How much inventory should I keep
Finding the Balance: Managing Inventory for Your Business’s Success
In the complex world of business management, one crucial aspect often overlooked is inventory management. For any organisation, be it a small retail store or a large manufacturing firm, pharmacy or mechanic finding the right balance in inventory levels is critical. In this blog, we will delve into the intricacies of inventory management and help you understand how much inventory your business should hold to optimise its operations and financial health.
Working Capital: The Lifeblood of Your Business
Working capital is the heartbeat of any organisation. It represents the funds available to cover day-to-day operational expenses and seize new opportunities. An efficient inventory management system ensures that working capital is not tied up unnecessarily in unsold goods. Holding excess inventory can hinder cash flow and impact your ability to invest in growth or weather financial challenges.
On the flip side, insufficient inventory can lead to lost sales and unhappy customers and delayed jobs affecting scheduling. So, how do you strike the right balance?
Scarcity and Limited Resources
One key factor in determining your inventory levels is understanding the scarcity and limitations associated with your products. If your goods are rare or have long lead times for production, holding some extra inventory might be a prudent move to prevent stockouts.
However, it’s crucial to strike a balance. Excess inventory can lead to obsolescence, increased storage costs, and the risk of items becoming outdated. Evaluating the scarcity of your products will help you make informed decisions about your inventory levels.
The Cost to Store
Storing inventory isn’t free. Warehousing costs such as rent, wages, forklift, robot dispensing, insurance, and potential spoilage or damage expenses can quickly add up. It’s essential to consider these costs when deciding how much inventory to hold. A lean and efficient inventory management system can help you minimise storage costs while ensuring you have the right amount of stock to meet demand.
Time to Order: Balancing Supply and Demand
The time it takes to restock your inventory is a critical factor in determining how much to hold. If your supplier has long lead times, it might be wise to keep higher levels of stock to bridge the gap between orders. However, if your supplier can quickly replenish your inventory, you can maintain lower levels and reduce holding costs.
Costs of Not Having Inventory in Stock
Running out of inventory can be costly. It can result in lost sales, dissatisfied customers, and potentially damage your brand’s reputation. Additionally, rush orders or expedited shipping to restock can significantly increase your expenses. Analyse your sales data and lead times to understand the consequences of not having enough inventory in stock.
In conclusion, finding the right balance for your inventory levels is a delicate but essential task. It involves considering factors like working capital, scarcity, storage costs, lead times, and the costs of stockouts. Working closely with an experienced accounting firm can provide you with the financial insights and data analysis needed to make informed decisions about your inventory management strategy.
Remember, managing your inventory effectively not only keeps your business financially healthy but also ensures your customers are satisfied and your operations run smoothly. Finding the perfect equilibrium in your inventory levels is an ongoing process that can pay dividends in the long run, leading to increased profitability and a stronger market position for your business.
Optimising Inventory: Unravelling the Economic Order Quantity
In the ever-evolving landscape of inventory management, the Economic Order Quantity (EOQ) stands as a fundamental concept. EOQ represents the ideal order quantity that minimises the total cost of inventory, striking the delicate balance between holding costs and ordering costs. It’s a concept that can greatly enhance the efficiency of your inventory management processes and drive financial savings for your business.
In essence, EOQ helps businesses answer the critical question: How much should we order to meet demand while minimising expenses? This question can be especially complex when considering various factors like carrying costs, ordering costs, and demand fluctuations.
EOQ employs mathematical formulas to calculate the sweet spot, where the cost of carrying excess inventory and the cost of frequent ordering intersect at the lowest point. By finding this equilibrium, businesses can optimise their inventory levels, reduce carrying costs, and avoid stockouts, all of which contribute to healthier bottom lines.
Implementing EOQ effectively requires a deep understanding of your unique business dynamics, including product demand patterns, lead times, and carrying costs. In essence, it’s about achieving the delicate harmony between having enough stock to meet customer demands promptly and economically while minimising the burden of holding excess inventory.
In conclusion, Economic Order Quantity is a pivotal concept in inventory management that empowers businesses to streamline their operations, enhance financial health, and deliver superior customer service. By harnessing the power of EOQ, businesses can navigate the complexities of inventory management with precision, ensuring that they neither tie up excessive capital in stock nor incur undue expenses from frequent orders. It’s a strategy that can elevate your business’s efficiency and competitiveness in today’s dynamic economic landscape.
Reorder point
A reorder point is the level of inventory at which a business should place a new order or run the risk that
stock will drop below a comfortable level, or even down to zero.
Reorder point = (daily sales velocity) × (lead time in days) + safety stock
Metrics for Tracking Inventory: A Critical Component
In the pursuit of optimising inventory through EOQ, businesses rely on a set of key metrics to track and manage their inventory effectively. These metrics provide valuable insights into inventory performance and aid in decision-making. Here are some essential metrics to consider:
1. Inventory Turnover Ratio: This metric measures how quickly your inventory is sold and replaced over a specific period. A higher turnover ratio indicates efficient inventory management, while a lower ratio may suggest overstocking.
2. Days Sales of Inventory (DSI): DSI calculates the average number of days it takes to sell your current inventory. It offers a more tangible perspective on inventory turnover and helps identify slow-moving items.
3. Stockout Rate: This metric tracks the frequency and duration of stockouts or instances when demand exceeds available inventory. A high stockout rate can result in lost sales and customer dissatisfaction.
4. Carrying Cost of Inventory: Calculating the carrying cost, which includes expenses like storage, insurance, and depreciation, provides insights into the true cost of holding inventory. Reducing carrying costs is a core objective of optimising EOQ.
5. Ordering Cost: Tracking the costs associated with placing and receiving orders, such as administrative expenses and shipping fees, helps in understanding the financial impact of order frequency.
6. Lead Time: Knowing the average time it takes for an order to be delivered from the moment it’s placed is crucial for determining how much safety stock (extra inventory) should be held to avoid stockouts during lead times.
7. ABC Analysis: Categorising inventory items into groups based on their importance or value can help prioritise management efforts. “A” items are typically the most critical and require close monitoring, while “C” items are of lower significance.
8. Service Level: This metric quantifies the percentage of demand that your business can fulfil from its available inventory. Balancing service levels with inventory costs is central to EOQ optimization.
By diligently tracking these metrics, businesses can fine-tune their inventory management strategies, implement EOQ effectively, and achieve the delicate equilibrium between stock levels and financial efficiency. In doing so, they not only enhance their bottom lines but also bolster their ability to respond to changing market dynamics and customer demands. Successful inventory management, underpinned by robust metrics, is the cornerstone of competitiveness in today’s business world.
The right inventory software can be programmed to perform many of these tasks and reports for you. A review of your tracked inventory can help you clear out dead stock, make space for new stock, free up working capital and devise a plan to manage inventory for cash flow, contingency planning and competitive advantage.