Optimal Inventory Levels

Holding excessive or inadequate inventory is bad for business and has negative impacts on the business.

The business has to consider optimal inventory levels, which is a factor of your business, product, demand cycles, and supply chain consistency. Just-in-time (JIT) inventory systems are used by most businesses for safety stock calculations to meet these conflicting priorities.

To build effective inventory levels, these key processes need to be implemented. By establishing these processes, businesses can avoid the pitfalls associated with inventory imbalances—such as excessive holding costs and capital constraints on one end, or stockouts and customer dissatisfaction on the other.

1. Demand Forecasting

• Review history of sales statistics
• Define seasonal cycles and patterns
• Consider factors in the market and growth situations
• Implement statistical forecasting methods (moving averages  exponential smoothing)
• Build short and long-term forecast of demand

2. Inventory Classification (ABC Analysis)

• Identify items of value and significance (A: high value/significant, B: moderate,C: low value). The aim is to prioritize the high value items to ensure you reduce the risk of stock outages
• Implement different stock strategies based on classification
• Allocate resources in relation to inventory values

3. Lead Time Analysis

• Track supplier performance and delivery lead times
• Tabulate variation in lead times
• Determine reliability issues with specific suppliers
• Calculate average lead times and standard deviations

4. Safety Stock Calculations

• Establish service level goals (e.g., 95%, 98%)
• Calculate on the basis of demand variability and lead time uncertainty
• Make adjustment for critical vs. non-critical items
• Review and rebalance on a regular basis

5. Economic Order Quantity (EOQ) Analysis

• Calculate optimal order quantities that will drive down total cost
• Balance ordering cost and holding cost
• Account for quantity discount offered by suppliers
• Account for storage constraints

6. Inventory Turnover Analysis

• Track inventory turnover ratios by product category
• Compare with industry
• Identify slow-moving or obsolete inventory
• Set turnover objectives by product type

7. Cost Analysis

• Calculate all costs related to inventory (storage, insurance, obsolescence, etc.)
• Define stockout costs and impact on customer satisfaction
• Review cost of capital invested in inventory
• Review handling and processing costs

8. Technology Deployment

• Implement inventory management software
• Implement barcode/RFID systems for accurate tracking
• Use real-time data collection throughout supply chain
• Build dashboards to monitor key metrics

9. Regular Review Process

• Have routine inventory audits and cycle counts
• Develop exception reporting of inventory differences
• Conduct regular optimization meetings with cross-functional teams
• Institute feedback loops from sales, operations, and finance

10. Continuous Improvement

• Document inventory performance metrics
• Test and evaluate inventory policy changes
• Train staff on inventory management best practice
• Adapt to evolving market conditions and supply chain disruptions

The success of the process implementation depends on cross-functional collaboration between sales, operations, finance and procurement groups to tie in with broader business objectives.