Inventory analysis definition

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What is Inventory Analysis?

Inventory analysis is the examination of inventory to determine the optimum amount to keep on hand. Traditionally, this has been done by balancing the costs of ordering and holding inventory (known as the economic order quantity). However, considerably more inventory analysis must be conducted to account for additional factors, including the following:

  • Just-in-time ordering. A business may have a just-in-time system, which is designed to minimize the amount of inventory on hand. In this situation, suppliers are likely to be close by and able to deliver small quantities with great frequency. If so, the amount of inventory kept on hand may represent only a few hours of usage. However, this presents the risk of a complete production shutdown if there is a delayed delivery. Consequently, many organizations strive to maintain a modest amount of safety stock to act as a buffer.

  • Order fulfillment philosophy. If management wants to reduce the turnaround time on orders placed by customers, it may be necessary to store large amounts of finished goods inventory near the shipping area, in every possible product configuration. This can be a real concern when a business maintains large numbers of stock keeping units, since the related inventory investment can be astronomically high. Conversely, rapid order fulfillment is easier when the range of product options is strictly confined to a small number of items.

  • Inventory obsolescence. If a company manufactures goods that are only relevant in the marketplace for a short period of time (such as consumer electronics), it will need to maintain tight control over the amount of inventory kept on hand. This is also a concern when the inventory can spoil in a few days, as is the case with food inventory in a restaurant.

  • Cash availability. If an entity has little excess cash, it will have little to invest in inventory, and so is forced to keep inventory levels lower than may be optimal. This could involve accepting stockout conditions, where customers must wait for extended periods before goods are delivered to them. An extreme scenario is that the company maintains no inventory at all, and instead only places orders for inventory from suppliers after it has received payment from customers.

  • Customer service levels. If a business wants to compete based on high levels of customer service, then it will likely need to maintain a significantly higher investment in inventory, so that the goods customers want are always in stock. A high level of customer service can correspond to a substantially higher investment in inventory.

In short, inventory analysis involves more than the use of a single calculation to determine inventory levels. Instead, a number of factors involving company strategy, production systems, financing, and the requirements of the marketplace must all be examined to arrive at the optimal inventory level.

Advantages of Inventory Analysis

The top advantages of running an inventory analysis in a regular basis are as follows:

  • Reduced carrying costs. Inventory analysis helps identify excess stock, slow-moving items, and unnecessary reorder quantities, reducing storage, insurance, handling, financing, and obsolescence costs.

  • Fewer stockouts. By reviewing usage patterns, lead times, and demand variability, inventory analysis helps maintain enough stock to meet customer or production needs.

  • Improved cash flow. Lowering excess inventory releases cash that would otherwise be tied up in goods that are not being sold or used promptly.

  • Better purchasing and production decisions. Inventory analysis supports more accurate reorder points, economic order quantities, safety stock levels, supplier planning, and production scheduling.

Inventory Analysis FAQs

What risks does inventory analysis help identify?

Inventory analysis helps identify the risk of obsolete or slow-moving stock that ties up capital and may need to be written down. It also highlights excess holding costs, such as storage, insurance, and spoilage, that erode profitability. Additionally, it reveals supply chain inefficiencies or errors in valuation that can distort financial results and mislead decision-making.