Setting a minimum stock level by calculating the appropriate amount of stock that your company must have at all times, safeguards it from stock contingencies. Going out of stock can prove to be a massive pitfall for the company as it would result in a loss of customers.
In this article, we have discussed minimum stock level, how to calculate minimum stock level, its advantages, as well as what type of limitations it can pose. So, let's begin!
What Is the Minimum Stock Level?
The minimum stock level is the lowest quantity of a product that a company wants to have on hand at any given time to avoid stockouts or backorders. The company's actual product or material stock must not fall below this pre-determined point. In other words, you can say that this is a lower limit of the stock amount of the products that your company must always store.
Maintaining stock levels is highly critical as it is directly responsible for the company to meet its market demand or to keep production going. If you are a manufacturer, and your raw material stock falls under the minimum level, the everyday manufacturing process will be hampered and stopped. If you're not already, you must give serious attention to calculating and maintaining minimum stock levels to run operations flawlessly.
Minimum Stock Level Calculation
Next, let's understand how to calculate the minimum stock level. Various methods to calculate the minimum stock level are:
- Average Demand Method
- Safety stock method
- Reorder Point method
All these methods take into account certain different factors and depending on those factors every minimum stock level formula differs. Let's understand how the minimum stock level is calculated below.
Average Demand Method: The factors you must know to calculate the minimum stock level in this method are -
- Average daily demand for a product
- Average selling time of a product
Formula: Minimum Stock Level = Average Daily Demand X Average Time to Sell
Example: Suppose you have just started a small retail clothing store. On average you sell 30 t-shirts in 2 days where the market demand is 50 t-shirts per day. So, you can calculate it like this:
Minimum Stock Level = Average Daily Demand X Average Time To Sell = 50 X 2 = 100
Safety Stock Method: Factors considered in this method of calculation are:
- Average daily demand.
- Standard deviation demand or expected demand fluctuation rate.
- Average lead time or the time a shipment takes to arrive from the supplier to you.
- Desired safety level which is the amount of extra stock you want to have to manage demand fluctuation.
Formula: Minimum Stock Level = Average Daily Demand X Standard Deviation Demand X Average Lead Time X Desired Safety Level
Example: Let's say that your retail t-shirt business is seeing growth and you have an average daily demand of 10 t-shirts where the standard deviation is 5 t-shirts, the average lead time is 1 day, and the desired safety level is also 5. So, the minimum stock level will be calculated as:
Minimum Stock Level = Average Daily Demand X Standard Deviation Demand X Average Lead Time X Desired Safety Level
= 10 X 5 X 1 X 5 = 250
Reorder Point Method: Factors you should consider in that case are-
- Average demand of product per day/ week/ month
- Number of days to receive a new shipment
Formula: Minimum Stock Level = Average Demand Per Day X Number of Days to Receive a New Shipment
Example: So, if you sell 20 t-shirts per day and it takes 3 days to receive new shipments the calculation will be like this:
Minimum Stock Level = Average Demand Per Day X Number of Days to Receive a New Shipment = 20 X 3 = 60
Factors Affecting Minimum Stock Level
In this section, let us next understand the factors that determine the minimum inventory level of your business. The key factors that affect minimum stock level are product rate and market demand.
If the market demand for a product has certainly decreased and the rate has also lowered, you will probably see a loss on the products that you have in stock already. It is because you have already purchased those products from the supplier at a high price.
The best way to cope with it is to be up-to-date with the market movement and calculate the minimum inventory level from time to time, especially before an off-season as in those times of the year the demand remains low generally.
Limitations of Minimum/Maximum Stock Level Rule
Where the minimum stock level is the lower limit below which the company's actual stock must not fall, the maximum stock level is the higher limit above which it is considered overstocking for a company.
They function on the basis of SKU (Stock Keeping Unit codes) that help in keeping track of the stocks. These two rules are great to control a company's stock or inventory count. Yet there are certain limitations. They are -
- In the trading business, order policies defer from supplier to supplier and some may need the buyer company to reach a particular selling point to reorder the goods. That level can be divided across all the goods that the supplier trades in. However, the parameter of minimum/maximum stock level functions on the basis of individual SKUs and not on an overall basis as per the supplier's order policy.
- During the SKU life cycle such as introduction, growth, maturity, and decline, the minimum/maximum stock level must be continuously checked. Without checking if replenishments get done constantly, there will be a risk of overstocking or having dead stock.
Advantages of Minimum Stock Level Management
The minimum stock level works as a great tool for companies to maintain inventory effectively and to cope with losses due to stockouts.
