To understand inventory software, it is important to take a close look at the main issues involved in managing inventory. First, there has to be correct identification of the functions performed by the inventories. Second, there has to be an establishment of the right relationship between inventory functions and inventory levels that decides the optimum level of inventory. Finally, strategies have to be worked out to keep inventories at optimum level.

Of these, the most important issue is defining what the optimum inventory is. In simple terms, it is the level that is sufficient to meet the projected demand, but not enough to erode the projected profits. The firm has to determine at what inventory level it can avoid lost sales due to stock out situations. Lost sales are a relevant concept in inventory management from more than one angle.

It is quite easy for any firm to totally avoid stock out situations and the consequent risk of lost sales by maintaining a very high level of inventory incurring a heavy cost. Sound business calls for optimization of inventory levels and costs subject to the condition that the forecasted sales are realized from the relevant territory. Reducing the inventory levels can reduce inventory costs. Obviously, one must assess the probability of run-out and the effect on sales and profit and offset the costs of holding the stocks against the profits accruing from holding the stocks and realizing the sales.

Since the task is basically one of offsetting the costs of holding the inventories against the benefits derived by holding the inventories, inventory management is essentially a balancing act. Inventory is primarily a function of the customer service level fixed by the firm. And the customer service level in the physical distribution context is primarily a function of the ability to meet a demand at the retail outlet level as and when the demand arise from the readily available stocks without having to generate a back order.