Inventory management means tracking what stock you buy, hold and sell so you never run out of fast movers or tie cash up in slow ones. The basics are an item master, a stock register for every receipt and issue, reorder levels, regular physical counts and valuation at the lower of cost and net realisable value. GST-registered businesses must also keep commodity-wise stock accounts under Rule 56.
Inventory management is how a business keeps track of the goods it buys, stores and sells. In a small Indian business, the stock on the shelves is often the largest asset after cash, so a sloppy stock register quietly eats profit through dead stock, theft and lost sales. This guide covers the building blocks: the item master, stock registers, reorder levels, physical counts and the GST record rules that apply to stock.
What is inventory management and why does it matter?
Inventory is any goods held for sale, goods being produced for sale, or materials and supplies used in production. For a trader, that is finished goods on the shelf. For a manufacturer, it also includes raw material, work in progress, packing material and scrap.
Inventory management answers four daily questions:
- What do I have? Quantity and location of every item.
- What is it worth? Value at cost, for your books and your bank.
- What should I buy next, and when? Reorder levels and lead times.
- What is not moving? Slow and dead stock that ties up cash.
When these questions go unanswered, the symptoms are familiar: a customer asks for a fast-moving item and it is out of stock, while the back room holds three cartons of something that has not sold in a year. Both problems cost money. The first loses a sale; the second freezes working capital you could have used to pay suppliers or take a cash discount.
What records does a basic inventory system need?
You need three layers of records.
The item master
The item master is the list of everything you stock, with the fixed details of each item:
| Field | Example | Why it matters |
|---|---|---|
| Item code / SKU | PL-PVC-110 | Unique identity; avoids duplicates |
| Description | PVC pipe 110 mm, 6 m | What prints on the invoice |
| HSN code | As applicable | Needed on GST invoices |
| Unit of measure | Piece / length / kg | Prevents unit-conversion errors |
| GST rate | 18% (example) | Tax on sale |
| Purchase cost | ₹640 | Valuation and margin |
| Selling price | ₹820 | Billing |
| Reorder level | 40 pieces | Triggers purchase |
| Batch/expiry flag | Yes/No | For perishables and medicines |
Clean item master data prevents half of all stock errors. If the same pipe exists as "PVC Pipe 110mm" and "PVC pipe 110 mm 6m", your stock will look short on one and excess on the other.
The stock register (stock ledger)
Every movement of an item goes into a stock register: opening balance, purchases received, sales issued, returns in and out, transfers between godowns, and adjustments for damage, loss or samples. Closing balance is always:
Closing stock = Opening stock + Receipts − Issues ± Adjustments
Supporting documents
Each entry must trace back to a document: a purchase invoice, a sales invoice, a delivery challan for goods moving without a sale, a credit note for returns, or an internal note for write-offs. Without the document, the entry is just a number.
What stock records does GST law require?
Section 35(1) of the CGST Act requires every registered person to keep a true and correct account of, among other things, inward and outward supplies, stock of goods, input tax credit availed and output tax payable and paid, at the principal place of business (and at each additional place of business listed in the registration certificate).
The accounts and records rules go further. Every registered person, other than a person paying tax under the composition scheme (section 10), must keep a stock account for each commodity received and supplied, showing:
- opening balance,
- receipts,
- supplies,
- goods lost, stolen, destroyed, written off, or disposed of as gifts or free samples, and
- closing balance, including raw materials, finished goods, scrap and wastage.
Manufacturers must also keep monthly production accounts showing quantities of raw material used and goods manufactured, including waste and by-products.
Why does this matter in practice? Section 35(6) lets the proper officer treat goods that are not accounted for as if they had been supplied and determine tax on them. An unexplained shortage of 200 units is not just a business loss; it can become a tax demand. The retention and electronic-record rules are covered in our guide to GST record keeping rules.
How do you set reorder levels?
A reorder level is the stock quantity at which you place the next order. The simplest working formula is:
Reorder level = (Average daily sales × Lead time in days) + Safety stock
Worked example: a Pune hardware shop
A Pune hardware shop sells PVC pipes. Over the last 60 days it sold 360 pieces, so average daily sales are 6 pieces. The distributor delivers 5 days after an order. The owner wants a 3-day buffer for delays.
- Lead-time demand = 6 × 5 = 30 pieces
- Safety stock = 6 × 3 = 18 pieces
- Reorder level = 30 + 18 = 48 pieces
When the stock register shows 48 pieces or fewer, the shop orders. How much to order depends on cash and supplier minimums. If the shop orders a fortnight's worth (6 × 15 = 90 pieces) each time, maximum stock right after delivery would be roughly 18 + 90 = 108 pieces.
