Management of inventory levels is a balancing act in manufacturing businesses. A large inventory will result in dead stock, which will increase overhead costs. If you have low inventory levels, you may face stockouts and will not be able to satisfy customer demand. Optimal levels of inventory lie somewhere between these two options and it can be difficult to stay there without moving to either side.
The question is how to find out the optimal inventory levels for your business. In this blog post, we will understand the details of inventory levels and look at the different types of stock. We will also look at ways to improve your inventory management.
What Are Inventory Levels?
Inventory levels are the quantities of raw materials, semi-finished goods, and finished goods that a business maintains across its entire distribution and logistics network, at any given point in time. Inventory is an important part of any operation, regardless of size. It is a buffer between supply and demand and helps you avoid stockouts or excess inventory.
But, many businesses need to learn how much inventory they need to carry to meet customer demand. This can lead to overstocking and understocking. Both of them can be costly in terms of lost sales and wasted shelf space. A company has many types of stock levels and inventory control levels.
What Are the Different Types of Inventory Levels?
Inventory levels in the supply chain can be used to determine the amount of inventory that your company should keep in stock. The four levels of inventory are minimum, maximum, average, and danger stock levels.
1. Minimum Inventory Levels
Minimum inventory levels are the base or minimum levels you should maintain per every Stock Keeping Unit (SKU). If you fall below this level, you risk stocking out and not being able to meet customer demand. A company needs to maintain minimum stock levels in inventory management to avoid that. Not having the necessary items in stock can also result in longer lead times.
2. Maximum Inventory Levels
Maximum inventory levels are the highest amount of inventory a business should have at any given time. If your inventory exceeds that level, you will be at the risk of unnecessary overhead costs. Maximum stock levels in inventory management are calculated by considering sales trends, seasonal variations, and inventory costs. Therefore, before placing a purchase order (PO), you should calculate maximum inventory levels.
3. Danger Inventory Level
Danger inventory levels mean that a company's inventory supply is quickly running out. When inventory levels for a particular item reach the danger level of stock, this shows that the company should immediately restock that item to avoid a supply shortage and interruption of production. When the inventory of a business hits the danger level of stock, the business is forced to purchase stock from suppliers who can deliver it within the shortest time frame. But this might be expensive compared to regular prices.
4. Average Inventory Level
An average inventory level is the ideal quantity of stock you should maintain for your business. This way, you have enough inventory to satisfy your customers' demands at any given time. All while minimizing inventory costs, moving cash flow, and increasing profit margins. For example, if a business typically sells 100 items a month, it should aim to keep an average inventory of 100 items. This will make sure that it has enough stock level management to meet customer demand but not so much that it ties up too much cash in inventory.
What Are Optimal Inventory Levels?
There are different stock levels of inventory and it is very important that you maintain the best level. Overstocking can lead to holding up excess capital. Even then, not all the inventory may be sold at the end. Keeping less stock can also lead to backorders and stockouts, affecting your sales and profits. While determining inventory levels that best suit your business, or optimal inventory levels, you should account for the ideal stock levels required, based on your demand across the year. These are the right quantity of stock levels that an organization should have in its warehouses or fulfillment centers at any given time.
Why It Is Important to Maintain the Right Inventory Levels?
The cost of inventory is often a big portion of a company's expenses. At the same time, the value of inventory decreases over time as it becomes less valuable and its value depreciates. Maintaining an optimal level of stock is important so that companies can meet customer demand while keeping their costs down.
Optimizing inventory control levels helps to build trust and loyalty with customers. It also helps companies offer discounts to encourage customers to increase their purchases from the business. Moreover, maintaining low holding costs helps businesses reduce overhead costs associated with storing excess stock and maximize profits.
How to Determine Optimal Inventory Levels?
Logistics managers consider many factors when determining the optimal stock levels. While every manufacturer might have a different method to calculate inventory, they are bases on the following four elements:
1. Customer Demand
Account and inventory level management teams should work together with logistics managers to analyze demand trends over time, demand forecasts, and seasonal demand.
2. Stock turnover
Good slotting needs to be managed by knowing the turnover for each SKU. Demand may be analyzed with methods like ABC analysis to organize SKUs.
3. Type of product
When determining the optimal stock level, you should consider the company's business sector and product characteristics. Managing inventory for certain products such as medical or food businesses differs significantly from cable and pipe storage.
4. Lead time
The warehouse inventory management team should also know the lead times of suppliers. Lead time refers to the difference between when a stock entry order is created in a warehouse and when the supplier delivers the goods to the warehouse.
Best Practices for Maintaining Optimal Inventory Levels
Let's look at some of the best practices that support businesses to achieve optimal inventory levels in supply chain:
1. Organize inventory by priority: Some products require more attention than others due to their high demand. For this, inventory management techniques help by organizing inventory and ranking items from most to least important. There are many methods to follow like ABC analysis, HML analysis etc. For example, below are the levels of hierarchy in ABC Analysis:
- A- products with a high level of sales that need to be reviewed frequently and reordered regularly.
- B- products of moderate value requiring monthly reorders.
- C- low-value products that are reordered minimally
2. Establish points for reordering: Reorder points are determined by how quickly you sell a product and how long it takes to restock it. By setting reorder points, you make sure that you never run out of stock. The best way to do this is to assess customer demand and lead times. It is helpful to have inventory management software that alerts your team to begin refilling.
3. Inventory management software: Inventory management software allows SKUs, orders, and inventory to be synced in real-time. It also simplifies the process of centralized inventory management, fulfillment centers, and sales channels.
