Inventory Management and Accounting

By Peter Spaulding, Sr. Content Writer

Last Updated June 5, 2025

4 min read

Classifying Inventory

In the retail supplier space, inventory is often classified based on a variety of cycles/stages:

Stage of the Production Cycle – e.g., raw materials, works-in-progress, finished goods
Inventory Type – e.g., raw materials, merchandise inventory
Inventory Condition – e.g., new, returned, refurbished, damaged, obsolete
Demand or Turnover – e.g., seasonal, fast-moving, slow-moving
Costing Methods – e.g., First-In, First-Out (FIFO); Last-In, First-Out (LIFO), weighted average
Location – e.g., consignment, on-hand, in-transit
Value – e.g., high, low
Category – e.g., clothing, grocery, home improvement
Functional Classification – e.g., core, supplementary

Classifying inventory at these and other levels is key for doing performance management at a variety of levels.

Maximizing Inventory Management in Retailers

When trying to get the most out of inventory management, there are a few key factors that suppliers should keep in mind. These factors are some of the leading causes of inaccurate inventorying.

Shrinkage

Shrinkage is broadly defined as the loss of physical inventory, but it should be thought of also as discrepancies between what accountants think retailer inventory is and what the physical inventory in retailer warehouses is.

This often results from what suppliers call Overages, Shortages, and Damages (OSDs). Really, though, any discrepancies between what the retailer claims was received, what the supplier believes was sent/sold, and what the actual on-hand inventory is create shrinkage. These discrepancies can involve any number of errors that go way beyond OSDs.

Phantom Inventory

Phantom inventory occurs when the inventory levels recorded at the store level are inaccurate. Many retailers rely on their Global Replenishment System (GRS) forecasts to automatically reorder products based on projected needs compared to their existing supply.

For example, if Walmart forecasts expect store 100 in Bentonville, AR, to sell three units next week and the store’s pipeline indicates five units On Hand that aren’t actually there, the system will fail to generate an order.

If Walmart’s GRS system believes a store has product even when it doesn’t, it will delay an order (or not place it altogether), leading to:

Out-of-stocks
Lost sales

In fact, phantom inventory is one of the major root causes behind instock problems at Walmart.

Phantom inventory can be dangerous because it’s a “silent killer.” This issue often sneaks up on a lot of suppliers because everything looks “right” on paper (filling orders On Time and In Full, instocks look “healthy,” etc.), but the supplier just doesn’t seem to be selling what’s expected. As the supplier sells fewer products because of phantom inventory, Walmart’s system artificially suppresses its forecast because it believes the product isn’t “moving,” leading to fewer orders and further lost sales.

Phantom inventory is usually caused by:

Replenishment errors
Shrinkage
Improper handling of merchandise
Incorrect recording of sales

Suppliers can curb phantom inventory by running a phantom inventory analysis and comparing recent point-of-sale (POS) activity at an item-store level against:

Store pipeline
Historical POS

From there, suppliers can flag a store if it has had historical sales but hasn’t sold at similar levels recently, despite having enough product in the pipeline, which indicates a potential for phantom inventory.

Once there is a list of stores suppliers suspect have phantom inventory, a few tactical options become available:

Send an SSO/DC Push
Request Walmart perform an On Hand audit

SKU Rationalization

SKU (Stock Keeping Unit) realization is also known as SKU optimization or product rationalization. It is the process of deciding whether to keep or discontinue a specific product. SKU rationalization enables suppliers to cut down inventory costs and reduce complications in purchasing, production, and distribution.

SKU rationalization is a critical element that fuels the enhancing of Personal Consumption Expenditures (PCE), as SKU proliferation raises extra non-productive time and also increases costs. These costs can include straightforward manufacturing of product and release expenses, inventory investment, sales and marketing costs, service/support spending, and surplus and outdated inventory handling charges.