture company repairs returned goods so it can sell them for less money.

Formula:

Reuse Cost Saving = Cost of New Item − Refurbishment Cost

32. Inventory Relocation Policy

In order to meet demand and maintain supply levels, this policy calls for shifting inventory across locations.

Example: A retail chain moves extra inventory from a poorly performing store to one that is in high demand.

Formula:
Transfer Cost = Transportation Cost + Handling Cost

33. Cycle Counting Policy

the cycle counting policy uses periodic partial inventories instead of waiting to complete inventory counts. By extending the counting process over time, this increases accuracy and operational efficiency.

Example:  A sizable warehouse counts several inventory categories once a week, paying extra attention to high-value items. This lessens interruptions and keeps accurate records all year long, guaranteeing that inventory levels are constantly current and that inconsistencies are promptly found and fixed.

Formula:

Cycle Count Frequency=Count Days per Year ÷ Total Inventory Items

34. Inventory Reconciliation Policy

The practice of verifying your inventory data with what you really have in stock is known as inventory reconciliation. An organization can find disparities by comparing data records and physical inventories in this way.

Formula:

Inventory Reconciliation = Physical Count – Accounting Records

35. Inventory Loan Policy

Under this policy, corporations are able to lend inventory to other businesses or obtain loans to cover short-term shortages.

Example: A manufacturer lends extra raw materials to a partner business that is having delays in the supply chain.

36. Inventory Cost Management Policy

This next policy focuses on using effective management techniques to lower total inventory costs.

Example: To cut down on holding expenses, a manufacturing corporation, uses just-in-time ordering.

Formula:
Total Inventory Cost = Ordering Cost + Holding Cost + Stockout Cost

37. Drop Shipping Policy

This policy states that orders are shipped straight to the client from the supplier. As a result, the company can stop keeping inventory and save money on handling and storage.

Example:  Drop shipping could be used by an internet merchant that specializes in large furnishings. The furniture is shipped straight to the buyer by the supplier after an order is placed. This lowers the logistical complexity and expenses related to inventory management while sparing the shop from having to keep bulky items.

Formula: 

Drop Shipping Cost Savings= Traditional Inventory Costs − Drop Shipping Costs

38. Demand Forecasting Policy

A business predicts future product demand using analytical methodologies and historical data in a demand forecasting policy. This keeps stock levels in line with anticipated sales, preventing overstocking and stockouts.

Example: A toy retailer forecasts demand for particular toys over the Christmas season by examining historical sales data and current market trends. By doing this, they guarantee that there is enough inventory to satisfy consumer demand without going overboard, which lowers expenses and increases sales potential at busy times.

Formula: 

Forecast Demand= ∑(Historical Demand)​ ÷ Number of Periods

Benefits of an Effective Inventory Policy

Common Mistakes in Inventory Policy and Strategy

Ignoring Variability in Demand

Demand variations can cause stockouts during busy times or surplus inventory during calm periods, which are bad for business and consumer happiness.

Skipping Lead Times

Order fulfillment delays and possible sales losses might result from supply chain activities that are not adjusted for the time needed to replace stock.

Rare Policy Reviews

Inventory policies can become out of date and result in inefficiencies and lost opportunities if they are not revised on a regular basis to account for changes in the market or business growth.

Disregarding Supplier Trustworthiness

Without continuous oversight, assuming that suppliers would fulfill their obligations on a regular basis may lead to unanticipated shortages that affect sales and production.

Steps to Create an Effective Inventory Policy

Define Business Objectives

First and foremost, set clear, well-defined objectives for your inventory policy. Making the most of your storage space, cutting expenses, raising customer happiness, and preventing stockouts are a few examples. Speaking with other departments, such as operations, finance, and sales, can also be crucial to understanding their requirements and how inventory affects them. You can make sure that the policy benefits the entire organization by bringing everyone up to speed. Also, make sure your objectives are quantifiable so you can monitor your progress and make the required corrections.

