A Guide to E-Commerce Inventory Analysis

Ashley Stander
By Ashley Stander
Joel Taylor
Edited by Joel Taylor

Published April 30, 2022.

A 3D illustration with the words "Inventory Management" and icons related to inventory management

An inventory analysis can play a critical role in achieving a better return on investment for your company. But it doesn't only enhance your bottom line, it also helps inventory managers establish optimized control over your warehouse layout, it improves cashflow and simply manages your company's capital in a smarter and more effective manner.

What Is Inventory Analysis?

An inventory analysis is the process of working out how much stock you need to keep in storage to be able to give your customer what they want without overstocking and landing up with dead or outdated stock. It's a continuous process of analyzing your inventory costs and aligning these costs to your website's Key Performance Indicators (KPIs) so that you can fine-tune your stock levels to maintain optimal levels.

An inventory analysis has these goals:

  1. Always have enough stock to keep your customers happy
  2. Lower overall business costs and expenses
  3. Manage your cashflow optimally
  4. Reduce incidents of theft and fraud

Types of Inventory

Inventories are broken down into five main categories. In the list below we use an example of a clothing manufacturer's inventory:

  1. Raw materials This would include various materials, cottons, zips, buttons, etc.
  2. Work-in-progress (WIP) inventory Let's say the manufacturer makes denim pants and tops. The WIP inventory would include the items of clothing as the go through the different stages such as material cut, material sewn, buttons and zips added, washing and ironing, packaging.
  3. Finished goods Once the clothing has gone through all of the above stages and are ready for dispatch, they will fall into the finished goods category. The finished goods category can be broken down into further inventory categories such as ready for sale, allocated, in-transit, seasonal and safety. This means that there are, in actual fact 10 inventory categories when you include these into your inventory analysis.
  4. Maintenance, repair, and operations (MRO) goods These are goods that are used in the process of manufacturing the final product, such as industrial sewing machines, safety equipment, cleaning materials and uniforms.
  5. Packing materials This inventory includes all the materials you use to pack your products for shipping, such as bubble wrap, boxes, plastic covers and tape.

Inventory Analysis Techniques

There are many different techniques that you can use to analyze your inventory. Let's look at the most common techniques used:

  1. Economic Order Quantity (EOQ) This technique uses a formula that calculates the ideal order quantity that your company needs to be at optimal levels. The formula uses variables such as cost of production and rate of demand. The main aim of this technique is to bring costs down to a minimum.
  2. Just-in-time (JIT) The JIT technique involves keeping as little stock as possible, lowering the risks and costs involved with keeping a large amount of stock on hand. This is a risky technique because if you have an unexpected boost in sales, you may need to let customers down.
  3. ABC Analysis This technique categorizes inventory items according to their annual consumption value. Some managers classify their inventory according to Pareto's Principle. An ABC analysis splits your inventory into section A (10% of the total inventory, accounting for 70% of the total consumption value), section B (20% of the total inventory, accounting for about 20% of the total consumption value) and lastly, section C (70% of the total inventory, accounting for only 10% of the total consumption value). This technique can take the analysis one step further with the XYZ technique.
  4. Material Requirements Planning (MRP) This is a control analysis method that integrates data from the different business area inventories. The inventory manager will place an order based on the data as well as the market demand.
  5. Minimum Order Quantity This technique helps your company to stay profitable and have a healthy cash flow. It is based on your total cost of inventory plus any expenses you need to pay before you see a profit. This technique is used to deter bargain shoppers, increase profits, and get rid of stock quickly.
  6. High Cost/Medium Cost/Low Cost (HML) This technique measures your inventory according to the cost per item by segmenting products into three categories. Firstly, high cost for high unit value items, secondly medium cost for medium unit value items, and thirdly low cost for low unit value items. HML considers each item's unit price but not its sales value, however, it is still very insightful when you are trying to control your budget.
  7. Scarce Difficult Easy (SDE) This technique speaks to the scarcity of products or how quickly you'll be able to get the goods you need - it takes a look at the availability of the inventory. Scarce items have very long lead times, difficult goods need a lead time of a couple of weeks up to six months and easily available items can be acquired without delay.
  8. Vital Essential Desirable (VED) This technique uses the value of goods to compartmentalize the analysis. It is more popular in manufacturing companies that stock a large variety of parts and components. A VED inventory, as its name suggests, has three categories: vital goods (must be in stock), essential goods (need a minimum amount) and desirable goods (optional stock).

The Role of Inventory Forecasting

Inventory forecasting (or demand planning) and inventory analysis, though closely linked, are not the same thing. The inventory forecasting essentially predicts the amount of stock your inventory manager needs to order, while the analysis looks at optimizing the levels of inventory you have to make sure you are running your business as lean as possible. There are four types of inventory forecasting:

  1. Graphical forecasting Using historic data
  2. Trend forecasting Looks at your current trends
  3. Quantitative forecasting Uses past numerical data
  4. Qualitative forecasting Uses focus groups and market research

The main benefit of forecasting is that you use actual data from the past to more accurately predict the inventory levels that you will need in the future. As we know, past behavior is not always a sure way of predicting the future but it most definitely will give you a much better idea than an educated guess.