In this article, we explore the question: “How much inventory should I have?” We also share our simple 6-step framework to help you determine the right amount of inventory for your business. Read on to learn more.
How Much Inventory Should I Have?
You should carry enough inventory to meet anticipated customer demand without overstocking and incurring excess holding costs. It's crucial to balance the risk of running out of stock against the cost of holding too much. Using past sales data and forecasting methods can help determine this optimal amount.
Example: "WinterWear Co." observed from past sales data that they sell around 1,000 winter coats each December. To avoid excess holding costs, they stock up on 1,100 coats, accounting for a small buffer. This approach ensures they meet the high December demand without incurring unnecessary expenses from overstocking.
6-Step Framework to Determine How Much Inventory to Carry
Determining how much inventory you should carry is important. Here’s how we do it:
Step 1: Understand Your Sales Cycles
Look at your sales data. When do you sell the most? When do you sell the least? By identifying high and low sales periods, you can better plan your inventory needs.
Example: Peak Shoes observed they sell 300 pairs of sandals in summer and only 50 in winter. This data helps them prepare their summer stock in advance.
Step 2: Set Minimum Stock Levels
Determine a minimum amount of stock to always have on hand. This ensures that even during unexpected demand spikes, you won't run out immediately.
Example: Tech World ensures they always have at least 100 units of their best-selling laptop. This buffer prevents them from running out during unexpected sales spikes.
Step 3: Use the EOQ Formula
The Economic Order Quantity (EOQ) formula can help businesses figure out the ideal order quantity that minimizes costs related to ordering and storing inventory:
EOQ = Square Root of (2 x Annual Demand x Ordering Cost) / Holding Cost per Unit
Annual Demand is how many units you sell in a year.
Ordering Cost is the cost to place one order.
Holding Cost per Unit is the yearly cost to store one unit.
Example: Using the EOQ formula and their costs, Dress & Dazzle calculates that ordering 500 dresses at a time is the most cost-effective approach.
Step 4: Factor in Lead Times
How long does it take for products to be delivered after placing an order with suppliers? By understanding supplier lead times, you can time your orders to ensure continuous stock availability.
Example: Knowing their supplier takes 4 weeks to deliver, Gadget Hub places orders a month in advance, ensuring they always have their popular headphones in stock.
Step 5: Safety Stock
Always maintain a buffer or safety stock to safeguard against unexpected demand or supply chain disruptions. The amount can be determined based on past emergencies or potential risk factors in the supply chain.
Example: Fresh Food Inc. keeps a safety stock of 200 cartons of milk based on past unexpected demands and potential dairy supply chain disruptions.
Step 6: Regularly Review and Adjust
The business environment, customer preferences, and external factors can change. Regularly reviewing and adjusting your inventory levels can ensure you remain adaptive and efficient.
Example: Every quarter, Auto Elite reviews their car accessory sales, adjusting inventory from 1,000 to 1,200 units during racing seasons based on trends and feedback.
Remember, the goal is not just about having enough stock to meet demand but also about managing costs, optimizing storage, and ensuring business continuity.
Let’s consider a hypothetical example. SunnySports Gear, a retailer specializing in outdoor sports equipment, has recently noticed fluctuations in their sales and wants to optimize their inventory to match demand and reduce costs.
They decided to implement our framework:
Step 1. Understanding Sales Cycles
SunnySports reviews their sales data and observes they sell the most hiking boots in spring (around 1,200 pairs) and the least during winter (around 400 pairs).
Step 2. Setting Minimum Stock Levels
Based on sales trends and to ensure availability, they decide to always keep at least 100 pairs of hiking boots in stock as a baseline.
Step 3: Using the EOQ
SunnySports determined the ideal order quantity for their hiking boots. Here's how they calculated it:
Annual Sales (D): SunnySports sells 12,500 pairs of hiking boots each year.
Ordering Cost (S): Every time SunnySports places an order, it incurs a cost of $100.
Holding Cost per Pair (H): The annual cost to store a pair of hiking boots is $10.
Using the EOQ formula:
EOQ = Square Root of (2 x 12,500 pairs x $100) / $10
= 500 pairs
Thus, SunnySports determined that they should only order 500 pairs of hiking boots at a time.
Step 4: Factoring in Lead Times
SunnySports knows their supplier takes three weeks to deliver after an order. Thus, they place orders well in advance, ensuring they never run low on stock, especially before the spring sales surge.
Step 5: Maintaining a Safety Stock
SunnySports knows that unexpected hiking events or local trekking festivals can surge the demand. So, they maintain a safety stock of 50 pairs to meet such unforeseen demands.
Step 6: Regularly Reviewing and Adjusting
After implementing these changes, SunnySports sees a marked improvement in their sales-to-stock ratio. However, they don't rest on their laurels. Every quarter, they review their sales data, adjusting their inventory levels and strategies as needed.
By following this step-by-step process, SunnySports Gear efficiently optimizes their inventory, matching it closely to their customer demands while keeping costs in check.
We hope this article has given you a better understanding of how much inventory you should have and how to determine the right amount for your business.