Analyze Current Inventory Practices

Study your present inventory management system in detail. Examining your ordering procedures, item storage practices, and inventory turnover rates are necessary for this. To find out what’s working well and where issues exist, get information from your inventory systems and speak with your staff. Understanding your current procedures will help you design a stronger policy by pointing out areas that require change.

Classify Inventory Items

Sort the items in your inventory into groups according to their relative value and rate of sale. An ABC analysis, for example, could be used if A is high-value but low turnover, B is intermediate, and C is low-value but high turnover. It allows you to concentrate your attention and energy on the most important things. Check these areas on a regular basis to stay aware of shifts in industry trends and sales.

Determine Inventory Levels

Next, to meet client demand without going overboard, calculate the quantity of each item you must have in stock. To figure out these levels, take into account lead times and supplier dependability in addition to historical sales data. This process aids in striking a compromise between the expense of inventory holding and the possibility of stock outs. Keep an eye on these numbers and make any necessary adjustments depending on real sales and market circumstances.

Choose an Inventory Management Method

Now, select the inventory management strategy that works best for you. First-In, First-Out (FIFO), which uses older stock first, and Just-in-Time (JIT), where you order products just when needed, are two common options businesses go for. But always pick the approach that best suits your company’s requirements as each has advantages and disadvantages. For example, FIFO is excellent for keeping things from going bad, especially for perishable goods, while JIT can reduce storage costs but needs a stable supply chain.

Set Reorder Points and Quantities

This is where you define when and how much stock needs to be ordered again. Make sure you place your reorders before your stock runs too low by basing them on lead times and safety stock levels. Reorder amounts need to be such that holding and ordering expenses are balanced. Make sure that these choices are accurate and up to date with supplier performance and current demand by reviewing them on a regular basis.

Develop Ordering Procedures

Next it is important to remember that clearly defined, standard ordering processes for inventories need to be established. Choosing suppliers, assigning orders, and establishing requirements for order approval are all included in this step. Consistency and error reduction are ensured by standardizing processes. If your business wishes to have uninterrupted operations, create backup plans in case the supply chain is disrupted.

Establish Tracking and Monitoring Systems

This is where you put systems in place to monitor your inventories in real time. Barcodes, RFID tags, and inventory management software and more can all be used in this process. As making sensible choices requires having accurate records of your inventory- real-time tracking comes in handy. For maximum efficiency, integrate these technologies with your purchasing and sales operations.

Implement Inventory Controls

Managing a business can be a risk and an unknown one. So putting protections in place to guard against inventory errors, theft, and loss is always a smart choice. This means process controls like routine inventory counts and physical controls like safe storage spaces. Set precise protocols for managing inconsistencies and carrying out audits. Strong inventory controls will protect your assets and help you keep your inventory data accurate.

Train Employees

To make sure that your employees are aware of their responsibilities, train them on new processes, systems, and best practices. Employee training is key to the effective execution of your inventory policy. Suppose that in order to track inventory your business decides to use a new barcode scanning system. So staff members need to get training on how to use these scanners, enter data accurately, and troubleshoot standard issues. Employees can type in data incorrectly if they are not properly trained, which could result in gaps in inventory records.

Review and Improve

Finally, review your complete inventory policy on a regular basis to see what is and is not working. To judge performance, use information from your tracking systems and stakeholder input. You can also make adjustments in response to these reviews to maintain the policy’s efficacy and compatibility with your company’s goals.

Download Inventory Policy Sample Template Below!

To sum up, inventory policies are necessary for efficient stock management, cost containment, and customer satisfaction. They help businesses in keeping the proper amount of inventory on hand, avoiding shortages or excess, and streamlining their processes. Profitability and efficiency can both be increased with good inventory management practices.

Pro Tip–  Any business looking to improve inventory control and guarantee seamless operations can start out with the Smart Sales Kit’s sample inventory policy documents. Visit www.smartsaleskit.com to get ahead and stay on top.

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