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Learning how to manage inventory efficiently is critical to any business that sells physical goods. Anything that involves your products, from timely ordering to proper receiving, tracking and storage, is part of inventory management. It’s vital to get these things right because mistakes here directly impact your bottom line. By minimizing lost sales, misplaced stock and excess ordering, inventory management boosts your profits and can even reduce your taxes.

Inventory management is the umbrella term for the procedures and processes that affect ordering, receiving, storing, tracking and accounting for all of the goods a business sells.

Inventory management is a key element of supply chain management, but the terms aren’t interchangeable. Supply chain management oversees the flow of products from raw goods and production sourcing through final distribution. Inventory management deals with receiving, tracking and storing the products you hold, plus provides data for informed purchasing.

For a small business or solopreneur, supply chain and inventory management procedures easily meld together. However, it’s important to know the distinctions as you grow and begin delegating supply chain and inventory tasks to staff or outside contractors.

Any business that sells products must manage goods properly in order to survive. If you don’t have goods in stock to sell, or if you can’t find items to fill orders, you have no income. It’s that simple.

However, stock shortages are just the first stumbling block caused by bad—or no—inventory management. It’s very easy to order excess inventory when you don’t closely track stock, which leaves you cash-strapped in the short term. Over time, inventory overages also lead to bottom-line losses due to expired, outdated and otherwise unsellable stock.

And let’s not forget business taxes. Too much unsold inventory on hand at the end of the year equals higher business property tax and income tax bills. Luckily, you can avoid these roadblocks by incorporating simple inventory management procedures and tools into your operating plan.

If you find that inventory-related tasks take up a major portion of each day, it’s probably time for a review and reboot. Good inventory management is more than increasing stock accuracy, it makes your day more efficient. Once you have good processes and procedures in place, you’ll soon find more time for business-building activities.

Here’s a seven-step approach to creating an inventory management plan with procedures, controls and tools tailored to your business’s unique needs.

How you source and store the various products you sell determines how you manage your inventory. If you stock all products in your own facility, your inventory controls and processes are handled internally.

However, if you store goods externally in fulfillment centers or supplier warehouses, or if you use dropship suppliers, you need to tie inventory processes and data tools to their systems.

Whether you stock goods yourself, use a fulfillment partner or focus on dropship vendors, keeping close tabs on inventory data is vital to inventory management. For this, spreadsheets and inventory management systems are invaluable tools.

Square POS is a free system with a full suite of inventory tools that help you track all types of product data.

The inventory data you’ll want to record and track generally includes:

You can use a spreadsheet for simple inventory tracking needs, say for less than 100 items. However, integrated inventory management systems such as Square POS, Lightspeed or Clover are very cost-effective and make handling small business inventory a snap from day one.

These systems streamline customer orders, inventory tracking, supplier data, purchase orders and stock receipts within one system. Plus, most seamlessly connect to retail point-of-sale (POS) systems, online sales channels, fulfillment centers and dropship partners for real-time inventory updates.

Creating an internal product SKU system is helpful for quickly identifying and tracking products during daily activities. SKUs generally use a combination of letters and numbers which are arranged to deliver key details about an item at a glance.

For example, BW066-3201_RASP is an internal SKU that’s coded to communicate specific information for a home goods company.

So, with a glance at the SKU, employees know exactly what an item is and other key details such as where it’s stored and how it displays or ships.

Having a place for everything and everything in its place makes all of your inventory-related tasks quick and efficient. If you handle inventory in your own facility or store, first organize and identify storage areas, such as racks, shelves and bins, then assign each product to a specific area.

Small inventory items can be sorted and stored by SKU in labeled bins or on sections of shelves, while larger products can be stored on pallets.

Here’s where internal SKUs come in very handy. You can easily connect certain areas of the retail floor, stock room or warehouse using your SKU’s vendor or category codes.

Forecasting is predicting how much inventory you’ll need on hand to meet upcoming demand. Naturally, this involves many factors, such as product sales velocity, upcoming promotions, market trends, seasonality and business growth, to name a few.

The goal of forecasting is to have just enough inventory on hand to cover predicted sales for a prescribed period of time, such as 15, 30 or 60 days. Understanding sales velocity for products is critical to forecasting and inventory management systems greatly help with built-in forecasting tools in purchase orders.

