Levels of Inventory
Establishing the correct reorder points is essential for cash flow and customer service. They need to be as low as possible to reduce the amount of money being tied-up in stock, but high enough to ensure good customer service levels are maintained. With the correct reorder levels, a business knows it has safeguards in place to prevent excessive inventory or shortages. Each business must determine its minimum and maximum levels of inventory suitable to meet demand, accounting for lead time from supplier and variations in both.
When a business is in its infancy and production is manageable, guessing reorder points may work just fine. As the business grows, relying on experience and instinct is seldom enough, and good inventory systems are needed to analyze supply, demand, seasonality, etc. All stock holding businesses face this challenge.
Establishing the Minimum Stock Level Point
Minimum Stock is the level of inventory that you cannot afford to drop below. If you do, then production can be compromised for lack of materials, risking late or unfulfilled orders and dissatisfied customers.
There are many reasons a company runs out of stock, a miscalculation in lead time from supplier being one. Even reliable suppliers can experience problems with their own production and supply chains. Many businesses will maintain safety stock (extra inventory) to cover the variations in delivery times.
From the sales side, a miscalculation of demand can also cause a shortage. Most companies will look at past sales records, noting fluctuations at certain times of the year, to make a prediction about expected demand. To calculate your minimum stock level, you will use figures representing normal consumption numbers, factored by seasonality and known events.
If products are custom-made, materials may be ordered as sales orders are received. In these cases, the manufacturer may not carry the stock themselves.
As a matter of practicality, a business shouldn’t wait until the minimum order is reached before reordering and will determine reorder points. Waiting until the minimum level is reached is like driving with the gas tank on empty – you just don’t know if you’ll make it if you’re running on fumes. The minimum stock level should be calculated by subtracting the normal amount of consumption overage times the normal reorder period from the reorder level.
Establishing a Reorder Level
Your reorder level will fall somewhere between the minimum and maximum stock levels. Other formulas can be used to determine this figure: for example, multiply the maximum consumption rate by the maximum reorder period. If you always reorder when you reach this stock level, you’ll never have to worry about dipping below the minimum amount nor letting things slip away from you until you reach the danger level. These amounts should be calculated for every material needed to stock or manufacture. Your reorder points must account for the lead time and how much material already at your facility will be used up while you wait for that next delivery to arrive. You don’t want to get into the habit of using up your safety stock because you wait too long to reorder. So, it’s a fine balance to optimize cash invested in stock versus customer service.
SOS Inventory sets reorder levels to place orders automatically (if preferred), assuring you will always refresh your inventory stores on time. You can also set alerts to notify you when inventory reaches certain levels.
At the other end of the spectrum is the maximum level of inventory to carry. Businesses don’t want to exceed this amount, or they risk wasting product. Carrying too much inventory can also mean extra storage is required and more money tied up in inventory. Every business must consider its available capital for inventory and available space when determining this amount as these considerations can both override what other calculations indicate is practical.
- Maximum materials required
- Consumption rate
- Storage costs
- Raw material cost fluctuations
- Expiration dates
- Government regulations
- Trends & Seasonality
All these considerations boil down to the following formula:
The maximum stock level = Reordering Level + Reordering Quantity – (Minimum Consumption x Minimum Reordering period)
Danger Stock Level
If you ran on fumes for too long, you’d find yourself at the danger stock level. At this point, you’ve dropped below your minimum and possibly cannot produce any new product. Manufacturing maybe halted.
Danger Level = Average Consumption x Maximum reorder period for emergency purchases.
Average Levels of Stock
The average simply represents the midway point between the minimum and maximum levels of stock.
Average Stock Level = Minimum stock Level + 1/2 of Reorder Quantity.
As your business grows, your reorder points can change because you’ll add new suppliers or your production increases to meet increased demand.
The best way to prepare for growth is to modernize your inventory management system with SOS Inventory. Know exactly how much inventory you have at any point in time and when you need to reorder. Get started with your free trial today!