At a cost of ₹640 per piece, holding 108 pieces at peak locks up ₹69,120. Cutting the order size to 60 pieces lowers peak stock to about 78 pieces (₹49,920), freeing nearly ₹19,200 — at the cost of ordering more often. That trade-off between ordering cost and holding cost is the core of inventory planning.
How do you classify stock to focus your effort?
Not every item deserves the same attention. ABC analysis ranks items by annual consumption value (quantity sold × cost):
| Class | Typical share of items | Typical share of value | Control approach |
|---|---|---|---|
| A | Small number | Most of the value | Weekly counts, tight reorder levels |
| B | Moderate | Moderate value | Monthly review |
| C | Large number | Small share of value | Simple rules, bulk ordering |
These shares are rules of thumb, not fixed ratios; your own sales data decides where the cut-offs fall. The point is to spend counting time on the items where errors cost the most.
Pair ABC with a movement check: list items with no sale in the last 90 or 180 days. These are candidates for discounting, returning to the supplier, or writing down to net realisable value at year end.
How should you run a physical stock count?
The book stock in your register is only a claim. A physical count proves it. Here is a simple procedure:
- Fix a cut-off. Choose a date and time; stop receipts and dispatches or record them separately.
- Prepare count sheets by location, listing item codes but not the book quantity, so counters are not influenced.
- Count in pairs. One person counts, one records. Recount high-value items.
- Check the cut-off documents. Goods received but not yet invoiced, and goods invoiced but not yet dispatched, must be handled consistently.
- Compare counted quantity with book quantity and list differences.
- Investigate large differences: billing errors, wrong units, unrecorded returns, theft.
- Post adjustments with a written reason and approval, and record write-offs in the stock account as the GST rules require.
- Value the counted stock at the lower of cost and net realisable value.
Cycle counting — counting a few items every week on rotation — keeps the register honest all year and makes the year-end count much faster. The year-end steps are listed in our year-end closing checklist.
How do you value inventory at the end of the period?
Under ICAI's Accounting Standard (AS) 2, inventories are valued at the lower of cost and net realisable value. Cost includes the purchase price, duties and taxes other than those later recoverable from the tax authorities, inward freight and other directly attributable costs, less trade discounts and rebates. That means GST you can claim as input tax credit is not part of inventory cost.
For interchangeable items, AS 2 allows the FIFO or weighted average cost formula. The choice changes your closing stock value and profit, so it deserves its own read: see stock valuation methods.
Which inventory method fits which business?
| Business type | Key inventory concern | Useful practice |
|---|---|---|
| Kirana / general store | Many low-value SKUs | Barcode billing, ABC focus |
| Pharmacy | Expiry and batch recalls | Batch and expiry tracking, FEFO |
| Hardware / building material | Bulky items, unit conversions | Clear units of measure, godown-wise stock |
| Garment shop | Size and colour variants | Variant-level SKUs |
| Small manufacturer | Raw material and WIP | Monthly production account, bill of materials |
Pharmacies, food businesses and cosmetics sellers need batch-level records; see batch and expiry tracking. High-volume retailers benefit most from scanning at the counter; see barcode billing for retail.
How does software help with inventory?
A spreadsheet works for a few dozen items, but it breaks down when one person forgets to update it after a sale. When billing and stock live in the same system, every invoice reduces stock, every purchase entry increases it, and credit notes for returns add goods back automatically. Billing Software by Betterwork, for example, updates stock from each invoice and can track batch and expiry for items that need it, so the stock report and the sales register always agree. Whatever tool you use, the discipline is the same: one item master, every movement documented, regular counts.
Common mistakes
- Duplicate item names for the same product, creating phantom shortages and excesses.
- Mixing units, such as buying in boxes and selling in pieces without a defined conversion.
- Not recording free samples, gifts and breakage. These must appear in the GST stock account, and unexplained gaps can be taxed as supplies.
- Counting only at year end. Errors accumulate for twelve months and become impossible to trace.
- Including recoverable GST in stock cost, which overstates inventory and profit.
- Ignoring dead stock instead of writing it down to net realisable value.
- Letting goods leave without a document, especially branch transfers and goods sent for repair.
Key takeaways
- Build a clean item master first; most stock errors start there.
- Keep a stock register where closing stock = opening + receipts − issues ± adjustments.
- GST-registered businesses (other than composition dealers) must keep commodity-wise stock accounts, including losses and free samples.
- Set reorder levels from average sales, lead time and a safety buffer.
- Count physically, at least yearly, ideally in weekly cycles.
- Value stock at the lower of cost and net realisable value under AS 2, excluding recoverable taxes.
This guide is general information, not tax advice. Rules last checked on 20 October 2026; confirm with your tax professional for your situation.