Understanding supplier lead times also plays a key role in forecasting. Reliable suppliers that ship quickly let you stock fewer items and order more often, which helps with cash flow. With slower-shipping suppliers or seasonal purchases, you’ll have fewer and larger purchases, which ties up more cash in inventory.

Promptly receiving inventory shipments is another key element of learning how to manage inventory. You can’t sell or ship inventory that’s not checked in and properly shelved or displayed. So, it’s wise to make inventory receipts a priority in your inventory management plan.

Stock checkin must be accurate, too, since errors directly impact your product QOH data and lead to over-ordering, false backorders and unsold stock. All of this impacts your bottom line.

The best procedure is to receive stock against your purchase order, and open and check all cases and containers to make sure everything is correct. Don’t rely on box labels and supplier packing slips since their staff can make mistakes, too.

After receipt, stock should be quickly shelved in its assigned space. Or, if it’s overstock or seasonal goods, note temporary locations in your inventory management system so you can find it when needed.

When shelving or stocking new inventory, you can use methods such as “last in, first out” (LIFO) or “first in, first out” (FIFO). Generally, it’s smart to use the FIFO method, which stocks new goods behind older stock, so you sell older goods first. This is especially important with perishable foods and goods with expiration dates, such as cosmetics.

Most inventory-driven businesses do an annual inventory count, called an audit, for tax purposes. This compares a physical count of all goods in stock to the inventory quantity on hand (QOH) shown in the data records. However, discrepancies found in annual counts are nearly impossible to trace and account for since it may be months after the errors occurred.

Physical, hands-on inventory counts spot errors that even the best technology can’t catch.

That’s where interim counts such as cycle counts and spot checks fill the gap. These help you find and remedy small inventory inaccuracies before they become big problems.

Simply put, when in doubt—count. Closely monitoring inventory is key to improving your cash flow, spotting theft or other loss issues, and boosting that bottom line.

There are many economical inventory management tools on the market. Some are even free, such as Square POS. Most of these systems deliver everything you need to manage inventory. Plus, they seamlessly connect sales channels and fulfillment sources within one system, so you’re primed for growth.

Here are some top inventory management tools to consider:

It’s easy for startups and small business owners to jump into sourcing products and selling without an inventory management plan. However, if left too long, inventory management shortfalls quickly become headaches that cost you both customers and profits. By putting these seven essential elements in place, you’ll be on the road to learning how to manage inventory and—best of all—set up for profits from day one.

Inventory management tracks the goods a company purchases to sell. Inventory is only an asset until it’s sold, then it becomes a “cost of goods sold” (COGS) expense. Asset tracking accounts for the cost and depreciation of the equipment and supplies that a business purchases to operate.

The 80/20 productivity rule of thumb states that 80% of your profits come from 20% of your efforts. Applied to inventory, it means 20% of your overall product line accounts for 80% of your profits.

Inventory formulas are equations that give you insight into the health and profitability of your inventory. Useful formulas to know are inventory turnover, which is cost of goods sold ÷ average inventory, and sell-through rate, which is units sold ÷ units received over a set period of time.

There are several types of inventory that businesses track. Raw goods include materials, parts and ingredients used to make or repair finished goods. Assembly units are goods made only when ordered. In-progress units are unfinished items. Finished goods are completed products ready for sale. Product packaging and shipping supplies can also be tracked as inventory items.

Krista Fabregas is a seasoned eCommerce and online content pro sharing more than 20 years of hands-on know-how with those looking to launch and grow tech-forward businesses. Her expertise includes eCommerce startups and growth, SMB operations and logistics, website platforms, payment systems, side-gig and affiliate income, and multichannel marketing. Krista holds a bachelor's degree in English from The University of Texas at Austin and held senior positions at NASA, a Fortune 100 company, and several online startups.

Kelly is an SMB Editor specializing in starting and marketing new ventures. Before joining the team, she was a Content Producer at Fit Small Business where she served as an editor and strategist covering small business marketing content. She is a former Google Tech Entrepreneur and she holds an MSc in International Marketing from Edinburgh Napier University. Additionally, she manages a column at Inc. Magazine.