If you store an amount of product less than the minimum stock level, you will run out of stock and see losses in sales. On the other hand, unnecessary overstocking in the storage or warehouses risks converting goods into dead stocks, and as you have already engaged your money there this is also potential for losses.
Moreover, the amount of product you store in the warehouse is directly related to the market demand, production necessity, and cost, with other factors of the supply chain. The minimum/maximum inventory level helps in mitigating these concerns and smoothly running the supply chain.
How to Optimize Inventory to Maintain Minimum Stock Level
Right and meaningful steps, such as inventory optimization can create a huge difference in the growth of your business. Optimizing inventory means having the right number of products in stock, which contributes to the seamless maintenance of minimum stock levels. Effective inventory optimization relies on checking several factors as discussed below.
Demand Forecasting
Demand forecasting is a process that helps in predicting the number of sales and revenue for a future period. This is a predictive analysis method based on previous sales of a company.
Having understood how the minimum stock level is calculated, we can now understand that previous sales records play a great role here. You must be aware of the market demand for the products you sell based on the sales you have already made.
By doing so you can get an idea of how much stock you need to have for a particular future period and the chances of running out of stock will be lowered.
Inventory Replenishment
This is a process of transportation of goods from the manufacturer or the supplier to the retailer or from the inventory storage to the picking shelves.
Timely inventory replenishment ensures that enough product is ready on your picking shelves and once orders are received, you can quickly pack and release them for delivery. The growth of a company hugely depends on how quickly you can get the right type of product to your customer. Timely inventory replenishment will never allow you to go out of stock, helping in growing customer satisfaction and interest in your company.
Inventory Levels
Having an idea of your inventory level is another great way to manage stock in your company. When you have a smaller number of products in your stock you may lose sales as well as customers for not meeting their needs in time.
On the other hand, having excessive stock items means you have engaged more capital than needed. Optimizing inventory levels helps you know the actual needed stock amount that must be there in your storage, resulting in smooth business operations, improved cash flow, and customer loyalty.
Inventory Storage
Another important factor that must be prioritized is optimizing inventory storage. Your storage capacity must be high and at the same time, it needs to be cost-effective.
Manage your inventory in such a way that you have stock in your hand to meet market demand as well as, have the capacity to store new products in an emergency. The storage management must be smooth, efficient, and error-free.
Challenges in Setting Minimum Stock Level
Calculating and keeping track of the minimum stock level is indeed challenging. It needs real-time inventory analysis, sales history, and accurate calculations, without which several challenges may crop up.
- Inaccuracy in predicting customer demand, i.e., incorrect demand forecasting can pose a challenge to maintaining optimum stock level. Both underestimating and overestimating can pose a challenge.
- Since the lead times of suppliers can fluctuate, it becomes difficult for businesses to know how much buffer inventory they must maintain. If the lead time is longer, then businesses need to keep higher minimum stock levels to prevent stockouts.
- The cost of carrying inventory like storage and handling costs also affects profitability.
- The demand for certain products depends on the season. So for such products, businesses need to revise their minimum stock level from time to time.
- Without automated software, setting and monitoring minimum stock levels may become time-consuming and complicated for businesses that have many SKUs.
Manage Inventory Levels Seamlessly With TranZact
Setting a minimum stock level means creating the right balance between inventory and demand and ensuring that while doing so costs are low. With deep analysis and close supervision by using software like TranZact, the above-discussed challenges can be handled.
TranZact's cloud-based ERP and inventory solutions enable you to monitor inventory and manage minimum and maximum stock levels with ease. It offers in-depth visibility of your inventory at one glance, simplifying inventory management and reordering processes. Tracking of purchases and sales can also be done seamlessly with smart dashboards to give you a complete overview of your business functions and help you make informed decisions!
FAQs on Minimum Stock Level
1. Is safety stock necessary for all businesses?
Yes, having safety stock is necessary for maintaining consistency in the inventory and supply chain, and omitting the chance of going out-of-stock.
2. What are the advantages of a minimum stock level?
The minimum stock level helps in indicating reorder points so that you never run out of stock. It helps to ensure the timely delivery of orders, and retention of customers, increase cash flow and liquidity, and leads to better inventory management.
3. What are the types of minimum stock levels?
There are two types of minimum stock levels: Reorder Point (ROP) and Safety Stock. The ROP is the level of inventory at which a company places an order to replenish its stock, while safety stock is the additional inventory held by a company as a buffer against unexpected fluctuations in demand or supply chain disruptions.
