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How Much Stock Is Enough?

Posted by Dominic Sutton on Jan 29, 2019 12:27:06 PM

A great inventory forecasting method will mean that you always have ‘just enough’ stock on hand to make sure you can meet your customers’ demand, but without needing to invest excess capital in a bloated inventory.

If you follow these steps you should be able to get a pretty smooth inventory forecasting operation going

Step 1: Make sure you know the lead time

It’s very important to assess the lead time correctly. You need to make sure you have enough stock to cover your customer demand from now until when your next shipment of goods from your supplier will be ready to deliver to your customers.

This will vary for each of your suppliers, and possibly also each SKU. So you should set the lead time at either a supplier or a SKU level.

Your supplier should have some SLA’s, but you can also get a good idea from looking at your purchase order history, and assessing the average difference between the order date and arrived date for each supplier, or SKU.

If you only place orders periodically (eg: once per month), you should add on this delay to the supplier lead time.

If there is an internal process you need to follow between when the shipments arrive and when they are ready for your customers (eg: time for unboxing, assembling, or stocking on the shelf) you’ll also need to add this to the lead time.

Step 2: Analyse the trends

Forecast the Lead Demand. Figure how much stock you are likely to need to cover the demand over the lead time.

This will probably be different for each product. Some will be difficult to predict, others simple. By looking at the sales history of each product you’ll be able to see the trends to base your forecasts on.

Is there seasonality? If the product varies month-to-month you should apply a factor to your planning.

Are you doing extra promotional activity? If so, you should increase the amount you order by a factor (usually around 20%, depending on the type of promotion).

Are there new products coming on the market? If so, you might be better off buying these, and less of the older products that they are replacing.

Is the demand flat – does the product sell the same amount every month? No need to do anything complicated here, just order the same as last time.

Step 3: Set the buffer stock (also called safety stock)

In addition to the lead demand, there’s also the buffer stock to consider. Decide on the service level (ie: the probability of not going out of stock) you need, then look at the variability of the demand.

The more variable, or harder to predict, your demand is the higher the buffer stock should be. A higher service level will mean more investment in stock, and a lower one will mean you may be short of stock if there is a sudden spike in demand. The goal is to set your service level to the point where the amount of investment in buffer stock is less than the cost of the occasional stock out.

To decide on the best formula to use, check out the Wikipedia article, or use a good piece of software to automate this for you.  https://en.wikipedia.org/wiki/Safety_stock

Step 4: Consider your Bill of Materials (BOM) if you build/manufacture your finished goods

Once you have calculated the lead demand of your finished goods, you’ll then need to translate this into the orders you need to place for each of the components.

The lead time should be increased to also include the assembly time for the finished goods (call this the Service Time). So the order quantity should be the demand over the service time * the assembly quantity.

Step 5: Calculate your optimal reorder point and order quantities

The optimal reorder point is the Lead Demand + The Buffer Stock

The optimal order quantity is the Reorder Point – The Stock On Hand – The Stock On Order

Step 6: Make sure you automate this with a good software app

As you can see there are a lot of things to consider for a smooth inventory forecasting method. It can be very time consuming to manually decide on your lead demand (having to read through lots of sales reports), and difficult to make the calculations required for every SKU individually.

Some people like to create their own spreadsheets to help, but these can also be awkward. It’s hard to integrate new sales data, or for them to respond to changing trends in the market. Plus, they’re usually created by one person in the business, and get really complex, so no one else can understand them creating a reasonable business risk.

So the best practice is to use a good piece of software like StockTrim, that’s easy to understand, and applies a professional level of standardization to your business.