4. Audit inventory regularly: To avoid danger stock level, you must perform inventory audits with an effective inventory management system. The good thing is that with modern inventory software, you can also automate this process. With this software, spot checks, cycle counts, and complete annual checks can be carried out.
5. Bundling and kitting: Using kitting, separate products are bundled together and sold as a single unit, which increases the average order value. This is a cost-effective way to keep shipping costs down and deadstock at a minimum.
6. The use of hedge inventories: Inventory hedging is a method of avoiding adverse effects from strikes or interruptions of supplies. In hedging, risks, and potential costs involve speculation and forecasts of events that may not occur. But, it may benefit organizations when adverse conditions arise.
7. Ability to respond quickly: A quick response strategy has usually proven useful for businesses with high turnover and low profit margins. When data generated at checkouts are promptly available to suppliers, they can manage inventory and reduce lead times by developing more accurate forecasts.
How to Calculate Minimum and Maximum Inventory Levels?
Identifying your minimum and maximum stock level of inventory is the first step in calculating your optimal inventory levels. To learn that, you should first understand the following definitions:
1. Reorder point - when your inventory needs replenishment to avoid a stockout situation.
2. Optimal quantity - how much inventory quantity can be purchased economically at one time.
3. Minimum consumption - is the least amount of demand expected over a given period.
4. Consumption rate - estimated demand for that period based on your historical sales.
5. Minimum lead time - waiting time for your replenishment once your order has been placed.
6. Normal delivery time - when you expect your replenishment to arrive at your warehouse once the order is placed.
Your inventory levels can be calculated effectively once you have these numbers.
Minimum Inventory Level Formula
The minimum inventory levels formula is defined as follows:
- Minimum inventory level = reorder point - (normal consumption x normal delivery time).
Let's take t-shirts as an example. Typically, your normal delivery time is 3 weeks for reorder points of 15,000 t-shirts. Each week, 600 units of these shirts are consumed.
- Minimum inventory level = 15,000 shirts - (600 shirts per week x 3 weeks) = 13,200
- You would need 13,200 shirts as inventory levels in cost accounting.
Maximum Inventory Level Formula
Use the following formula to determine the maximum inventory level:
- Maximum inventory levels = reorder point + reorder quantity - [minimum consumption x minimum lead time].
In this example, you reorder around 20,000 shirts, but your reorder point is still capped at 15,000. Your minimum lead time hovers around 3 weeks, and you consume 500 shirts per week.
- Maximum inventory levels = 15,000 shirts + 20,000 shirts - (500 shirts x 3 weeks) = 33,500
- In this example, the stock levels in cost accounting are 33,200 shirts.
Calculating Optimal Inventory Levels
The optimal stock level is between your minimum and maximum levels. For a better understanding, you need to calculate minimum inventory level and maximum inventory level. It is more than just plug numbers into a formula and get optimal levels. You need to consider your real-time inventory data and the growth assumptions you use to forecast future demand. As these factors constantly change, it can be challenging to calculate maximum inventory level and minimum inventory levels.
Some businesses use spreadsheets to calculate this number, but this method is unreliable and time-consuming. Instead, an inventory management software or operations optimization tool is the better option. It helps to automate inventory processing, improves stock control, and enhances order fulfillment.
Keeping your inventory in check with TranZact
Keeping your inventory levels in check is challenging for businesses. With many data points to keep in mind, it becomes difficult for them to maintain spreadsheets and build upon hours of calculation for every data point. This holds them back from expanding their offerings and scaling effectively. This is where TranZact comes in.
TranZact goes beyond an ordinary ERP and is an important software solution for your business. It helps you keep your inventory in check and monitors your end-to-end inventory and sales cycle. This tool is a must-have for companies looking to automate their business and reduce their costs effectively in no time.
By integrating with Google Sheets, Tally, and other solutions, you can effectively integrate TranZact with your existing tools while leveraging the power of a robust platform to optimize your business further.
FAQs on Inventory Levels
1. How to forecast inventory levels?
Inventory forecasting is a method of predicting the amount and timing of inventory a business needs to meet future demand. It's a process that helps you decide how much inventory to purchase or make and how much to store to meet customer demand at the lowest cost.
2. What is the minimum inventory level?
A business' minimum inventory levels are the lowest quantity of stock on hand. This is based on the demand for their products and how quickly they can replenish their stock if needed.
3. What is the maximum inventory level?
The maximum inventory levels are the highest amount of inventory that should be stored in your warehouse. Several factors, including time, determine what it takes to replenish stock, how often you sell items, and how long customers buy items.
4. What are the 4 inventory stock levels?
The four inventory stock levels are safety stock, danger level, maximum stock level, and minimum stock levels.
5. How do you determine inventory levels?
Inventory levels are determined by forecasting demand, considering lead times, and analyzing sales trends and historical data.
6. What are 4 types of inventory in supply chain?
The four types of inventory in the supply chain are:
- Raw materials
- Work-in-progress (WIP)
- Finished goods
- MRO (Maintenance, Repair, and Operations)
7. What is the stock level of inventory?
The stock level of inventory refers to the number of goods a business has on hand at any given time. This is important for meeting customer demand and avoiding stock outs or overstock situations.
8. What are the different types of stock levels?
The different types of stock levels include safety stock, reorder level, maximum stock level, and minimum stock level, each serving a unique purpose in inventory management.
9. What are inventory control levels?
Inventory control levels refer to the different thresholds set to manage inventory, including reorder level, safety stock, and maximum and minimum stock levels, which help prevent stockouts and overstock.
10. What are the biggest factors affecting inventory levels?
The biggest factors affecting inventory levels include demand forecasting accuracy, lead times, supplier reliability, and changes in market trends or customer preferences.
